How to Improve Operational Efficiency and Reduce Costs

Key takeaways

Implementing certain strategies, such as artificial intelligence, to improve operational efficiency can lead to higher profits.

• A recent survey of companies found that 78 percent of respondents use artificial intelligence for at least one task [1].

• Strategies that can improve operational efficiency are automation, energy management, and employee training.

• Advance your ability to improve operational efficiency by learning how to incorporate artificial intelligence into your process.

Discover more about how to improve operational efficiency. If you’re ready to begin developing an artificial intelligence skill set, enroll in IBM’s AI Foundations for Everyone Specialization, where you can learn about workflow management, generative AI, and self-service technologies.

How to define operational efficiency

When your organization performs with operational efficiency, you get the most out of your processes and resources while maximizing production and reducing costs without a loss in quality. Essentially, as operational efficiency increases, your profits do as well. 

Why operational efficiency matters

By utilizing operational efficiency, you can establish a competitive advantage within your industry. If your organization can lower costs and increase output, it can earn more profit, which can be invested in development and continuous improvement. Building efficient operations also impacts scalability because a well-functioning organization acts as a reliable platform for growth. 

Effective operational efficiency can also create a better relationship with customers because, with enhanced processes, customers tend to receive your products and services faster. Other positive results of operational efficiency include improved quality control, enhanced risk management, and a stronger company reputation.

What are the 3 factors of operational efficiency?

The three factors of operational efficiency are cost, time, and quality, which include:

• Cost: Reducing how much it costs to operate

• Time: Optimizing the production timeline and delivering goods faster 

• Quality: Making sure to maintain quality

How to improve operational efficiency

Fortunately, you can implement several strategies, such as automation, employee training, and energy management, to improve operational efficiency in your organization. By adhering to these strategies, you can reduce costs while maintaining or even increasing profits. Discover more about these five methods for improving operational efficiency.

Process mapping

With process mapping, you create a complete layout of all the systems and actions that comprise operations throughout your business. You can then examine the efficiency of each individual process to determine areas for improvement. By implementing process mapping, your organization can increase operational efficiency by identifying bottlenecks in production, tasks susceptible to human error, and processes that consume excessive time.

Introduce automation

When you automate processes previously done manually, workers have additional time to focus on more meaningful tasks. For example, a financial services company might employ robotic process automation (RPA) bots to handle repetitive, administrative tasks such as data entry, account reconciliation, and report generation, allowing employees to focus their time on other, more critical responsibilities. 

Employee training

If your employees undergo successful training, they become more effective workers who can also provide valuable insights on how to improve organizational operations. For example, when a software development company trains its employees on new technologies, its workers not only remain current in terms of the tech landscape but can also devise innovative methods for utilizing these advancements in their current duties. Offering to train your employees can also increase operational efficiency by improving worker satisfaction, which leads to a better rate of employee retention. 

Energy management

Monitoring your organization’s energy consumption is another method for refining operational efficiency. If you manage to optimize how much energy your company uses, you can reduce waste and lower overall costs. For example, you could install energy-saving lightbulbs and encourage your employees to switch off all lights prior to leaving at the end of the day.

Artificial intelligence and machine learning

By including artificial intelligence (AI) and machine learning (ML) in your operations, you can maximize the supply chain process, tailor marketing efforts to specific customers, and use chatbots to enhance customer service. AI also contributes to operational efficiency by providing real-time data analysis, producing valuable insights that support the decision-making process. AI continues to become more common; a recent survey found that 78 percent of participating businesses use AI for at least one work-related task [1].

How to measure and monitor operational efficiency

One common method for measuring operational efficiency is the operational efficiency ratio. For this formula, you add the company’s expenses to the cost of goods sold (COGS) and then divide that number by the net sales—the result is your ratio. You can then multiply that number by 100 to determine the percentage. Take a look at the formula:

(Operational expenses + cost of goods sold)/net sales = ratio

Generally, if your operational efficiency is 50 percent or less, you're doing well. For example, if a refrigerator business named Frozen Company made $14 million in net sales while having $2.5 million in expenses and $7 million in COGS, the formula would be:

($2,500,000 + $7,000,000)/$14,000,000 = .679 or 67.9%

In this scenario, Frozen Company’s operating expenses are 67.9 percent of its net sales, which is significantly above the 50 percent threshold. Frozen Company needs to improve its operational efficiency to bring down that percentage.

Tracking specific key performance indicators (KPIs) can also help you identify areas for improvement in your organization. Depending on your industry, a few of these KPIs could be accounts receivable turnover, overtime hours, order and picking accuracy, inventory carrying costs, and empty warehouse space.

Operational efficiency vs. operational effectiveness

While operational efficiency measures an organization’s ability to reduce the cost of producing a product while maintaining quality, operational effectiveness examines whether the business's functioning aligns with its future plans and goals.

Operational efficiency examples in the real world

By enhancing operational efficiency, you can gain a competitive advantage while also streamlining standard processes. The following companies successfully implemented operational efficiency:

• Carvana: To remove the red tape associated with purchasing a car, Carvana made the process simpler. Customers can select a vehicle online, pick it up at a car vending machine, and then pay for it, eliminating the need to deal with a physical dealership.

• Ford: At a factory in London, Ford uses drones to fly around the manufacturing plant and inspect the vehicles so workers don’t need to spend time doing so by hand. 

• Walmart: The company uses a cross-docking system in which an incoming truck simply transfers its products to an outgoing truck rather than dropping the goods off in the warehouse. This process allows Walmart to respond faster to shifts in demand at its stores.

• Toyota: Implementing a just-in-time (JIT) system for inventory management means the production facility works with suppliers to receive only the parts it needs. This reduces warehouse space requirements and storage expenses.

Common mistakes to avoid for improved efficiency

When improving operations throughout your business, avoiding certain pitfalls, such as overcomplication and lack of research, can save you time and money. Explore these common mistakes more closely:

• Overcomplication: Make sure you focus on streamlining processes rather than complicating them.

• Unclear goals: To measure the success of your changes, you need to establish explicit goals beforehand.

• Lack of communication: Make sure to communicate with your employees about the changes being made to keep them engaged in the process.

• Lack of research: Use data analysis to fully understand how your operations currently function and the root causes of the issues, so you can measure any improvements.

How to use technology to improve operational efficiency

Businesses incorporate technology, including the Internet of Things (IoT) and machine learning, into their processes to enhance operational efficiency. For example, in the manufacturing sector, companies install sensors and increased connectivity solutions to monitor the performance and state of their equipment. Medical manufacturers also use the IoT to determine optimal delivery routes to ensure the devices reach their destinations on time. 

Because ML can learn from experience, you can use it in your organization for predictive maintenance, demand forecasting, and personalized recommendations. Several types of software that can assist with improving operational efficiency are integrated workplace management systems (IWMS), enterprise resource planning (ERP) software, energy management software, and process mapping platforms.

Moving toward operational effectiveness

You can take certain steps to begin improving operational performance. Follow these steps to start making changes in your organization:

1. Assess your existing processes.

2. Establish clear goals.

3. Rank areas for improvement.

4. Formulate a plan.

5. Create KPIs.

6. Implement your plan.

7. Measure outcomes.

8. Revise and improve your plan.

Stay current with trends and job opportunities in business operations

If you’d like to keep up with trends and job opportunities in business operations, join our Career Chat on LinkedIn. You might also find the following free resources helpful:

• Watch on YouTube: How Generative AI is Transforming Business Operations | Real Examples

• Learn related terminology: Data Analysis Terms & Definitions

• Use generative AI: How to Use GenAI in Your Job: Insight from Coursera’s Former CEO

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