Operational Efficiency – Definition

Cite this article as:"Operational Efficiency – Definition," in The Business Professor, updated March 25, 2019, last accessed August 5, 2020, https://thebusinessprofessor.com/lesson/operational-efficiency-definition/.


Operational Efficiency Definition

Operational Efficiency is the ratio of profits gained over the transactional costs in the investment markets. Transactional costs include the expenditures made, or the fee incurred while buying or selling goods. It is analogous to the Operational Efficiency in production. Transactions with the highest margins, that yield more profits with minimal transactional fee are called efficient operations.

A Little More on What is Operational Efficiency

In production, companies try to maximise the output by lowering the operational costs of producing goods. Scaling up is one way of improving Operational Efficiency. For example, in Intraday trading, buying and selling stocks in bulk at fixed prices, reduces the fee per stock traded, and is charged as a one way transaction, bringing down the operational cost while maximizing returns.

Products and services that can be traded without incurring heavy transactional costs, or at costs that are almost on par with the actual cost of the product or service being paid for, leads to Operationally Efficient markets. Market competition is another factor that reduces operational costs. Capped transactional fee, fixed by governmental regulation to protect investors, also leads to better Operational Efficiency. An Operationally Efficient market is also called an Internally Efficient Market.

Investment portfolios gain immensely from Operationally Efficient markets. The lower the transactional costs on buying and selling securities, the more transactions it promotes. It encourages people to invest by lowering ancillary costs and transactional risk factors.

Operational Efficiency is also an important metric in the analysis of Investment funds as well as calculating their expense ratios. Management fee, administrative costs, transaction charges, all contribute to the expense ratio of a fund. Operationally Efficient investment funds have low expense ratios.

Examples of Operationally Efficient Investment Markets

Management assets funds traded in bulk incur low transactional costs gaining better Operational Efficiency. Passive funds have better expense ratios compared to active funds as they provide better market exposure. The economy of scale also helps in keeping transactional costs to a minimum.

The imposition of 8.5% regulation cap on mutual fund commissions has greatly improved their Operational Efficiency reaping better profits for individual investors.

The Commodity Futures Trading Commission’s resolution to allow money market funds to pass off as eligible margin requirements in lieu of cash has greatly improved the Operational Efficiency of the Futures trading market.

References for Operational Efficiency

Academic Research on Operational Efficiency

Operational efficiency in banking: An international comparison, Allen, L., & Rai, A. (1996). Journal of Banking & Finance, 20(4), 655-672. This journal does a comparative study of input and output Operational Efficiency of 15 international banks.

Operational efficiency and effectiveness measurement, Jeong, K. Y., & Phillips, D. T. (2001). International Journal of Operations & Production Management, 21(11), 1404-1416. This paper computes a new scheme for measuring Operational Efficiency by factoring in time sinks and Overall Equipment Effectiveness (OEE).

An analysis of the operational efficiency of major airports in the United States, Sarkis, J. (2000). Journal of Operations management, 18(3), 335-351. This journal studies empirical data to evaluate the Operational Efficiency of 44 major airports in the US.

Benchmarking the operational efficiency of third party logistics providers using data envelopment analysis, Min, H., & Jong Joo, S. (2006). Supply chain management: An International journal, 11(3), 259-265. This journal sheds light on the Operational Efficiency of third party logistics providers (3PLs), with the aim to benchmark industry standards and postulate best practices.

Empirical evidence on the operational efficiency of National Oil Companies, Eller, S. L., Hartley, P. R., & Medlock, K. B. (2011). Empirical Economics, 40(3), 623-643. This journal studies empirical data from 78 National and International Oil Companies to gauge their Operational Efficiency by using the Data Envelopment Analysis (DEA) method and applying stochastic frontier estimation.

Linking strategic flexibility and operational efficiency: The mediating role of ambidextrous operational capabilities, Kortmann, S., Gelhard, C., Zimmermann, C., & Piller, F. T. (2014). Journal of Operations Management, 32(7-8), 475-490. This paper studies the relationship between Operational Efficiency and Strategic Flexibility by incorporating insights from literature, practice, and dynamic resources.

Increasing the operational efficiency of container terminals in Australia, Kozan, E. (1997). Journal of the Operational Research Society, 48(2), 151-161. This paper studies the factors affecting the Operational Efficiency of railway containers in Australia and devises a heuristic model to simulate and address limitational barriers.

The Indian auto component industry–Estimation of operational efficiency and its determinants using DEA, Saranga, H. (2009). European Journal of Operational Research, 196(2), 707-718. This paper studies empirical data from 50 auto manufacturing firms in India and analyses the determinants of their Operational Efficiency using the DEA model. It suggests labour law reforms and better capital management to reduce inefficiencies.

Improving business processes for increased operational efficiency: a case study, Kumar, S., & Harms, R. (2004). Journal of Manufacturing Technology Management, 15(7), 662-674. This is a case study of business practices that can improve Operational Efficiency.

The end of the month as a preferred habitat: A test of operational efficiency in the money market, Ogden, J. P. (1987). Journal of Financial and Quantitative Analysis, 22(3), 329-343. This journal takes a close look at the factors affecting Operational Efficiency in the money and financing world.

Alliances in liner shipping: an instrument to gain operational efficiency or supply chain integration?, Evangelista, P., & Morvillo, A. (1999). International Journal of Logistics: Research and Applications, 2(1), 21-38. This paper explores the concept of Operational Efficiency in the liner shipping sphere, shedding light on the growth and adaptation of the sector to the changing environment.

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