# Improve Operational Efficiency: Definitions, Examples, and Key Comparisons

## What Is Operational Efficiency?

Operational efficiency is primarily a metric that measures the efficiency of profit earned as a function of [operating costs](https://www.investopedia.com/terms/o/operating-cost.asp). The greater the operational efficiency, the more profitable a firm or investment is. This is because the entity is able to generate greater income or returns for the same or lower cost than an alternative.

In [financial markets](https://www.investopedia.com/terms/f/financial-market.asp), operational efficiency is achieved by lowering transaction costs and fees. This can also be called an "internally efficient market."

### Key Takeaways

*   Operational efficiency is a critical metric that evaluates how effectively a company or investment manages its operating costs to maximize profit.
*   In financial markets, operational efficiency often equates to low transaction costs and fees, enhancing profitability and market competitiveness.
*   Achieving operational efficiency frequently involves leveraging economies of scale, allowing firms to reduce per-unit costs and increase returns.
*   Regulation and structural changes in markets, such as fee caps and eligibility criteria adjustments, can enhance operational efficiency by reducing unnecessary costs.

## How Operational Efficiency Impacts Financial Markets

In investment markets, operational efficiency usually focuses on [transaction costs](https://www.investopedia.com/terms/t/transactioncosts.asp). Operational efficiency in the investment markets can be compared to general business practices for operational efficiency in production. Operationally efficient transactions are those that are exchanged with the highest margin, meaning an investor pays the lowest fee to earn the highest profit.

Similarly, companies seek to earn the highest [gross margin profit](https://www.investopedia.com/terms/g/gross_profit_margin.asp) from their products by manufacturing goods at the lowest cost. In nearly all cases, operational efficiency can be improved by [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp). In the investment markets, this can mean buying more shares of an investment at a fixed trading cost to reduce the fee per share.

A market is operationally efficient when participants can transact at prices that reflect actual service costs. Regulations that cap fees can make markets more operationally efficient by protecting investors from high costs.

### Enhancing Investment Portfolios Through Operational Efficiency

Operationally efficient markets can help to improve the overall efficiency of investment portfolios. Greater operational efficiency in the investment markets means capital can be allocated without excessive frictional costs that reduce the [risk/reward](https://www.investopedia.com/terms/r/riskrewardratio.asp) profile of an investment portfolio.

[Investment funds](https://www.investopedia.com/terms/i/investment-fund.asp) are also analyzed by their comprehensive operational efficiency. A fund’s [expense ratio](https://www.investopedia.com/terms/e/expenseratio.asp) is one metric for determining operational efficiency. A number of factors influence the expense ratio of a fund: transaction costs, management fees, and administrative expenses. Comparatively, funds with a lower expense ratio are generally considered to be more operationally efficient.

## Comparing Productivity and Efficiency in Business

Productivity [serves as a measurement of output](https://www.investopedia.com/terms/g/gross-value-added.asp), normally expressed as some units per amount of time—for example, 100 units per hour. [Efficiency](https://www.investopedia.com/terms/e/efficiency.asp) in production most often relates to the costs per unit of production rather than just the number of units produced.

Productivity versus efficiency can also involve analysis of economies of scale. Entities seek to optimize production levels in order to achieve efficient economies of scale, which then helps to lower per-unit costs and increase per-unit returns.

## Examples of Operational Efficiency in Investment Markets

Funds with greater [assets under management](https://www.investopedia.com/terms/a/aum.asp) (AUM) can obtain greater operational efficiency because of the higher number of shares transacted per trade.

Generally, [passive investment](https://www.investopedia.com/terms/p/passiveinvesting.asp) funds are typically known to have greater operational efficiency than active funds based on their expense ratios. Passive funds offer targeted market exposure through index replication. Large funds have the advantage of economies of scale in trading. Passive funds also have lower transaction costs by following an index's holdings.

In other areas of the market, certain structural or regulatory changes can make participation more operationally efficient. In 2000, the [Commodity Futures Trading Commission](https://www.investopedia.com/terms/c/cftc.asp) (CFTC) passed a resolution allowing [money market funds](https://www.investopedia.com/terms/m/money-marketfund.asp) to be considered eligible margin requirements—prior to this only cash was eligible. This minor change reduced the unnecessary costs of trading in and out of money market funds, making the [futures markets](https://www.investopedia.com/terms/f/futuresmarket.asp) more operationally efficient.

Financial regulators have also imposed an 8.5% [sales charge](https://www.investopedia.com/terms/s/salescharge.asp) cap on mutual fund commissions. This cap helps to improve operational trading efficiency and investment profits for individual investors.

> **Article Sources**
>
> 1.  Commodity Futures Trading Commission. "[History of the CFTC](https://www.cftc.gov/About/HistoryoftheCFTC/history_2000s.html)."
>     
> 2.  Financial Industry Regulatory Authority. "[2341\. Investment Company Securities](https://www.finra.org/rules-guidance/rulebooks/finra-rules/2341)."