The most profitable businesses don’t necessarily make the most sales or charge the highest prices; they wring value out of every resource—every centimeter of lumber or denim or silicon. What’s more impressive, they do it without burning out employees or sacrificing product quality.
The name of the game is efficiency—specifically cost efficiency—and it can make your business more resilient, sustainable, and, of course, profitable. Here’s what cost efficiency is and four ways to get more bang for your buck.
What is cost efficiency?
Cost efficiency is a measure of the resources a business uses to generate a desired output relative to the minimum resources with which it could achieve that output. Essentially, it’s a way to ensure you get the maximum return from a production, distribution, or management process. Cost-efficient businesses use fewer resources than inefficient ones, saving money and time, and maximizing profits.
Cost efficiency vs. cost-effectiveness
Although both cost-efficiency and cost-effectiveness evaluate your return investments in your business, they’re distinct metrics. Cost-effectiveness evaluates the relationship between process inputs and outputs. It’s a results-oriented measurement: A process is cost-effective if inputs achieve the intended or expected result, and it becomes more cost-effective as inputs decrease. Cost efficiency is process-oriented. A process is efficient if it accomplishes a goal in the best possible manner, i.e., without wasting time, money, or effort.
Businesses measure cost-effectiveness with cost-effectiveness analyses (CEAs), which compare the value of an outcome with the cost of its inputs. In a cost-effective solution, the total value of the outcome exceeds the cost of inputs. Businesses measure cost efficiency by comparing the actual cost of inputs to their minimum possible cost; in an efficient business, these figures are roughly equal.
Cost-effectiveness vs. cost-efficiency example
Cost efficiency and cost-effectiveness are closely linked. They also inform each other: Pursuing efficiency is one way to increase cost-effectiveness—and as long as you’re focused on the right goals, boosting cost-efficiency increases a business’s overall effectiveness.
Here’s an example to help you keep it straight. Compare material-sourcing processes for two luxury silk muumuu businesses, Dionysia and Citrone.
- Dionysia spends $80 per yard on raw silk, twice the going rate.
- Production costs are $600 per item.
- Muumuus retail for $2,000.
- Dionysia generates $500,000 in profits annually.
Dionysia’s material-sourcing process is cost-effective because the inputs ($80 per yard) drive the intended outcome (making money selling muumuus)—but because it’s overspending on silk, the process isn’t cost-efficient. Dionysia could improve effectiveness and efficiency by switching to a comparable supplier with lower prices.
Now consider Citrone:
- Citrone sources premium silk for just $30 per yard, 25% less than its competitors.
- Production costs are $300 per item.
- Muumuus retail for $400.
- It loses $50,000 a year.
Citrone’s material-sourcing process is cost-efficient but not cost-effective. Because the company isn’t generating profits, material spending isn’t helping it meet its goal. Citrone can’t improve cost efficiency for this particular process, but it can boost cost-effectiveness by manipulating outputs—or raising product prices.
Importance of cost efficiency
Improving cost efficiency can boost profitability and increase resilience. Here’s an overview of the benefits.
Increased profit margins
Achieving cost efficiency increases profits by lowering costs incurred while maintaining output quality and quantity. It can also free up time, which you might devote to ramping up production or exploring additional revenue streams.
Environmental benefits
Although many people think of sustainable business practices as expensive, the cost-efficient way to do something is often the most sustainable. Near-sourcing can lower your carbon footprint and the material-use strategy that generates the least waste can help you maximize asset value. Installing smart energy monitors in your headquarters can lower your electricity bills.
Competitive advantage
Cost-efficient businesses can operate with limited resources, which increases their flexibility and resilience. If you want to reduce prices to increase market share or challenge a new competitor, you can. If the economy takes a hit, you have a buffer. And if you’re just starting out, you can go to market sooner (and with limited investor obligations).
Strategies for improving cost efficiency
Improving efficiency is all about saving money—whether by restructuring your entire organization or switching to a cheaper brand of toner. Here are four strategies to help your business achieve cost efficiency.
Improve operational efficiency
Business operations are how you get things done, or the tasks and processes you use to generate revenue. The more efficient they are, the more revenue you’ll generate for a given cost. Here are three strategies for cost-efficient operations:
Streamline business processes
Ask each department to record key protocols—such as the steps for onboarding a new hire, publishing a blog, or packing a shipment. Then have internal teams meet to review records, identify inefficiencies, and propose solutions. When they’re done, convene department heads to review changes and look for additional improvements, being on the lookout for any cross-departmental redundancies.
Use artificial intelligence and automation
Look for software tools that can automate repetitive tasks (like email list-cleaning) and routine tasks (like invoicing for monthly retainers). You can also look for AI tools that can speed up time-consuming tasks like compiling and formatting monthly performance reports.
Monitor employee utilization
Have your human resources lead perform an employee utilization audit to see where you have extra capacity. If your social manager is struggling to keep up with their responsibilities but your email marketing coordinator doesn’t have enough to do, you might have your head of marketing reallocate tasks to balance workloads.
Reduce costs
Review your current expenses and look for opportunities to cut costs, considering both direct and indirect figures:
- Indirect costs. Indirect costs are the overhead expenses associated with running your business. Think of them as the cost of keeping the lights on. They can include rent, utilities, administrative expenses, and accounting software fees.
- Direct costs. Direct costs are associated with revenue-generating activities. They can include labor costs, material costs, project-related software costs, and manufacturing costs.
You can eliminate extra costs by cutting entire line items from your budget, reducing purchase or payment volumes, or finding lower-cost alternatives to a current solution.
Consider your project management software, for example. If you recently purchased a new system with an in-app chat function, your previous office chat software is now redundant. Cancel that subscription to eliminate the cost.
If you pay for more storage than you need, inquire about the cost savings of downgrading storage limits. And if your new system is three times as expensive as an equally effective competitor, consider changing project management systems entirely.
Use cost-benefit analyses
A cost-benefit analysis (CBA) evaluates the costs of a specific initiative relative to its potential benefits. It supports better decision-making and improves cost efficiency, helping business owners determine whether an action is financially feasible and weighs the potential rewards and risks options.
Here’s how it works:
1. Define the initiative. Choose an initiative or project to analyze, defining goals and scope.
2. Lists costs. Note all the costs of the initiative, including measurable financial metrics like manufacturing, material, labor, and warehousing costs, as well as intangible costs, like effects on customer satisfaction and employee morale. Factor in opportunity cost, which refers to a loss of potential benefits as the result of choosing one alternative over another.
3. List benefits. Determine benefits to your company, such as revenue earned, money saved, and improvements in brand awareness.
4. Quantify intangible benefits. You can’t add $25,000 to the concept of customer satisfaction—so assign a dollar figure to intangible outcomes. Review the effect of past business decisions, read industry research and case studies, or bring in a consultant to help with estimates.
5. Calculate profits. Subtract total costs from total benefits to calculate the projected profitability of a course of action.
Businesses are complex; that’s why CBAs are key to cost efficiency. Say you want to save money by moving 2,000 greyhound snoods to a less expensive warehouse, for example. You perform a CBA and figure out that although your vendor payments would decrease, your shipping costs would rise. Because the new warehouse won’t ship internationally, you’d sacrifice the opportunity to expand overseas later on. You might determine that it’s more cost-efficient to stay with your current vendor.
Seek outside help
Businesses are complicated, and one of the biggest challenges to improving cost efficiency is that you’re not an expert in everything. You might have a lot of experience in pattern-making, sourcing fabric dyes, bookkeeping, inventory management, or employee development, but not all five. And you may not have experience in multi-state payroll compliance, international supply chain optimization, and the hundred other necessities that keep your business running.
It’s hard to minimize inputs when you aren’t familiar with a process, so consider partnering with a consulting firm or independent professional specializing in your industry. Your partner can draw on extensive experience with companies like yours to quickly identify inefficiencies and propose cost-saving solutions.
Cost-efficient FAQ
What is an example of cost efficiency?
One example of cost efficiency is letting an office-building lease lapse after your workforce goes remote. Other methods might include using AI and automation to improve workforce efficiency or changing shipping carriers to lower costs.
What makes something cost-efficient?
A process is cost-efficient if it achieves an outcome for the lowest possible cost. Businesses can improve cost efficiency by reducing expenses and streamlining operations.
What is a cost-benefit analysis?
A cost-benefit analysis is the process of weighing the total potential benefits of a course of action against its total potential costs.
