Why We Fascinate and Focus on Total Efficiency
“The worst enemy of life, freedom and the common decencies is total anarchy; their second worst enemy is total efficiency” Aldous Huxley
This is a series of articles on the challenges facing modern businesses. It is told by drawing metaphors from the history of entropy. What’s the motivation? Partly to satisfy my own curiosity to understand ever more about software development, team dynamics, products and innovation, and organisational change. But in doing that hopefully provide benefit to others, to give insight and context to many of the modern buzzwords: those of Lean & Agile; strategy & culture; servant leadership & management; pivots & transformation; uncertainty & feedback loops; scale & complexity; and many more.
The Carnot Engine
Last year marked the 200th anniversary of the death of James Watt. He is most associated with the steam engine although the concept long pre-dated his birth. The steam engine works by changing heat energy into kinetic energy — allowing it to do mechanical work.
James Watt’s innovation was that of a separate condenser for steam engines which radically improved their efficiency. In doing so it made it economically viable in many cases for machines to replace manpower, thus triggering the Industrial revolution. So started a fascination of energy and how we can harness it.
Nearly five years after Watt’s death, a Frenchman, Sadi Carnot, recognised that heat always transfers from a hot body to a cold body and that the maximum amount of mechanical work that could be derived would be the difference in energy as a result of this transfer.
From this he identified a theoretical maximum for the efficiency of a steam engine — the Carnot Engine. In practice no real heat engine could ever achieve this 100% efficiency due to factors such as friction or dissipation. Unfortunately, Carnot died young with little recognition of his work. No one could know that his ideas had laid the foundations for what would later become one of the most famous laws in science — the second law of thermodynamics. Otherwise known as entropy.
This is the first metaphor I’d like to explore — our search and desire for a Carnot Engine. The lure of total efficiency.
What is efficiency?
Firstly, let’s agree what efficiency means as it is one of those words that can be used in many contexts and with different interpretations. Searching for definitions there are many — performing or functioning in the best possible manor, doing things well, doing things right, minimising waste, maximising productivity. Are we any clearer? Let’s skip a philosophical debate and agree a definition:
A measure of how little resource we need to achieve a desired outcome (where resource could be space, size, money, people, energy, time, effort, etc).
So why are we so fixated with efficiency? It is something we strive for everyday because it makes our lives better or easier: fuel economy, a warmer jacket, better battery life, getting fitter, abbreviations, recycling, finding a bargain, taking shortcuts, or meeting that deadline. The list is endless.
There is also a negative side as it relates to the competition for scarce resource — the rich get richer, the poor get poorer, cost cutting, redundancies, pay cuts, reducing benefits, greed, conceit and exploitation. It can even be about survival. Think of the slowest animal in the stalked herd, the wounded soldier on the battlefield, or the company reporting heavy losses.
In a way, the urge to optimise is innate amongst us, and the rest of the natural world. This is referred to as the path of least resistance or principle of least action.
So how do we maximise efficiency? That depends on the context. There are many methods of efficiency with trade-offs required between them. A lot depends on the scale, diversity and complexity of the environment we are operating in. It is for this reason that efficiency is so often misunderstood and can have so many different interpretations. Let’s explore some of these methods of efficiency starting with the simplest, before moving onto the complex.
Resource optimisation
These are our most intuitive methods of efficiency which we use every day. They increase efficiency by concentrating on the resource being used.
- increase reuse — this might be a tool or technology we acquire, a skill we develop through practice, or even just a habit we form through repeated action. The efficiency involved relates to the cost of acquiring the resource — whether it is bought, made or learned. Once we have paid this cost, we can then reuse this resource almost for free (the saving can be reduced a little by a cost to keep the resource available for reuse — cost of storage, refreshing skills, etc). This puts us at an advantage over always acquiring a resource, or over someone else who doesn’t have the resource. For example, I could plaster a wall in my house but I’d have to learn how to plaster first. So instead I pay a plasterer to do it for me as they are more efficient as they have already paid the cost of acquiring that skill.
- find better — find a resource that is cheaper or faster than the one you currently have. This has been a key driver in the development of our species. From the origins of civilisation with the development of tools, use of slave labour and pack animals. To the modern world of technological advance with first the industrial revolution and mechanisation, and now in the information age with automation, and globalisation where we outsource to cheaper geographical locations.
- maximise usage — so you have a resource but can you use it more than you currently do? Think of resource utilisation and overtime.
- prioritise usage — given our resources are scarce what do we apply them to maximise the outcome of their usage. For example with constrained resources choosing the next book to read or film to watch (time), which car to buy (money), where to go on holiday (money), who to invite to your party (space), what furniture to put in your house (space and money), triage in a hospital (time). We are always prioritising.
Scale exploitation
As we have grown from families to tribes, states to nations, empires to a global economy, the increasing scale of our endeavours has revealed a multitude of new efficiencies. The real exploitation of this started in the 18th century with the industrial revolution, followed by mass production and then management thinking in 20th century corporations. It has had a profound impact on our quality of lives. So what does scale have to do with efficiency? For example, I have two Weetabix for breakfast. My three year old daughter has three. Yet I am probably seven times heavier. If this was proportional, I should be eating 21 Weetabix! Why is this? Basically, when things scale not everything scales proportionally. For example, a house with two floors is twice the volume of a single floor house but it is not twice the price. This is because a lot of costs are independent of the volume — land, foundations, roof, etc. Economies of scale identify a property that is not scaling in proportion to another, and then leverage this for efficiency. Let’s look at common terminologies.
- spreading overhead — this is one of the most fundamental scale economies in business. Overhead costs are those fixed in relation to the production process — buying or renting premises (e.g. office, factory, shop, etc), permanent staff salaries, utility bills, insurance, management salaries and admin staff. If your production fell to zero you would still have these costs. These fixed costs are actually only fixed within a certain scale, what is referred to as the short run (in the long run everything is variable). For example, the cost of an office will only be fixed until you have to move to a bigger office, or two offices. In a way, this efficiency is like our fundamental efficiency of maximising usage but with regards to one property in relation to another. Variable costs include salaries of contractors and raw materials involved in production. At a small scale the overhead is a significant contributor to the overall cost. As scale increases and production goes up the impact of overhead reduces.
- batching — a transaction cost is the fixed cost involved in an economic exchange. The variable cost is the effort to produce the production units associated with the transaction. For example, if you do a weekly supermarket shop then the transaction cost is the fuel trip cost in your car. The variable cost is the goods you buy. If you change from shopping weekly to biweekly then your transaction cost has halved. In a production process, there may be a number of stages where each stage needs setup. This could include transporting materials to the equipment and reconfiguring equipment for the batch needs. These contribute to the transaction cost. If you can batch up the production units within a transaction then the number of setups at every stage are reduced. For smaller companies batching is more difficult as they don’t have the capital to support the additional work in progress that it entails (this was Toyota’s predicament post-war which partly led to the just-in-time innovation).
- specialisation — when a certain scale is achieved, it becomes possible through cooperation to specialise — that is for something to focus on a specific area within some larger system. This applies not just in business but in any human social group and in fact at all levels of biological organisation — animals, insect colonies, genes within a genome, cells within the body, even bacteria. Adam Smith recognised the economic benefit of this in “The Wealth of Nations” in 1776 exhorting the virtues of division of labour and free trade. At an individual level, the efficiency comes through the cost of acquiring skills. It is cheaper if a set of groups each master one skill than everyone masters all the skills. Another saving from this is the Babbage Principle which recognises that when you specialise, there are different activities at different skill levels and you can hire people with the appropriate level of skills to do each job, rather than having highly skilled (and expensive) people spending time on lowly skilled work. Another form of specialisation is expensive but more efficient equipment. Again, scale is required to be able to purchase (spreading overhead cost) and adequately utilise it.
- mutual scale benefits — a by-product of operating at scale is that you deal with other suppliers at scale and leverage their scale economies. Bulk ordering is one example. If it is a smaller supplier a large order can also give longer term security and they will be willing to pay to achieve that certainty. Another example is that bigger firms with more assets get better credit ratings and can borrow more cheaply. From the bank’s point of view not only do they deem larger companies as less risk, they can loan a lot more money in one transaction and therefore save on transaction costs.
- geometric — if an elephant was scaled proportionally down to the same size of a mouse, its legs would be much thicker; and if an A380 aircraft was scaled proportionally down to the size of a 737 its wings would be much bigger. But why? It is because of the square-cube law. The surface area scales according to the square of the dimension whereas the volume increases by the cube. This has efficiency implications for all sorts of industries — packaging, cargo, transport, storage, brewery tanks, pipework. It was James Watt’s knowledge of this law that led to his innovation that sparked the industrial revolution.
- centralisation — this is a strategic decision to leverage scale economies by preferring to structure decision making, function or infrastructure into fewer forms. This makes use of some of the scale economies already discussed such as spreading overhead or specialisation. This could be local services such as police stations, banks or hospitals. Or it could be pooling specific functions (e.g. customer services, IT, procurement). Companies like Amazon have leveraged this with huge warehouses to offer greater variety via a website, whilst in high street chains their variety is limited by the size of the inventory that can be stocked in their smaller more local shops. Centralisation can also be of management.
- opportunity cost — although not directly a scale economy, it is helpful to introduce the concept here as it can be applied in different ways when a market reaches a certain scale and specialisation occurs. It is the cost incurred by not having a resource utilised on the best alternative, so a type of prioritisation of resource usage. One form of this is comparative advantage where at a national (or regional) level, if another nation specialises in an item and produces it cheaper than you (because of access to natural resources, expertise, etc), it pays to import those goods from them (rather than produce yourself) in exchange for goods that you can produce cheaper than them. In that way both nations benefit. This concept helps to explain why free trade is mutually beneficial. Another example is where a business makes strategic choices to ensure their employees concentrate on innovative work that is key to the business core domain and product USP, rather than have them work on any ancillary capabilities which can be outsourced or purchased as commodity products or services. Wardley maps are a great visualisation tool to help in optimising this decision making.
Summary
So we know all about resource efficiency and scale efficiency, is this everything we need to be efficient? Certainly, this is where a lot of people draw the line but if only it were that simple. When we derive efficiency from scale it is through the dependency between different properties as we discussed earlier. But with scale comes many more dependencies and relationships and the definition of efficiency suddenly becomes much more nuanced and contradictory. Our different types of efficiencies are in themselves interdependent and a multitude of trade-offs are required. Next time let’s discuss what happens to efficiency when we consider systems and complexity.
References
Entropy God’s Dice Game — Oded Kafri and Hava Kafri
Entropy: The Truth, the Whole Truth, and Nothing But the Truth — Arieh Ben-Naim
Scale: The Universal Laws of Life and Death in Organisms, Cities and Companies — Geoffrey West
