why efficiency is important for a business

4.1.1 Production Processes – Why Efficiency Is Important for a Business

1. Business Activity – The Context for Production

• Needs vs. wants: A need is essential for survival (e.g., food, shelter); a want is a desire that is not essential (e.g., designer shoes).
• Scarcity & opportunity cost: Because resources are limited, choosing one use means forgoing another.
• Specialisation & added value: Dividing work into specialised tasks increases output and creates added value for customers.
• Primary, secondary & tertiary sectors:
  • Primary – extraction of raw materials (e.g., farming, mining).
  • Secondary – transformation of raw materials into finished goods (e.g., manufacturing).
  • Tertiary – provision of services (e.g., retail, banking).
• Private vs. public sector:

  Aspect	Private sector	Public sector
  Ownership	Individuals / shareholders	Government
  Objectives	Profit maximisation	Service provision / welfare
  Funding	Sales, equity, borrowing	Taxes, grants

• Stakeholders & their objectives (short checklist):
  • Owners – profit, return on investment.
  • Managers – growth, efficiency, job security.
  • Employees – stable wages, good working conditions.
  • Customers – quality, value for money.
  • Suppliers – long‑term contracts, timely payment.
  • Community – employment, environmental care.

2. People in Business – Motivation, Organisation & Legal Controls

• Motivation theories:
  • Maslow’s hierarchy of needs (physiological → self‑actualisation).
  • Herzberg’s two‑factor theory (hygiene factors vs. motivators).
  • Taylor’s scientific management – work‑study, standardisation.
• Organisation structures:
  • Simple (owner‑managed), functional, divisional, matrix – each with different lines of authority.
• Leadership styles:
  • Autocratic, democratic, laissez‑faire – impact on morale and decision‑making speed.
• Trade unions & industrial relations:
  • Collective bargaining, strikes, lock‑outs – how they can affect productivity and costs.
• Recruitment & selection:
  • Internal vs. external recruitment, advertising, interviews, tests, reference checks.
• Training & development:
  • Induction, on‑the‑job, apprenticeships, e‑learning – links to technical and time efficiency.
• Redundancy, dismissal & legal controls:
  • Redundancy = position no longer needed; dismissal = employee at fault.
  • Key legislation: contracts of employment, minimum wage, health & safety, data protection.
• Communication in business:
  • Formal vs. informal channels, barriers (language, hierarchy, noise), and the importance of feedback loops.

3. Marketing – Linking Production to the Market

• Customer needs & market segmentation:
  • Identify needs through primary (surveys, interviews) and secondary (industry reports) research.
  • Segment by demographics, psychographics, geography, behaviour.
• The Marketing Mix (4 Ps):

  P	Key Decisions
  Product	Features, quality, branding, packaging, after‑sales service.
  Price	Cost‑plus, penetration, skimming, psychological pricing.
  Place	Distribution channels, logistics, location of sales outlets.
  Promotion	Advertising, sales promotion, public relations, personal selling, digital marketing.

• E‑commerce & legal controls:
  • Online sales, digital payment systems, consumer protection (distance selling regulations).
• Foreign‑market entry strategies:
  • Exporting, licensing, franchising, joint venture, wholly‑owned subsidiary – each with different risk and control levels.

4. Operations – Production, Costs, Quality & Location

4.1 Production Basics

• Production: Converting inputs (labour, materials, capital, information) into goods or services.
• Productivity: Output per unit of input (e.g., units per hour). Answers “how much?”.
• Efficiency: The degree to which the *least* possible input is used to achieve a given output. Answers “how well?”.

4.2 Main Methods of Production

4.3 Types of Efficiency

• Technical efficiency – Maximising output from a given set of inputs.
• Economic efficiency – Producing at the lowest possible cost while maintaining required quality.
• Resource efficiency – Minimising waste of raw materials, energy and water.
• Time efficiency – Reducing the time taken for each production stage without sacrificing quality.

4.4 Calculating Efficiency

Basic efficiency ratio:

Efficiency = Output ÷ Input

In LaTeX: \(E = \frac{\text{Output}}{\text{Input}}\)

4.5 Costs & Break‑Even Analysis

• Cost classification:

  Fixed Costs	Variable Costs
  Rent, salaries of permanent staff, depreciation	Raw materials, hourly wages, electricity (linked to output)

• Break‑even point (BEP):
  • Formula: BE Units = Fixed Costs ÷ (Price per unit – Variable cost per unit)
  • Graphical representation – label axes (Units on X, Cost/Revenue on Y), show total cost line, total revenue line, and the BE point.
  • Margin of safety = (Actual sales – BE sales) ÷ Actual sales × 100 %.

4.6 Quality Management

• Quality control (QC) – Inspection and testing to ensure products meet specifications.
• Quality assurance (QA) – Systematic processes (e.g., ISO 9001) that prevent defects from occurring.
• Link to efficiency: Fewer defects mean less re‑work, lower waste and higher technical efficiency.

4.7 Location Decisions

• Key factors (useful checklist):
  • Proximity to markets and raw materials.
  • Transport costs and infrastructure.
  • Labour availability and cost.
  • Legal & tax environment.
  • Environmental regulations.
  • Community attitudes.

5. Raising Productivity – How Efficiency Helps

• Automation – Machines replace manual tasks, raising output per hour and technical efficiency.
• Training & skill development – A more skilled workforce works faster and makes fewer errors, improving time and economic efficiency.
• Lean production:
  • Just‑In‑Time (JIT) – Produce only what is needed, when it is needed; cuts inventory holding costs and improves resource efficiency.
  • Kaizen (continuous improvement) – Small, incremental changes that cumulatively raise technical and time efficiency.
• Inventory management – Efficient production reduces the need for large stock buffers, lowering storage costs, risk of obsolescence and tying up capital.

6. Impact of Efficiency on Business Performance

• Cost reduction – Less input for the same output lowers variable costs.
• Competitive advantage – Ability to offer lower prices or achieve higher margins.
• Profitability – Higher output per input raises revenue without a proportional rise in cost.
• Capacity utilisation – Efficient processes free up capacity to meet demand spikes without extra capital expenditure.
• Environmental sustainability – Less waste and energy use support CSR and can lower regulatory costs.

7. Financial Information – Relating Efficiency to the Numbers

• Sources of finance:
  • Short‑term: overdraft, trade credit, commercial paper.
  • Long‑term: equity (shares), retained earnings, debentures, term loans.
• Cash‑flow forecast (simple 3‑step method):
  1. Estimate cash inflows (sales receipts, loans, asset sales).
  2. Estimate cash outflows (payments to suppliers, wages, overheads, loan repayments).
  3. Calculate net cash flow = inflows – outflows; add opening cash balance to obtain closing balance.
• Key statements:
  • Income statement – shows revenue, total costs and profit for a period.
  • Statement of financial position (balance sheet) – assets, liabilities and equity at a point in time.
• Ratio analysis (examples):

  Ratio	Formula	What it tells you
  Gross profit margin	\(\frac{\text{Gross profit}}{\text{Sales}} \times 100\)	Efficiency of production & pricing.
  Current ratio	\(\frac{\text{Current assets}}{\text{Current liabilities}}\)	Short‑term liquidity.
  Return on capital employed (ROCE)	\(\frac{\text{Profit before interest \& tax}}{\text{Capital employed}} \times 100\)	Overall efficiency of capital use.

8. External Influences on Efficiency

• Economic cycle – Recessions may force firms to cut costs and improve efficiency; booms can hide inefficiencies.
• Government policy – Taxation, subsidies, minimum wage, health & safety regulations can affect cost structures.
• Environmental & ethical issues – Pressure to reduce carbon footprints can drive resource‑efficiency initiatives.
• Globalisation – Access to cheaper overseas inputs encourages firms to improve technical efficiency to stay competitive.
• Exchange rates – Fluctuations affect the cost of imported raw materials and the price of exported goods, influencing decisions on location and production methods.

9. Data Interpretation Practice

Figure 1 – Monthly Output vs. Input (Bar Chart)

Question: In June, output increased from 1 200 to 1 500 units while input fell from 600 to 550 man‑hours. Calculate the efficiency for May and June and explain what the change tells a manager about the production process.

Model answer:

• May: \(E_{May}= \frac{1\,200}{600}=2.0\) units / man‑hour
• June: \(E_{June}= \frac{1\,500}{550}\approx2.73\) units / man‑hour
• The rise in efficiency indicates that the firm has either streamlined operations, reduced waste, or introduced a productivity‑boosting measure (e.g., better scheduling or a minor automation). The manager should investigate the specific change and consider applying it to other months.

10. Real‑World Example – Lean Car Manufacturing

1. JIT delivery – Parts arrive only when needed, cutting warehouse space by 30 %.
2. Kaizen workshops – Workers suggest 15 minor layout changes over a year, reducing average motion per car by 0.5 minutes.
3. Result: Assembly time falls from 12 hours to 9 hours per vehicle; daily output rises from 500 to 600 cars (20 % increase); cost per car drops by 15 % (labour & inventory savings).
4. Efficiency calculation:
   • Old efficiency: \(E_{old}= \frac{500}{12}=41.7\) cars / labour‑hour
   • New efficiency: \(E_{new}= \frac{600}{9}=66.7\) cars / labour‑hour
   • ≈ 60 % improvement – a clear illustration of how lean techniques raise both productivity and efficiency.

11. Limitations of Efficiency Measures

• Ratios ignore quality; high output with many defects is undesirable.
• They do not capture externalities such as environmental impact or employee wellbeing.
• Short‑term efficiency gains may lead to over‑stocking or under‑investment in capacity if demand forecasts are inaccurate.
• Efficiency is a snapshot – it can mask seasonal variations or temporary disruptions.

12. Summary

• Business activity, people, marketing and external influences set the context for production decisions.
• Production turns inputs into outputs; productivity measures quantity, efficiency measures how well inputs are used.
• Job, batch and flow production each suit different products and market demands.
• Technical, economic, resource and time efficiency are the lenses through which businesses assess performance.
• Efficiency = Output ÷ Input; calculating it highlights areas for improvement.
• Automation, training, lean production (JIT, Kaizen) raise productivity and therefore efficiency.
• Higher efficiency reduces costs, strengthens competitive position, improves profitability, frees capacity and supports sustainability.
• Financial statements and ratio analysis translate efficiency gains into monetary terms.
• Students must interpret data, recognise the limits of efficiency ratios, and link efficiency to broader strategic decisions.

13. Key Concepts Checklist (for teachers & students)

• Business activity: needs vs. wants, scarcity, specialisation, sectors, stakeholders.
• People: motivation theories, organisational structures, leadership styles, trade unions, recruitment, training, legal controls, communication.
• Marketing: market research, segmentation, the 4 Ps (plus technology), pricing, promotion, e‑commerce, foreign‑market entry.
• Production methods: job, batch, flow – advantages & disadvantages.
• Efficiency types and calculation (E = Output / Input).
• Cost classification, break‑even analysis, margin of safety.
• Quality control vs. assurance, location‑decision factors.
• Ways to raise productivity: automation, training, lean (JIT, Kaizen), inventory management.
• Impact of efficiency on cost, competition, profit, capacity utilisation and sustainability.
• Financial information: sources of finance, cash‑flow forecast, income statement, balance sheet, key ratios.
• External influences: economic cycle, government policy, environmental/ethical issues, globalisation, exchange rates.
• Limitations of efficiency measures (quality, externalities, short‑term focus, snapshot nature).
• Data‑interpretation skills – calculate efficiency, analyse charts, draw business conclusions.