In a business context, operational efficiency can be defined as the ratio
between the input to run a business operation and the output gained from the
business. When improving operational efficiency, the output to input ratio
improves. Inputs would typically be money, people
or time/effort. Outputs would typically be money, new customers, customer
loyalty, market differentiation, headcount productivity, innovation,
quality, speed & agility, complexity or opportunities.
The terms "operational efficiency", "efficiency" and "productivity" are
often used interchangeably. An explanation to the difference between
efficiency and productivity is found in "An Introduction to Efficiency and
Productivity Analysis". To complicate, "operational excellence" which is about
continuous improvement - not limited to efficiency - is occasionally used when
meaning operational efficiency. From time to time "operating efficiency" is
also used with the same meaning as "operational efficiency".
Measuring operational efficiency In order to improve operational
efficiency one has to start by measuring it. Since operational efficiency is
about the output to input ratio, it should be measured both on the input and
the output side. Quite often, company management is measuring primarily on the
input side, e.g. the unit production cost or the man hours required to
produce one unit. Even though important, input indicators like the unit
production cost should not be seen as sole indicators of operational
efficiency. When measuring operational efficiency, a company should define,
measure and track a number of performance indicators on both the input
and output side. The exact definition of these performance indicators will vary
from industry to industry, but typically these categories are covered:
Input: Operational expenditure, capital expenditure, headcount
Output: Revenue, customer numbers/distribution between segments,
quality, growth, customer satisfaction Comparing operational efficiency
If the intention is to compare numbers with others through benchmarking it is
important to define, measure and track performance indicators for load and
complexity as well. Even within the same industry, customer behaviour might e.g.
be significantly different between two markets leading to one company having to
assign more resources and cost to handling of customers. Not measuring
such load and complexity factors might lead to incorrect conclusions on
operational efficiency. When interpreting the quantitative
results of the benchmarking, it is important to consider the strategic
differentiation: "Cost is generated by performing
activities, and cost advantage arises from performing particular activities
more efficiently than competitors. Similarly, differentiation arises from
both the choice of activities and how they are performed."
When qualitatively interpreting the quantitative results of the
benchmarking, one has to take the company strategy into consideration - as
well as the individual strategies of the other members of the peer group. If not
done, quantitative results that are a consequence of strategy, not of
inefficiency, can't be eliminated. One company might have a strategy to
differentiate with low price. For that company, it is critical to have low unit
production costs and high efficiency in distribution. For another company,
differentiating with premium quality, the unit production cost is not that
critical. Instead, it will be critical to have satisfied and loyal customers
and a high absolute revenue per customer. Actual quality levels will
also be key to understand. Improving operational efficiency
When improving operational efficiency, companies have a few alternatives. The
most common are: Same for less, i.e. same output for less
input More for same, i.e. more output for same
input Much more for more, i.e. much more
output for more input It is a common misconception that costs,
in absolute terms, are always cut when improving operational efficiency. It is
true for the "same for less" alternative, but not for the two other
alternatives. It can be operationally efficient to increase cost - as long as
the output is increasing more. One example of a same for less
alternative is when a manufacturing company reduces its total personnel
while still producing the same volume of goods. This can e.g. be achieved through
centralization, automation or optimization of working processes.
An example of a more for same alternative is a manufacturing company
reducing its output of faulty products without using more money or resources.
This can e.g. be achieved through use of quality management systems, addressing
quality in existing training programs for personnel or introduction of higher
quality requirements when prolonging subcontractor agreements.
An example of a much more for more alternative is when a manufacturing
company invests in a new production plant which will enable them to produce
products with a higher level of refinement than what could be produced
in the old production plants. These products can be sold with a premium that
more than compensates for the additional cost. Another example of "much more for
more" is when a service company invests in expanding its customer service in
order to increase customer satisfaction and customer loyalty.
References