The Global Supply Chain is thriving with each passing day. Business profitability and customer satisfaction always go hand in hand. However, the game-changer is how Cost Efficiency and Cost Effectiveness play their role in the supply chain. The holistic approach requires that accentuates the role of Cost Efficiency vs Cost Effectiveness in every aspect of the supply chain, from planning, sourcing, and operations, to logistics and distribution.
Cost and profitability are the vital component of any successful business. Companies should adopt a multifaceted approach to secure long-term success in a competitive marketplace. In addition, management commitment, and continuous improvement that includes process optimization, digitalization, supplier negotiation, and customer feedback can reap the rewards.
Let’s learn the role of cost efficiency vs cost effectiveness!
The Basic Difference between Efficiency and Effectiveness
Before exploring the key difference between Cost efficiency vs Cost effectiveness, first, we need to understand the basic difference between Efficiency and Effectiveness. So, first thing first! What is Efficiency and Effectiveness?
Efficiency pertains to the accomplishment of a certain goal or target. On the other hand,
Effectiveness is the tactical approach to achieving the planned, strategic, and targeted goals, consequently creating value.
Efficiency and effectiveness are interchangeable terms but do not imply the same concept. Every business focuses on solutions that enhance profitability with cost optimization. Businesses learn about cost-effectiveness vs. efficiency throughout the supply chain to improve capacity.
You can explore more about The Role Of Effectiveness & Efficiency in Supply Chain Optimization on our Website.
What is Cost Efficiency?
Cost Efficiency is the process of maximizing the productivity of the business with the lowest possible cost in terms of utilization of available resources. Moreover, the effective utilization of resources helps to achieve demonstrated output.
Cost Efficiency often refers to a cost reduction method to identify, minimize, and eliminate unnecessary expenses while maintaining quality. However, it is more a strategic approach to streamline operations, resource utilization, and better negotiation with suppliers
Formula of Cost Efficiency
The Formula of Cost Efficiency is the ratio that shows how much output is gained in terms of units produced/ service/ delivered etc. to the Cost incurred.
Examples of Cost Efficiency
An Abacus Company of Courier and Logistics operates two routes: Route 1 runs with costs of $5,000 per month and transports 1,500 parcels. Whereas, route 2 runs with costs of $4,500 per month and transports the same number of parcels. Which route is Cost-effective?
Calculations
Cost Efficiency of Route 1 = 1,500 Parcels / 5,000 dollars = 0.3
Cost Efficiency of Route 2 = 1,500 Parcels / 4,000 dollars = 0.375
In this case, you have observed that for Route 1, 0.3 parcels are delivered per dollar whereas for Route 2, 0.375 parcels are delivered per dollar. Hence, Route 2 is comparatively more Cost Effective.
You can learn more about the Efficiencies in Production and Operation by our comprehensive course Introduction to Production and Operations Management
What is Cost Effectiveness?
Cost Effectiveness is the approach widely adopted by businesses that bring value creation while achieving targeted results.
Cost effectiveness typically refers to reshaping the capacity, and cost utilization to meet the long-term goals. Hence, businesses can provide the same level of service with optimized service capacities that result in cost savings.
Formulas of Cost Effectiveness
The Formula of Cost Effectiveness is the budgeting ratio that compares how effectively the value/ outcome is delivered by the investment of a certain cost.
Examples of Cost Effectiveness
Let’s take an example of Care Health – a vaccination center. It offers two vaccinations aimed at preventing a disease. In Program A, 300 cases of the disease are vaccinated for $150,000. Whereas, in Program B, 400 cases of the disease are vaccinated with a cost of $200,000. What is Cost Effectiveness?
Calculations
Cost Effectiveness Ratio for Program A = 150,000 dollars / 300 cases = 5
Cost Effectiveness Ratio for Program B = 200,000 dollars / 4,00 cases = 5
As you noticed, Program A and Program B, both are equally Cost Effective. Here decision-makers need to consider more factors such as long-term health benefits, social impact, etc. when choosing a vaccination program.
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Cost Efficiency Vs Cost Effectiveness
One of the points that contribute to triggering a business performance towards sustainability of the business is Cost efficiency and Cost Effectiveness. We need to understand the differences between Cost Efficiency vs Cost Effectiveness are interchangeable but they do not imply the same. Cost Efficiency focuses on the achievement of results by streamlining the processes, and best utilization of resources at the lowest possible cost. However, cost-effectiveness is vividly adopted by businesses to accomplish strategic goals while producing outcomes, impact, and value.
Both Cost Efficiency and Cost Effectiveness are crucial for businesses. It depicts strong annotations on the business performance. Businesses should adopt a strategic approach and make decisions by considering how cost-effective vs efficient throughout the supply chain.
It helps companies establish a holistic, strategic approach that resonates with business profitability, process optimization, continuous improvement, and improved customer experience.
Have a look at the brief comparison, listed below:
Do you want to know more about costs? Head to our course guide Fundamentals of Systems Costs
Our E-Book on Activity Based Costing in Procurement will also help you upskill your knowledge of costing in procurement.
Ways to Improve Cost Efficiency
Cost Efficiency is the optimization of resources without compromising the quality. To enhance efficiency and drive business growth, businesses strategies to attain results. Let’s continue reading to explore ways to improve cost efficiency.
Resource Management
Cost efficiency focuses on resource management such as inventory controls, supplier negotiation, staff training, and development.
Analyze data on Key Metrics
Data-driven solutions can be an innovator to increase cost efficiency rapidly. This enables the business to make informed decisions based on data. This depicts the clear performance of key metrics, such as Inventory levels, Logistics Costs, and Energy Utilization by gathering and analyzing data.
Leverage Technology and Automation
Technology and Automation are like wizards that optimize the businesses to the next level. Cost efficiency can optimize the entire supply chain predominantly by minimizing errors. The ad hoc approach frees up resources and time.
Let’s learn more about Technology and Automation through our course Supply Chain Digitalization (Bundle)
Ways to Improve Cost Effectiveness
Most businesses adopt cost-effective solutions for steady growth and high profitability. For example, the following are some of the significant methods that businesses use:
Cost Benefit Analysis and SWOT Analysis
Cost-benefit Analysis approach signifies cost effectiveness. It Empowers businesses to make decisions keeping ground realities in consideration. Several tools are used for Cost-benefit Analysis such as SWOT (Strength, Weakness, Opportunity, and Threats); and PESTAL (Political, Economic, Sociocultural, Technological, Environmental, and Legal).
Formula
Cost Benefit Analysis is the ratio between the Present Value of Benefit to the cost incurred (Present Value).
Example of Cost Benefit Analysis
Cost-benefit analysis helps businesses make decisions between Outsourcing and Insourcing. Insourcing offers uniformity, flexibility, quality, timely availability, customization, ownership, and expression. On the contrary, outsourcing offers low labor costs, low energy utilization, variable capacity, and less resource management. So, cost-benefit analysis helps the companies to have a clear picture of benefits against involved costs.
Performance Metrics Via Digitalization
Performance Metrics play a vital role in Cost-effectiveness. Digitization identifies the problem areas and bottlenecks. Additionally, it enables the verification of the KPI and automates routine processes.
To learn more about how effectively you can verify KPIs, see our complete course Essential Supply Chain KPIs Measure, Analyze, Improve
Value Creation (Lean application)
Those Businesses that comprehend value creation focus on the regular assessment of their product or services. In addition, it helps the business to be cost-effective while providing the best product or service that eventually improves customer experience.
Customer Feedback
Businesses Lean on the customer experience by the feedback of the customer. Feedback is the key player that helps the businesses to improve.
Conclusion
In Conclusion, the process of finding the Cost Efficiency and Cost Effectiveness of any business is its inherent detail process. However, through Cost Efficiency and Cost Effectiveness, businesses align their strategies with their long-term goal, current performance, and a balance between supply and demand. Cost Efficiency and Cost Effectiveness not only help businesses optimize their processes but also improve their product/ service and enhance the overall customer experience.
Have to look at our YouTube Video for the insightful discussion on Logistics Course How to Reduce Costs in Logistics | On-Time with Dr. & Serge Logtech Podcast
About the Author – Dr. Muddassir Ahmed
Dr. Muddassir Ahmed is the Founder & CEO of SCMDOJO. He is a global speaker, vlogger, and supply chain industry expert with 19 years of experience in the Manufacturing Industry in the UK, Europe, the Middle East, and South East Asia in various Supply Chain leadership roles. Dr. Muddassir has received a PhD in Management Science from Lancaster University Management School. Moreover, Muddassir is a Six Sigma black belt. He has founded the leading supply chain platform SCMDOJO. It enables supply chain professionals and supply chain teams to thrive by providing best-in-class knowledge content, tools, and access to experts.
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