Can Too Much Efficiency Be a Bad Thing?

Study shows some slack in key resources may yield benefits for manufacturers; managers advised to look beyond efficiency gains in strategic decisions

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Montreal — March 31, 2011 — All things in moderation — even efficiency.

That's the message that emerges from an in-depth study of the financial performance of all publicly traded U.S. manufacturing firms from 1991 to 2006.

The study, reported in the current issue of the Journal of Operations Management, sheds new light on a dilemma that has resurfaced amid global manufacturing and supply chain disruptions stemming from the recent earthquake and tsunami in Japan: While maximum efficiency may serve companies well when everything is flowing smoothly, firms with little or no resource slack are also highly vulnerable to any external shocks.

The findings provide empirical evidence to support the view, advanced by some researchers, that as manufacturers pursue ever-greater efficiency, they experience tradeoffs that may lead to diminished performance.

"Although resource efficiency is important for firms to increase their financial value, there are also benefits of maintaining some slack in key resources," conclude the study's authors, Prof. Sachin B. Modi of the University of Toledo's College of Business and Innovation and Prof. Saurabh Mishra of McGill University's Desautels Faculty of Management.

The study builds on previous research by investigating the relationship of inventory, production and marketing-resource efficiency with three metrics of firms' financial performance: stock returns; Tobin's Q (the ratio of a firm's market value to the replacement cost of its assets); and returns on assets.

The authors' analysis of key data over the 16 years through 2006 shows that a focus on resource efficiency is positively related with all three of the metrics studied. But it also shows that the financial gains from efficiency exhibit diminishing returns for inventory and production resources under all three metrics — and for marketing resources under two of the three metrics.

"Overall, the results thus reveal that a focus on resource efficiency, albeit with a moderate level of slack, affords higher financial value to firms," according to Modi and Mishra. This finding bolsters the argument "that a focus on cost efficiency is typically not sufficient for competitive advantage, and thus should further motivate operations managers to look beyond efficiency gains in making their strategic decisions."

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