Industrial Efficiency

Industrial efficiency refers to the ability of a company or institution to maximize output while minimizing waste in terms of materials, energy, time, and financial resources. It is a critical measure of economic health and can be assessed at various levels, including the individual company, industry, and even national levels. The concept is closely related to productivity, which compares outputs to the inputs that contribute to production. Various metrics are employed to gauge efficiency, such as the coefficient of resource utilization and Pareto optimality, which help identify areas for improvement within operations. Organizations can enhance their efficiency through technological advancements, organizational restructuring, and aligning expansion with production returns. Furthermore, adopting green initiatives, such as energy management systems and carbon disclosure practices, can lead to significant cost savings and environmental benefits. Overall, improving industrial efficiency not only supports profitability but also contributes positively to the community and the environment.

Published in: 2021

By:

Subject Terms

Industrial Efficiency

Abstract

Industrial efficiency is the measure of a company's or institution's economic health regarding resource utilization and profit margins. Several measurements are used to determine a company's efficiency, and most are connected to the productivity of that company. Efficiency can be measured at the company, institution, or country level. A wrong decision based on efficiency measures can be the downfall of a company. The best use of efficiency measures incorporates the strengths and weaknesses of a company's performance and abilities, and improvement strategies are based on reasonable goals that are within the company's reach.

Overview

When a process or institution is described as efficient, it means that operations are occurring at a level that minimizes waste of materials, energy, time, and money while maintaining a high level of performance and earnings. Industrial efficiency can be defined as the capacity that an industry has to produce goods in a cost-effective manner and sell the goods at an attractive price while making a profit. It is intimately tied to industrial productivity. Industrial productivity is the ratio between an output and the variables that contributed to the production of a unit. Efficiency can also be defined as the ratio between output and input. Though efficiency and productivity are often used interchangeably, they are not the same concept.

Measures of efficiency are considered more precise when attempting to describe the most efficient behavior of an industry. A production frontier is a mathematical representation of the highest output that can be attained given a specific input level. It is normally used to compare one company's contribution in a market with another related company's contribution. It is a parameter that is often combined with other economic metrics of efficiency to describe an overall picture of the health of a company, industry, or country.

One measurement of efficiency is the coefficient of resource utilization, first introduced by Debreu in 1951. This measure represents the proportionate decrease in all variable inputs of a process that leads to production of a good or service. Another measurement of efficiency that is heavily economic in nature, is the Pareto optimality. In this concept, input-output values are not Pareto optimal if there is any further room for reduction in costs or increase in profits. Industries use this metric to help determine deficiencies in fixed or variable costs. Allocative efficiency is another economic metric that can determine the company's success in selecting the optimal input sets when considering a certain level of input prices. Structural efficiency is a metric that allows a company to evaluate their own best practices, or to compare best practices among different industries.

When used together, these measures can aid in directing the management of a company or government official to assess the efficiency of manufacturing or governmental processes and to rein in overspending or discard outdated policies that no longer serve the institution or country.

Further Insights

The following example identifies a problem with industrial inefficiency in the health care sector. It will highlight key issues that are related to resource waste and overall inefficiency. Then a comprehensive approach to reducing the inefficiency is delineated:

After the Patient Protection and Affordable Care Act was implemented in 2010 by the Obama Administration, the substantial profit margins from Medicare and Medicaid insurance payments that many hospitals enjoyed was reduced significantly. It uncovered a fragmented delivery system that was overdue for change. This fragmentation was due to a lack of coordination between providers and departments who did not work together for patient care needs. Resource waste was identified as unnecessary diagnostic testing and care plans that included excessive instructions for the patient. Hospital profit margins dropped to an all-time low, and hospitals struggle to make a profit after Medicare plans began reimbursing less for the nearly eighty million baby boomers who place the greatest demand on the health care system. To make matters worse, with decreased reimbursements, physicians will be paid less, and many will retire early, inducing shortages in care.

To address these issues, the clinical integration model, which represents a holistic approach to coordinating preventative medical care between primary care physicians and hospitals, will reduce the amount of diagnostic errors and improve patient care services. These integrated systems will require a customized set of performance metrics, which will include measures of efficiency compared against quality improvement of services at the provider and hospital levels. These metrics will allow for benchmarking among healthcare institutions. Among the interventions that will be used to drive improvement in operational efficiencies are (1) elimination of duplication in administrative departments, (2) improved administrative efficiency, (3) medical process improvements, (4) reduction in patient wait times, (5) better use of skilled care providers, and (6) optimized use of medical technology.

In this example, if variation in practices around a variable (diagnostic error) for health care delivery was plotted in a line graph (classic Pareto chart), with upper and lower confidence intervals, it would reveal a significant amount of variance. One of the metrics for efficiency is Pareto optimization. This means that when a process is out of control, efficiency is at a low level. It can be seen from the description of the problem that resource utilization was not optimal. This leads to unnecessary spending by insurance companies, excessive out-of-pocket patient costs, and decreases in hospitals' profit margins. Variation must be brought to a minimum for each variable being used as an outcome measure for quality improvement.

To address the issues that are within the hospital's control, a series of process improvements are implemented to drive down unnecessary expenditures, duplication of processes (which results in waste), and improved utilization of expensive medical equipment (i.e., MRI machines, surgical equipment). When this is performed on a local level, it results in local cost effectiveness and efficiency, but when it is implemented across all institutions within the health care industry, it can impact national spending and resource utilization in the same way. Other industries implement similar methods to bring about improvements in processes and to guide changes in institutional efficiency, as well as industrial efficiency.

Discourse

Companies or industries can maximize their productive efficiency in three ways: technological improvements, organizational change, and matching scale of expansion with returns of production. Taking advantage of technological advances that boost sales and decrease productivity costs (once the up-front investment has been earned back) has always been a driver for companies to increase productivity. Organizational changes that lead to more effective management and streamlined effort at the production level can reduce costs further, while maintaining excellence in production performance. As a company grows, it is necessary to implement changes that will allow production to expand (often by increasing the use of technology) or a decrease in profit may be observed.

The human resources component to improving efficiency incorporates managerial responsibility to ensure that employees are happy and compensated. Sometimes this equates to an overhaul from an administrative standpoint, including restructuring and downsizing administration personnel, or hiring additional personnel that are highly skilled in an area of an identified weakness.

If there are weaknesses in employee training or education, this can be addressed by ensuring periodic training is available to overcome the deficit, or remediation might be necessary. Any retraining or continuing education should be done with the intention of covering the immediate need of the company while promoting long-term relationships with employees. A happy and well-trained employee generally results in higher productivity. If these training sessions are budgeted in a training program as part of fixed costs, the increase in productivity will bring in additional revenue that will offset the initial costs of implementing an educational program and pay dividends in the future. On a similar note, including employees in the decision-making processes involving quality improvement will also foster a good relationship and result in greater productivity.

One cannot discuss improvement of industrial efficiency without addressing the green initiatives that have become popular on a global level. At the top of the list for reducing energy for industries is to have in place an energy management system (EnMS). Savings in energy costs enables a company to reduce production costs, which can translate into increased profits. Companies that stand to gain the greatest profit for implementing an energy management system are those with high-energy usage. Germany is a leader in EnMS, and under the Renewable Energy Resources Act of 2012, companies that have implemented an EnMS have shown that startup costs for the system are repaid within two years.

Another green initiative that has gained popularity on a global level is carbon disclosure. It has been shown through the Carbon Disclosure Project (CDP) that companies, such as BMW, Honda Motors, Nissan Motors, Volkswagen, Nestle, Samsung, and Hewlett-Packard, that measure their carbon contribution to the environment can gain control over their carbon footprint. The CDP is a non-profit organization based in the United Kingdom that encourages cities and companies to disclose the amount of carbon use is generated over a specified time period. More than 50 percent of a manufacturing company's carbon footprint comes from its supply chain. As a result, many major companies (Wells Fargo, Microsoft, Walt Disney) are factoring the price of carbon into their operational, or fixed, costs. These companies benchmark each other to compare the level of savings another company has achieved through implementing these policies and complying with government-sanctioned green initiatives. Currently, more than six thousand companies worldwide have disclosed their carbon production, and the number grows daily.

In summary, industrial efficiency encompasses many concepts but is measurable using econometrics geared at evaluating key areas of productivity. Though efficiency and productivity are not the same they are interdependent; productivity cannot be optimally obtained without efficient use of resources and minimization of waste, while efficiency cannot be measured without productivity.

The main reason for measuring efficiency is to identify areas that need improvement. When a company or industry is not operating in the most efficient manner, it results in a net loss of profit. This can damage the earning potential for the company, set it back in terms of access to the latest technological advances, and create a downward spiral of decreasing value. Companies that are in good standing from a benchmark perspective can take advantage of measures that will further reduce waste and help the environment as well. These options include implementing an EnMS that is specifically created to reduce waste, and to report carbon production (carbon footprint). Both incentives require significant up-front costs but will be earned back in costs savings within a few years. There are many more ways to utilize efficiency metrics to guide profit and environmental responsibility, but regardless of which measure a company or institution uses, a profitable business is an asset to a community and country.

Terms & Concepts

Allocative Efficiency: Efficiency measure in economics that evaluates the mixture of inputs (fixed costs and production costs) with outputs. Together with technical efficiency, both provide a global picture of how robust or weak a company's performance is.

Benchmark: The act of comparing industry bests for business practices and performance metrics of one company to another. It is one of the most powerful measures to determine where one's business is performing in relation to other companies in a market.

Pareto Optimal: An optimal allocation of resources that exhibits high levels of economic performance and resource utilization.

Production Frontier: A concept in economics used to measure industrial efficiency and represent the highest output that can be derived from each input level.

Productivity: The ratio of outputs (fixed costs) to inputs of a company. This concept is directly linked to industrial efficiency.

Structural Efficiency: Metric that allows a company to evaluate its best practices or to compare best practices among companies within an industry.

Technical Efficiency: A mathematical point that represents the partial efficiency due to technology implemented for a process. It is used with the concept of production frontier to measure where the company's performance lands.

Total Factor Productivity: Productivity measure that encompasses all factors of production. This is in contrast to partial measures of production such as labor and fuel productivity.

Bibliography

Aflaki, S., Kleindorfer, P. R., & de Miera Polvorinoa, V. S. (2012). Finding and implementing energy efficiency projects in industrial facilities. INSEAD Working Papers Collection, (60), 1–27. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=80233487&site=ehost-live

Aldhizer, G.R., & Juras, P. (2015). Improving the effectiveness and efficiency of healthcare delivery systems. CPA Journal, 85(1), 66–71. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=100887063&site=ehost-live

Depoers, F., Jeanjean, T., & Jerome, T. (2016). Voluntary disclosure of greenhouse gas emissions: Contrasting the carbon disclosure project and corporate reports. Journal of Business Ethics, 134(3), 445–461. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=114309097&site=ehost-live

de Oliveira Neto, G. C., & Lucato, W. C. (2016). Production planning and control as a tool for eco-efficiency improvement and environmental impact reduction. Production Planning & Control, 27(3), 148–156. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112454144&site=ehost-live

Dostie, B. (2016). The impact of training on innovation. ILR Review, 71(1), 64–67. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=126783983&site=ehost-live

Hagel, J. (2015). Technology should be about more than efficiency. Harvard Business Review Digital Articles, 2–5. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=118667449&site=ehost-live

Han, B., Ouyang, Z., & Wang, W. (2018). The relationship between regional industrial organizing levels and ecological economic efficiency. Journal of Cleaner Production, 171, 857–866. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=126296176&site=ehost-live

Liesen, A., Figge, F. Hoepner, A., & Patten, D. M. (2017). Climate change and asset prices: Are corporate carbon disclosure and performance priced appropriately? Journal of Business Finance & Accounting, 44(12), 35–62. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=121348893&site=ehost-live

Luo, L., Lan., Y. C., & Tang, Q. (2012). Corporate incentives to disclose carbon information: Evidence from the CDP Global 500 report. Journal of International Financial Management & Accounting, 23(2), 93–120. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=77327115&site=ehost-live

Mankins, M. (2017). Great companies obsess over productivity, not efficiency. Harvard Business Review Digital Articles, 2–5. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=121776476&site=ehost-live

Shee, A., & Sefanou, S. E. (2015). Endogeneity corrected stochastic production frontier and technical efficiency. American Journal of Agricultural Economics, 97(3), 939–952. Retrieved January 16, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=102200919&site=ehost-live

Industrial Efficiency

On this Page

Subject Terms

Industrial Efficiency

Abstract

Overview

Further Insights

Discourse

Terms & Concepts

Bibliography

Suggested Reading