How to measure and improve your operational efficiency?

Aiva Strelca 28.04.2022
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Illustration

If you’re a part of the business world, you’ve probably heard the term “operational efficiency” before. It’s pretty self-explanatory – efficient operations have everything to do with how effectively a company functions and uses its resources. 

From a business perspective, being aware of your company’s operational efficiency ratio and tendencies can be a real game-changer for growth. 

So, how do you measure operational efficiency, and what can be done to improve it? Keep reading – we’ve got these and more questions answered. 

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Table of contents:

What is operational efficiency, really? 

A woman learning about operational efficiency

Before we dive into operational efficiency metrics and improvement strategies, let’s clarify what operational efficiency is. 

Generally speaking, operational efficiency looks at how well a company puts its resources to use to deliver its services and products. The fewer resources such as labor hours, money, and inventory are “wasted” while producing goods and services, the more efficient business operations are. 

To clarify, “waste” in this situation is any activity that adds cost but doesn’t create value. There may be two types of “wasteful” activities:

  • Ones that add no direct value but are still essential for the company
  • Activities that don’t add value and are useless for the company

Understandably, any company looking to grow and excel seeks ways to reduce resource and energy waste.

The question is – how to measure operational efficiency?

While there isn’t one foolproof formula to measure a company’s operational efficiency, here is a way to gather the necessary overview. 

Operational efficiency can be measured by comparing the input-to-output ratio of company processes. Common mistake companies make when measuring efficiency is taking into account only the input – for example, costs and human hours required to produce a single unit. But this doesn’t show the whole picture. 

Instead, you should consider various performance indicators from the resource input and output perspective. 

While the indicators can differ between industries, generally, they are:

  1. Input
  • Operational expenditure – ongoing costs of running a business, system, or a product
  • Capital expenditure – money a company spends to buy, maintain or improve its fixed assets, such as buildings, vehicles, equipment, or land
  • Human resources used – headcount, including partners, hours worked
  1. Output
  • Revenue
  • Customer numbers
  • Product or service quality
  • Business growth
  • Customer satisfaction

Understandably, any company is interested in having the generated output exceed the production input. Plus, the lower the input vs. output ratio, the more efficiently a company generates its revenue (with the condition that product or service quality remains high). 

Moving further with the metrics, you can use a formula to determine the operational efficiency ratio:

(Operating expenses + Cost of goods sold) ÷ Net sales = Operational efficiency ratio

  • Operating expenses (OPEX) generally include such things as sales and administrative costs, salaries and wages, office supplies, system and machine maintenance, and more
  • Cost of goods sold (COGS) includes direct labor costs, direct material costs, equipment maintenance and repair costs, production facilities rent, and production staff salaries
  • Net sales are calculated: Gross sales minus returns, allowances, and discounts

Let’s put some numbers into this formula to understand how it works.

Company Z has reported total net sales of $300,000, total COGS of $180,000, and OPEX of $50,000 over X months. So, its operational efficiency ratio for the period is calculated as follows: 

(180,000 + 50,000) ÷ 300,000 = 0.76

Company’s Z operational efficiency ratio is 0.76 or 76%, meaning that its operating costs make up 76% of its net sales. In other words – 76 cents of every dollar company Z makes are the costs of generating the income. 

How to improve operational efficiency?

Two colleagues discussing

If you’ve gathered operational efficiency metrics for your company and they don’t look as good as you wish they were, you may want to explore ways to improve operational efficiency.

Where does one begin? 

By thoroughly reviewing and spring-cleaning the day-to-day processes and operations in your company. We know it’s a lot, but going through how your company organizes its work is crucial to improving the ratio. Plus, it’s often through optimizing the small processes that companies find more effective ways to function.

Here are some tactics to increase operational efficiency at your company: 

Automate, automation, automated

Automation

Regardless of whether you represent a software company or operate in manufacturing, there are administrative duties requiring your time and energy. We’re not saying that you must ditch all the administrative work. Without it, a company cannot function. However, there is a way to spend less time and energy on mundane tasks – automation.

Today nearly every repetitive task within the business world can be automated. There is a great variety of tools and software available, and with a little digging, you’re certain to find a perfect match for your needs. 

Begin with such simple things as automated invoicing, payroll, e-mail and push notifications, and see how it saves everyone’s time and energy.

Getting rid of bottlenecks

Another potential hurdle messing up operational efficiency at your company is process bottlenecks. It’s a stage of work that receives more requests than it can process when operating at a maximum capacity, resulting in delays and costing your company more money than estimated. 

The first step in getting rid of bottlenecks is identifying them, and, honestly, it’s the trickiest part. 

But if you notice a certain level of unpredictability within the company’s workflow, it’s the first sign that you may have a workflow bottleneck somewhere. It can be inefficient collaboration, lack of the right tools, or poor workforce management. To identify where the congestion is, you can use several techniques, for example, the 5 whys method, process mapping, and more. 

The importance of healthy company culture

Reviewing and changing company culture is another way to improve operational efficiency.

Overworked employees cannot deliver their best performance, no matter how hard they try. And it’s understandable – people have energy limits, both physically and mentally.

Data says that burned-out employees cost $3,400 out of every $10,000 in salary due to lack of engagement. Plus, the cost of employee turnover is even higher – from 50% to 200% of an employee’s salary. 

What you can do in this situation is reevaluate your company culture:

  • Do you support employee wellbeing? 
  • Do your employees receive enough time to rest and take paid leaves? 
  • Does the management encourage workers to keep a healthy work-life balance overall? 

Healthy company culture has everything to do with organizational efficiency. 

Invest in employee training

Improving operational efficiency through employee training

In a fast-paced world like ours, best practices evolve rapidly, and your employees may not always have access to the most effective work methods. And that, in turn, can negatively impact the efficiency of operations.

As a manager, your job is to provide workers with access to regular training and ensure they’re up to date on using the systems in place at your company. 

Mentoring and coaching programs are also a good investment in employee effectiveness and productivity, especially for entry-level positions. Newcomers may be highly enthusiastic but lack the necessary knowledge. Thus, supporting and guiding them is a great way to boost their work performance.

Set the KPIs right

When you’re aiming to make operations at your company more efficient, being able to track performance is crucial. And vague targets make the evaluation process more difficult. So, the solution is setting strategic KPIs (key performance indicators) for each area within your business.

A helpful approach to setting KPIs is the SMART method. According to it, a KPI must be:

SpecificClearly states what the KPI will measure and why it’s needed
MeasurableThe KPI can be measured and evaluated
AchievableThe KPI is realistic to achieve
RelevantThe KPI measures something that matters in your company’s performance
Time-boundThe KPI has a set time frame, and success is realistic

Parting remarks

While measuring the operational efficiency at your company and analyzing the results takes time and energy, it’s a necessary task for any growing business. Improving operational efficiency, however, isn’t just about cutting costs. It’s about reviewing how the work at the company is generally done and exploring the company’s culture, organizational structure, and policies along the way. 

Additionally, the impacts of more efficient operations at a company extend beyond just money-saving. Employee performance also benefits from a more organized work environment – they are likely to become more productive and engaged, delivering better results. 

From a management perspective, running a company that doesn’t constantly require fighting fires, but operates smoothly instead, allows focusing on business growth and implementing innovative strategies. 

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