What it means
Two meanings of the term are in common use. The operational meaning compares actual output with a standard, such as the number of units that a team should make in an hour, and gives a percentage.
The economic meaning is broader and applies to whole industries and countries as well as single factories. A business or economy is productively efficient when it makes goods at the lowest possible cost per unit, so that no resources are wasted and nothing can be produced more cheaply without lowering output.
Managers measure efficiency to find waste. If a line is running at 80% of its standard, the missing 20% might be caused by breakdowns, waiting for materials, errors or slow changeovers between products, and each cause needs a different fix.
Efficiency is not the same as effectiveness. A factory can be highly efficient at making products that nobody wants, so efficiency must be considered alongside quality, delivery performance and demand.
There are also trade-offs. Pushing efficiency too hard by running machines flat out can increase breakdowns, quality defects and staff turnover, which raise cost in the longer term.
For finance teams, efficiency links directly to cost variances. A shortfall in efficiency means more labour or machine hours were used than planned, which produces an unfavourable efficiency variance in standard costing.
In practice
Real-world examples.
Example
A bakery expects its oven line to produce 1,200 loaves in a shift but achieves 1,080. Its efficiency is 1,080 / 1,200 = 90%. The manager looks at the logs and finds that the line waited 40 minutes for flour deliveries. She agrees a delivery schedule with the supplier and the next month's efficiency rises to 95%.
Example
A call centre sets a standard of 12 resolved calls per agent per hour. A team averages 10 calls per hour, which is an efficiency of 83%. The centre introduces better scripts and sees the figure rise. Management also checks that customer satisfaction has not fallen as calls get shorter.
Example
An economist studies two steel plants making the same product. One produces a tonne at $600 and the other at $680. The first plant is more productively efficient, because it uses fewer resources for the same output. The difference of $80 a tonne is a major advantage when selling at the same market price.
Formula
Calculation
Production efficiency (%) = actual output / standard output x 100
Suppose a packing line has a standard rate of 100 units an hour, and it runs for an 8-hour shift. Standard output = 100 x 8 = 800 units.
The line actually packs 720 units. Production efficiency = 720 / 800 x 100 = 90%.
The 80 missing units, valued at a contribution of $5 each, represent lost contribution of 80 x 5 = $400 for the shift.Case study
Seen in the real world.
Marlow Plastics is an illustrative, fictional manufacturer that ran three shifts of moulding machines. Its standard rate was 500 parts an hour, but the monthly report showed an average of 430 parts an hour, an efficiency of 86%.
The operations manager tracked the lost time and found that most of it was caused by slow changes of moulds between products. By training the crew and using a standard checklist, the changeover time fell from 90 minutes to 45 minutes.
In this illustrative story, efficiency rose to 94%. At 500 parts an hour standard and a contribution of $0.60 per part, the 8% improvement was worth about 40 extra parts an hour, or $24 per hour of running time, which added up to a meaningful gain over the year. The manager also noted that the improvement cost almost nothing, because it came from training and a checklist rather than new equipment, and she set a new target of 96% for the following year.
Watch out
Common mistakes.
- Pushing efficiency so high that quality and maintenance suffer, which raises costs elsewhere through scrap, rework, repairs and unhappy customers.
- Setting an unrealistic standard, so that efficiency always looks poor and staff stop paying attention to the measure, when a good standard is demanding but achievable.
- Confusing efficiency with effectiveness, when a very efficient line can still make the wrong product.
Questions
People also ask.
What is the difference between efficiency and productivity?
Productivity is output per unit of input, such as units per hour, while efficiency compares actual productivity with a standard or best possible level.
What is productive efficiency in economics?
It is the situation where goods are produced at the lowest possible cost, so that more of one good could be made only by making less of another, meaning no resources are being wasted.
How does efficiency affect cost?
Higher efficiency spreads fixed costs over more units and reduces waste, so the cost of each unit falls, although only if the extra output can be sold or if inputs are reduced to match.
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