What Is Operational Efficiency? A Definition and Guide

Operational efficiency is a hot topic. As of early 2024, U.S. earnings calls mentioned “operational efficiency” more than ever before, according to Morgan Stanley, and for good reason: Efficient businesses are leaner, more agile and more profitable than their less efficient counterparts. But eliminating waste and focusing on high-quality outputs is important for any business, of any size, in any industry. Here’s a close look at what operational efficiency looks like in practice, its benefits and how to get started.

What Is Operational Efficiency?

Operational efficiency is about doing more with less, maximizing outputs (like products or services) while minimizing inputs (such as costs, time or resources), creating the most value possible without sacrificing quality. Operational efficiency helps a company work smarter, not harder, to deliver its goods or services in the most cost-effective way.

Productivity vs. Efficiency

Productivity and efficiency are related but distinct concepts. Productivity measures how much a company produces, focusing on output quantity. Efficiency looks at how well a company uses its resources. In simple terms, productivity is “how much we make” and efficiency is “how resourcefully we make it.”

While improved efficiency often leads to higher productivity, a company can be efficient without being highly productive, particularly if it’s using resources well but not producing much. This could happen in small-scale operations that focus on producing a limited number of high-quality goods. On the flip side, a company can be productive without being efficient if it’s producing a lot but wasting resources. A busy restaurant might serve many customers during peak hours (high productivity) but waste food or energy due to rushed preparation.

Key Takeaways

• Operational efficiency aims to maximize output while minimizing input.
• The goals of operational efficiency include cost minimization, productivity maximization and quality enhancement.
• The benefits of operational efficiency span across various aspects of an organization, from higher profitability and employee satisfaction to competitive advantage.
• Operational efficiency can be measured by tracking KPIs — among them, cost per unit and cycle time — and calculating the operational efficiency ratio.
• Implementing automation and better employee training are just a few strategies that can boost operational efficiency.

Operational Efficiency Explained

Operational efficiency refers to a business’s ability to improve its performance in several areas. Efficient operations aim to enhance:

• Resourceutilization, by making the most of available labor, equipment and materials.
• Production, by increasing output while reducing waste.
• Inventorymanagement, by striving to maintain appropriate stock levels to meet demand without tying up excess capital.
• Distribution,by developing ways to deliver products or services to customers as quickly as possible.

Measuring operational efficiency is important for identifying areas of improvement, tracking progress and strengthening performance. Go-to key performance indicators (KPIs) include productivity rates, cycle times, capacity utilization, inventory turnover and cost per unit. That said, operational efficiency benchmarks and best practices can differ significantly across business functions as well as industries, so businesses need to consider their particular context when setting goals and implementing strategies.

It’s also important to keep in mind that resistance to change, lack of collaboration, inadequate training, misalignment with business strategies and other types of challenges can make it hard for businesses to achieve the level of operational efficiency they strive for. Technology like automation, artificial intelligence (AI) and data analytics tools are increasingly being used to overcome these barriers, support operational efficiency and, in turn, boost profitability and long-term success.

Why Is Operational Efficiency Important?

Operational efficiency provides businesses with a strategic advantage in competitive markets. For example, companies that effectively use resources and reduce waste can lower their costs and improve profitability. More capital leaves more room to invest in innovation and development, both of which can directly inspire agility, facilitate expansion, support business growth and contribute to long-term sustainability. Further, efficient processes typically lead to better quality control and more consistent outputs, which can boost a company’s reputation and strengthen relationships with customers and even investors. Better monitoring and control systems can also improve risk management by making it possible to detect issues before they escalate, ensuring not only quality control but compliance with regulations, industry standards and internal benchmarks.

Tangible benefits aside, operational efficiency can also drive cultural change across an organization. Establishing efficient operations typically involves refining various aspects of the business, from inventory management to production processes. This pursuit of improvement helps foster a culture of continuous improvement and innovation. By encouraging data-driven decision-making, team members at all levels may feel more engaged and empowered, naturally aligning the organization toward delivering greater value to customers.

Goals of Operational Efficiency

The main idea behind operational efficiency is to create the most value possible using the least amount of resources without sacrificing quality. To achieve this overarching objective, businesses should focus on several key goals:

• Cost minimization: Reducing operational expenses while maintaining quality and productivity involves a comprehensive examination of all business costs, from production to overhead. The process requires critical evaluation of every aspect of operations to uncover ways to make refinements and cultivate a cost-conscious company culture.
• Maximize productivity: Optimizing resource usage and output across the organization means getting the most out of available time, labor and technology. Smart work — not hard work — is emphasized via productivity-boosting strategies, such as investing in employee skills and training, as well as using AI and automation where appropriate.
• Enhance quality: True efficiency is about delivering consistent, high-quality outputs. This goal stresses the importance of reliability and excellence in products or services; it involves focusing on consistency across all operational processes, from production to delivery, to make sure quality is sustained at every stage.
• Streamline processes: By simplifying workflows, reducing complexity and eliminating bottlenecks, companies can create smoother, more efficient pathways for work to be completed. Best practices can include identifying and eliminating redundant steps, implementing lean management principles, adopting agile methodologies and encouraging cross-functional collaboration.
• Reduce waste: Minimizing resource wastage and inefficiencies across all aspects of operations requires identifying and eliminating elements that don’t add value, whether in the form of excess materials, unnecessary process steps or underutilized assets. This goal aims to create a leaner, more efficient organization by improving resource use and scaling back — or doing away with — activities that don’t add value.
• Improve customer satisfaction: Delivering better services faster can enhance the overall customer experience. The intent is to reduce wait times, increase responsiveness and guarantee consistent quality across all customer interactions. Internal processes must be aligned with customer needs, from initial contact through post-purchase support, to create a seamless, positive and efficient customer journey.
• Boost profitability: Greater efficiency — especially when costs are reduced while quality is maintained or improved — ideally yields greater profits. In other words, it’s not just about cost-cutting but also employing strategic investments in efficiency that can drive long-term profitability and growth. This might include implementing quality control systems, investing in employee skill development or redesigning processes.
• Prioritize sustainability: By promoting eco-friendly practices and resource conservation to improve the long-term environmental and social impact of operations, companies recognize that true operational efficiency must be sustainable over time. Consider the broader consequences of business practices to balance economic factors with environmental preservation and social responsibility.

Benefits of Operational Efficiency

Cost reduction is often seen as the primary motivation for improving operational efficiency, but it’s just one of many benefits that contribute to a business’s long-term success. From increased productivity and faster response times to greater employee satisfaction and sustainability, running an efficient business leads to a wide range of advantages that can improve performance and competitiveness.

• Cost reduction: Efficient operations minimize waste and reduce operational expenses. This does more than improve the bottom line; cost reduction through efficiency creates financial flexibility and resilience. With more cash on hand, organizations are better able to weather economic downturns, invest in growth opportunities or gain a competitive advantage by passing savings onto customers.
• Increased productivity: Optimized resource use and streamlined workflows result in higher output with the same or fewer resources. Projects can therefore be completed faster, deliveries can be made sooner, employees may feel more accomplished and companies gain the breathing room needed to handle increased demand.
• Improved quality: Efficiency begets consistency and quality. By reducing defects and production errors, companies can get more done faster with less need for rework and less resource waste. Delivering consistently high-quality products to customers leads to fewer returns and warranty claims, which improves brand reputation and trust. Superior quality can also justify premium pricing, potentially boosting profitability.
• Faster response times: Efficient operations make it easier for organizations to quickly adapt to market shifts and changing customer demands. Streamlined processes with fewer inefficiencies, for instance, leave companies with more time to quickly respond to customer needs and bring products or services to market more quickly. With more time to devote to higher value activities — such as strategic planning — companies can cultivate resilience to external pressures, from supply chain disruptions to competitive threats.
• Higher profitability: Operational efficiency boosts profit margins by lowering costs and improving output. Higher profit margins provide companies with the financial flexibility to invest in growth opportunities, expand into new markets and weather economic downturns. In other words, profitability driven by efficiency creates a virtuous cycle: Resulting financial gains can be reinvested into further efficiency improvements to support continuous growth and success.
• Employee satisfaction: Less workload friction is a key benefit of operational efficiency. The more fluid an employee’s job, the fewer time-consuming headaches they need to deal with on a day-to-day basis. This improves job satisfaction, lowers turnover rates and increases productivity. In fact, a University of Oxford research study found that workers are 13% more productive when happy. At the same time, working for a well-run organization can boost morale and engagement, which can promote collaboration, attract top talent and even reduce absenteeism. The more satisfied and engaged a workforce, the better its performance — contributing to the overall success of the organization.
• Sustainability: Operational efficiency goes hand in hand with environmentally friendly practices. By reducing waste, conserving resources and saving energy, companies can shrink their carbon footprints and lessen their environmental impacts. This helps businesses comply with environmental regulations, while positioning them as socially responsible organizations — a significant competitive advantage in an increasingly eco-conscious market. Cost savings achieved through energy efficiency and waste reduction can also be reinvested into further green initiatives, supporting a self-sustaining cycle of environmental and economic benefits.
• Competitive advantage: Efficient organizations are in a much better position to strengthen market position than inefficient ones. Streamlined processes and less waste leave more room to offer competitive prices without sacrificing quality, helping to attract new customers and keep existing ones coming back for more. High-quality products and services earn a reputation for reliability, positioning a company as a trustworthy partner and resource. Efficient companies also make it a point to constantly improve and innovate, helping them stay ahead of the curve.

Measuring Operational Efficiency

Operational efficiency efforts need to be measured. It’s the only way to identify areas for improvement and track progress toward goals. Clear metrics and KPIs provide valuable insights into operations to support the data-driven decisions companies need to achieve tangible results. That said, effective measurement involves selecting the right metrics — as well as implementing robust data collection and analysis processes, while regularly benchmarking performance against industry standards and best practices.

To measure operational efficiency, businesses typically focus on a range of metrics across different categories, such as financial, productivity, quality and time-based indicators. Together, these metrics offer a comprehensive view of organizational efficiency, helping to pinpoint opportunities for improvement. Common metrics include:

• Cost per unit: The total cost of producing one unit of output, including direct materials, labor and overhead expenses.
• Cycle time: The total time it takes to complete a specific process or task, from start to finish.
• Defect rate: The percentage of defective products or errors in a process, indicating the level of quality control.
• Resource utilization: The extent to which available resources, such as equipment, labor or materials, are being used effectively.

Calculating Operational Efficiency

Efficiency can be measured in a number of ways, but actually calculating operational efficiency involves quantifying the relationship between the inputs consumed and the outputs generated by a business. This approach helps organizations objectively assess their efficiency levels. It’s also a useful way to compare performance against benchmarks or industry standards. One of the most commonly used metrics for calculating operational efficiency is the operational efficiency ratio (OER).

• Operational efficiency ratio: This financial metric compares a company’s operating expenses to its net sales, providing insight into how efficiently the business is managing its costs relative to its revenue generation. Here is the formula:

Operational efficiency ratio = Operating expenses / Total revenue

The lower the ratio, the more efficiently a company is managing its operating costs relative to its revenue. In other words, it spends less to generate each dollar of sales. However, the ratio should be interpreted in the context of industry norms, company size, business strategy, economic conditions and the company’s historical performance. For example, an extremely low ratio could indicate significant underinvestment in areas like research and development or marketing, which could stifle long-term growth.

How to Increase Operational Efficiency

Businesses often assume their processes are straightforward. In reality, they often contain hidden complexities and inefficiencies that hurt productivity and profitability. Improving operational efficiency involves identifying and eliminating these invisible bottlenecks to simplify workflows and maximize the value of every useful resource, from time and labor to equipment and inventory. Here are eight ways to get started.

1. Automate processes: Technology solutions can significantly contribute to operational efficiency, but their effectiveness depends on proper implementation and integration with existing processes. Recent data suggests that CEOs perceive roughly 40% of time spent on routine activities as inefficient, representing a potential $10 trillion in lost productivity. To address this, tools like robotic process automation (RPA) are being employed to handle routine, repetitive manual operations, while AI (including generative AI) and machine learning can simplify complex decision-making and forecasting. Meanwhile, software, such as enterprise resource planning (ERP) systems, integrate automated systems across departments to further streamline operations.
2. Streamline workflows: There are many ways to simplify workflows. Process mapping is often the first step. This analysis often reveals unnecessary steps, inefficiencies and bottlenecks that, when eliminated, can save time and resources. These maps can identify areas where lean management principles, such as reducing waste and promoting continuous improvement, should be used, as well as whether project management tools can be used to better allocate tasks and monitor progress. Regularly reviewing and adjusting processes accordingly is important for organizations to adapt to changing business needs and maintain efficiency gains over time.
3. Eliminate waste: Beyond process mapping, tackling the elimination of waste generally starts by auditing operations to identify and reduce unnecessary resources and activities. Audits can reveal opportunities to cut down on wasted time, materials and effort. For example, if a company sees it’s wasting space and holding costs on extra inventory, it might decide to implement just-in-time (JIT) inventory management. However, waste reduction efforts go beyond production processes. Waste audits can also identify underutilized areas in a facility, as well as areas to implement energy-saving practices, like switching to LED lighting with motion centers, using energy-efficient HVAC systems or improving insulation.
4. Enhance employee training: Just 44% of American workers said they are extremely or very satisfied with the training and skill-building opportunities provided by their workplace. Yet well-trained staff work faster, make fewer mistakes and can more readily adapt to new processes. Targeted training programs that address skill gaps can empower employees with the knowledge and abilities needed to perform their roles well. Cross-training can be used to build more flexible workforces, preventing disruptions when key employees are unavailable. Mentoring, coaching and e-learning platforms can be used to provide ongoing skill development. It is worth noting that tracking the impact of these initiatives can confirm they remained effective and aligned with efficiency goals.
5. Use data analytics: Continuous improvement is a key approach to achieving operational efficiency. Monitoring and analyzing performance is an all-but-guaranteed way to spot where improvements are needed. When data analytics are applied, companies can get a more informed sense of how to act accordingly. Predictive analytics and real-time dashboards, for instance, can provide early visibility into potential issues, allowing decision-makers to be less reactive and more proactive. Big data analysis can uncover patterns in operational performance trends, as well as identify opportunities for process optimization, cost reduction and innovation that can inform strategic decision-making and drive long-term efficiency.
6. Leverage outsourcing: Delegating noncore tasks to external experts allows organizations to focus on their own core competencies and improve overall efficiency. By outsourcing functions like IT support, payroll or logistics to specialized third-party providers, internal resources can be directed to higher-value activities, such as product development or customer engagement. Be sure to conduct a thorough cost-benefit analysis to make sure outsourcing decisions are financially viable, and aim to establish strong partnerships via effective communication channels. Regularly review and optimize these arrangements to be sure they align with business goals.
7. Optimize resource allocation: Operational efficiency hinges on a company’s ability to allocate labor, equipment and materials to the places where they deliver the most value. AI-driven demand forecasts can help predict aspects like staffing needs and inventory requirements so that resources can be directed for maximum impact. Activity-based costing can be used to help clarify the true costs of each process or product to guide smarter allocation decisions. Some industries, like manufacturing and healthcare, may find value in resource management software that provides visibility into resource utilization to identify areas of over- or underutilization in real time.
8. Improve communication: Clear, efficient communication is a must for any business — especially with more people working from home, at least some of the time. Collaborative tools, such as project management software and instant messaging apps, can encourage seamless information exchange among departments so that everyone stays connected. Clear communication protocols can make sure information reaches the right people at the right time. Regular team meetings and updates should be scheduled and posted to keep everyone on the same page. Visual management tools, like dashboards and Kanban boards, can be used to make progress and potential bottlenecks transparent to all stakeholders so that issues can, ideally, be resolved quickly.

Operational Efficiency and Benchmarking

Benchmarking helps companies gauge their performance to uncover insights that encourage meaningful improvements. Here are a few types of benchmarking that organizations can use to evaluate their operational efficiency:

• Internal benchmarking, which compares performance across different departments, locations or time periods within the same organization. For example, a company might compare order fulfillment cycle times across its various distribution centers.
• External benchmarking, which compares an organization’s performance against that of similar companies in the same industry. A retail company might compare its customer satisfaction scores, such as Net Promoter Score (NPS), against the industry average.
• Competitive benchmarking, which focuses on comparing a company’s performance against direct competitors. A regional bank might compare its average customer wait time for teller services against those of other local banks to identify ways to improve customer service efficiency.
• Functional benchmarking, which compares specific processes or functions across different industries to identify best practices that can be adapted to the organization’s context. A manufacturing company might compare its employee turnover rate with best-in-class companies known for excellent human resource management, even if those companies are in different industries.

The benchmarking process involves two main steps. First, identify the processes to be benchmarked and select appropriate operational metrics or KPIs. This internal data will be used to identify strengths and weaknesses relative to external peers and/or industry leaders. Then, use that data to set realistic efficiency targets, develop action plans to close performance gaps and implement best practices.

The real value of benchmarking doesn’t come from analysis; it comes from using insights to inform strategic plans to boost efficiency and create a roadmap for continuous improvement.

Operational Efficiency Examples

Let’s take a look at two examples of how organizations might apply principles of operational efficiency.

Say a car parts manufacturer is experiencing production delays due to machinery breakdowns that lead to downtime and productivity loss. To address this, the plant decides to invest in predictive maintenance technology powered by Internet-connected sensors that monitor equipment for wear and tear to anticipate when breakdowns are likely to occur. This allows maintenance to be scheduled proactively during off-hours, leading to fewer unplanned breakdowns, less downtime, continuous production flow and fewer resources wasted on emergency repairs. Despite the upfront investment, the company is rewarded with a more efficient operation that makes better use of the resources available.

Consider another scenario: A hospital, after benchmarking its performance against industry standards, discovers its average patient discharge time is 30% longer than the top-performing hospitals in its region. To boost efficiency, the hospital integrates an AI-driven system that analyzes patient data to predict discharge times more accurately, allowing staff to prep for the next patient in advance. By streamlining admissions and discharge processes, the hospital reduces patient wait times by 25% and cleans and preps rooms 40% faster. This leads to 15% more patients being served per day, a 20% increase in patient satisfaction scores and a 10% reduction in operational costs, thanks to quicker patient turnover and better resource management.

Improve Your Operational Efficiencies With Data at Your Fingertips

Data-driven decision-making is a cornerstone of modern business operations — especially when it comes to improving efficiency. NetSuite’s ERP system integrates key business functions — financials, inventory management, order management, human resources and more — into a single, cloud-based platform. This gives businesses a holistic view of operations, which helps them identify areas for improvement and support decisions that improve resource usage, cut costs, engage better with customers and quickly respond to market changes.

With NetSuite ERP’s real-time reporting and analytics capabilities, companies can monitor KPIs and metrics through customizable dashboards and reports. This instant visibility allows them to quickly identify inefficiencies and take corrective action to optimize processes. Meanwhile, advanced forecasting and planning tools help anticipate demand and support efficient asset usage.

NetSuite ERP also offers features designed to streamline and automate key business processes, such as automated invoice processing, approval workflows, intelligent inventory management and demand planning. By eliminating these manual, time-consuming tasks, businesses can focus on the higher-value activities needed to further support efficiency and growth initiatives.

Operational efficiency may seem like a buzzword, but any company that brushes off opportunities to improve its processes, cut waste and maximize resource utilization is missing out on potential growth and long-term sustainability. From cost savings and increased productivity to improved customer satisfaction and employee morale, the advantages of operational efficiency are far-reaching and transformative. But success requires continuous monitoring, measurement and improvement, which can be attained more easily through data analytics and tech solutions that support informed decision-making and proactive strategic plans.

Operational Efficiency FAQs

What affects operating efficiency?

Operating efficiency is affected by various factors, including resource utilization, process design, technology adoption, employee skills and engagement, supply chain management and organizational culture. Inefficiencies in any of these areas can lead to higher costs and lower output quality.

What are the three factors of operational efficiency?

Three key factors of operational efficiency are:

• Cost: Minimizing operational expenses.
• Time: Reducing cycle times and improving delivery speed.
• Quality: Ensuring consistent, high-quality output that meets customer expectations.

What is an example of operational effectiveness?

Let’s say a manufacturing company implements lean production techniques to reduce waste, improve process flow and increase productivity. By continuously identifying and eliminating nonvalue-added activities, the company can reduce costs, improve product quality and deliver products to customers more quickly, thereby enhancing its overall operational effectiveness.