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What is Operational Efficiency?:
Beginners Guide

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Operational efficiency is the relationship between an organization’s output and input, that when healthy, helps businesses cut down on unnecessary costs while increasing revenue. It’s what businesses strive to do: produce a high-quality product at scale with as few resources as possible.

To decrease extraneous costs, the operations manager must be able to identify which processes in place are not needed. To do this, they need to be able to identify a baseline of operations.

Choose where to start:

Productivity vs. Efficiency: Knowing the Difference

“Productivity” and “efficiency” are often used interchangeably, but they’re actually very different. Michael Mankins at the Harvard Business Review explains the difference simply: operational efficiency is about doing the same with less and productivity is about doing more with the same.

Improving productivity requires investing current resources to improve their performance, so because different companies have different focuses, there’s not a “one size fits all” approach. For a staffing company, improving productivity would mean bettering the performance of recruiters. For a manufacturing company, this would mean increasing the output of machines. For a brick-and-mortar, this would mean upping sales per square foot of the store.

When trying to improve productivity, operational efficiency managers need to find a way to take the resources they have and improve their performance, which may mean incurring additional costs in training or repairs. In this case, the cost is justified because the output is increased.

Operational efficiency is more concerned about producing at the same level with fewer resources, so if we revisit our manufacturing company example, this would mean the company wants to keep the same number of machines but have them produce more product.

What to Improve First: Efficiency or Productivity?

employee working in an unorganized environment in need of operational efficiency

We all know putting the cart before the horse just doesn’t work. Efficiency and productivity work in the same way. If your goal is to improve the overall performance of your organization, you’ll want to improve both, but it’s important to improve efficiency first. Doing so will decrease the level of wasted effort and resources on the part of the company. Once efficiency has been optimized, the organization can take steps to improve productivity.

With this strategy, efforts to increase productivity will be more fruitful because these efforts are built upon a baseline of operations that’s highly efficient.

How to Create a Baseline of Operations

A baseline of operations within an organization describes the functions in place that makes the organization run. You can do this by talking to major stakeholders within the organization and asking how each department works together to help the company reach its goals. In larger entities, each department may work more autonomously. In smaller organizations, roles and functions can crossover.
Questions to ask include:

  • What is the purpose of your department within the company?
  • How does this department help the company realize its vision?
  • What are the major responsibilities of this department?
  • What are the steps taken to carry out these responsibilities?

The goal is to be able to understand the major functions each department performs to carry out its duties.

How to Measure and Improve Operational Efficiency

Team trying to measure and improve operational efficiency

Operational efficiency is calculated by dividing output (revenue, sales, cold calls, inbound leads, etc) by input (resources, man-hours, licenses, etc). As explained by Mankins in the Harvard Business Review, efficiency is a matter of producing the same output with less input.

In order to calculate efficiency, decision-makers need to determine which output and input variables are most appropriate for their organization. These variables are determined by their key performance indicators; the quantifiable metrics that reflect the health of an organization (dictionary). These can shed light on the overall direction of an organization by providing unbiased data about performance.

  • Step 1: Record your performance and compare it against industry standards. This will give the organization a reference point to measure improvements.
  • Step 2: Review the baseline of operations and identify the functions and goals within each department.
  • Step 3: Understand the key players involved when it comes to executing those functions and goals.
  • Step 4: Then review how much time it takes to achieve those goals and the quality of work done every step of the way.
  • Step 5: Within each step, identify bottlenecks that make that process slower. Bottlenecks are any functions or steps that are unnecessary for completing the task at hand. For example, waiting a couple of days for another approval when two approvals are sufficient would be a bottleneck.
  • Step 6: Remove those bottlenecks. One strategy to eliminate waste is the 5S method: Sort, Shine, Straighten, Standardize and Sustain. The leadership team needs to collaborate with other employees to ensure the right steps are taken.
  • Step 7: Measure the performance and compare to the previous baseline of operations to track improvements. Make sure that the quality of work done along the way is not impaired.
  • Step 8: Track performance by creating reports or a dashboard. Convene with your team at regular intervals to discuss performance and areas of improvement.

Note to the COO:

There is much more to efficiency than simply cutting costs. It takes more strategy and forethought. A study done by PwC UK showed that two-thirds of UK businesses planned to cut costs over a 12-month period, but less than 30 percent of those organizations were able to reach their operational efficiency goals and only about a fifth of them could sustain the benefits of cutting costs over a period of three years.

In Summary

Improving operational efficiency within an organization requires identifying areas of waste and improvement to increase efficiency. Then management can focus on making the most of those resources to increase productivity.

Operational efficiency is much more than just cutting costs; it requires strategy and forethought to understand how an organization operates. These strategies create a win-win: optimal output for the company and an exemplary product for the customer.

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