If you Google the difference between efficiency and effectiveness you will find over 1.4 billion hits. There are endless opinions from accountants, business strategists, linguistics, and even psychologists on the topic. Clearly, there is confusion out there and my short video won’t clear it up. Instead of deciding on the debate, let me share a story on how a customer of mine uses these terms to create value for their business.
If you Google the difference between efficiency and effectiveness you will find over 1.4 billion hits. There are endless opinions from accountants, business strategists, linguistics, and even psychologists on the topic. Clearly, there is confusion out there and a 5-minute video won’t clear it up. Instead of deciding on the debate, let me share a story on how a customer of mine uses these terms to create value for their business.
Let’s take a look
So back in the day, when I got started out in business, they taught us the classic cliche: efficiency is about getting things done right, and effectiveness is getting the right things done. Like any cliche, this was true but hard to put into practice.
I used to tell myself that if I’m efficient, then I have a set goal and I have to achieve it at the lowest effort, cost, and time. With minimal waste. But I do not question if the goal makes sense in the first place.
To be effective, I needed to look at the business outcomes I was after and decide if all the effort you are putting in at ANY cost, achieves the right goals. I will let you explore the philosophical rabbit holes of this debate on your own. I’m curious what efficiency and effectiveness mean to you. Drop me a line.
Today, I wanted to discuss an investor friend I’ll call Mike. He and I got into this whole efficiency/effectiveness discussion and found some common ground.
What he said was this: forget the names and labels. None of that matters. What matters is this. There are only 3 things you can do to make a business better. Name them what you want.
Mike called them Cheap, Efficient, and Effective. He told me that when he looked at buying a business or helping a CEO improve it, he always asked them the same 3 questions.
- Can I make this cheaper?
- Can I make it more efficient?
- Can I make it more effective?
More often than not, business teams combine the various cost reduction strategies and are not clear if they improved costs, efficiency or effectiveness.
Let’s see how Mike looked at each and how you can combine them for a winning value creation approach.
Mike used to tell me: companies under pressure will push the cost problem outside slashing material and labor costs. If your budget gets cut, you will cut your hiring, contractors, and pressure vendors to cut unit costs. We all do it. The easiest way to drive short-term value (meaning cash flow) is to cut the spend. So CHEAP is important. But not sustainable. This is what Mike said: look at your business process before and after cost-cutting. Did you serve your customers better? Is your customer happier? Has your on-time delivery improved? Has customer churn improved? Most importantly, are they willing to buy more from you at higher prices?
How about the competition? Are we faster, better, or cheaper than they are as a result of our cost-cutting? Rarely, Mike said. Almost never.
Cutting labor costs, squeezing suppliers and even basic outsourcing lowers short-term costs. Does not improve long-term profitability.
Mike believed cost-cutting gives the business breathing room to get better. He said it is like a champion boxer dropping weight before a fight.
Unfortunately, many businesses are stuck in cost-cutting and never improving the processes. It’s like a boxer that keeps dropping weight but never gets in a match.
Mike believed improving efficiency should be second nature for all businesses. In most cases it is. Given decades of management science focusing on process improvements, six sigma, and similar strategies you’d think that was always the case. Many teams do this well. The key thing for Mike was making sure the efficiency improvements stood on their own. If a company decides to improve its collection, for example, the new process should be simpler and probably faster. Without cutting supplier costs. Think about it. If the process used to take 200 people 5 days to complete and now it takes 30 people 1 day with a collection system, that’s real efficiency improvement. If all you did is outsourced that 200 people to a BPO and it still takes 5 days, then you just made an inefficient process cheaper. Mike wanted efficiency to be there first then make the more efficient process cheaper. Double dipping in value.
When Mike looked at improvement projects, he always wanted to know if how much of the value is coming from efficiencies and how much from buying cheaper stuff. Making process improvements makes the business better long term. Buying cheaper is just a race to the bottom.
Mike believed most businesses have a good understanding of procurement (buying cheap) and process improvement (efficiency). He saw his role mostly as making sure his companies don’t sacrifice long-term process improvement for short-term cost savings. One of Mike’s pet peeves in business was the lack of focus on effectiveness. He believed way too many business leaders were tweaking the engine instead of putting the engine in the right races. He recalls several multi-year projects improving order management or supply chain processes when ultimately the right answer was to change suppliers or change their distribution centers to serve different customer segments.
Mike believed we should always ask this: should we even be doing this process to get our business results?
Many people and lots of money and resources in companies are doing things that customers don’t care about and won’t pay for. He tells me a story of a team wanting a new management reporting system for over $1M. Mike asked them for a list of customers that they would lose if the reports were not built. The list never came.
What I learned from my time with Mike was this: first, you have to ask the big questions: what is our business goal, what’s preventing us from getting there? And fix those things. This may mean new customer segments, a new supply chain network, or even entering new lines of business. This will guide effectiveness.
Once you know where you are going, then you can figure out the best way to get there. Which will be a combination of simplifying processes, doing more with less, and yes, cutting costs of your suppliers.
Effectiveness is our guide, process efficiency first and cost-cutting last is how we get there.
Thanks, Mike. You know who you are.