Reasons for measuring efficiency

http://pages.stern.nyu.edu/~wgreene/FrontierModeling/SurveyPapers/Lovell-Fried-Schmidt.pdf pages 10-11

Why the interest in measuring efficiency and productivity? We can think of three reasons. First, only by measuring efficiency and productivity, and by separating their effects from those of the operating environment so as to level the playing field, can we explore hypotheses concerning the sources of efficiency or productivity differentials. Identification and separation of controllable and uncontrollable sources of performance variation is essential to the institution of private practices and public policies designed to improve performance. Zeitsch et al. (1994) provide an empirical application showing how important it is to disentangle variation in the operating environment (in this case customer density) from variation in controllable sources of productivity growth in Australian electricity distribution.

Second, macro performance depends on micro performance, and so the same reasoning applies to the study of the growth of nations. Lewis (2004) provides a compelling summary of McKinsey Global Institute (MGI) productivity studies of 13 nations over 12 years, the main findings being that micro performance drives macro performance, and that a host of institutional impediments to strong micro performance can be identified. This book, and the studies on which it is based, make it clear that there are potential synergies, as yet sadly unexploited, between the MGI approach and the academic approach to performance evaluation.

Third, efficiency and productivity measures are success indicators, performance metrics, by which producers are evaluated. However for most producers the ultimate success indicator is financial performance, and the ultimate metric is the bottom line. Miller’s (1984) clever title, “Profitability = Productivity + Price Recovery,” encapsulates the relationship between productivity and financial performance. It follows that productivity growth leads to improved financial performance, provided it is not offset by declining price recovery attributable to falling product prices and/or rising input prices.

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