Why efficiency is everything
At the top of an income statement sits revenue. That income filters through expenses to leave net income, or profit, on the other side. What happens in between is where efficiency plays a crucial role.
If a firm can create more net income by lowering its cost of goods sold, general or administrative expenses, or its tax liabilities, that leaves everyone better off. The customer can benefit from lower prices since the firm can undercut its rivals and thereby expand its market share. The managers benefit by running a more dominant firm that reinvests its profits and becomes more valuable. Shareholders benefit by seeing an increase in the value of their assets and returns via dividends.
This is when things go right. Of course, things can go wrong, and more profit is squeezed out at the expense of something else, like higher prices for consumers, lower pay for workers, higher pay for managers, or inferior quality of products or services.
However, whether that’s the case on average is a topic for another day. My hunch is that this scenario happens far less often than we might think, despite the prevailing narrative. An activist investor like Carl Icahn, or a hedge fund taking a short position like Hindenburg Research, which happened to short Icahn last week, often punish companies for engaging in such activities, since over time those activities lower the overall value of the firm.
Activist investors aren’t the only reason companies seek efficiency. As capital ebbs and flows through different market ups and downs, pressures from that market demand that companies tighten the ship. Interest rates may rise, causing companies laden with debt to trim their balance sheets. New technologies may rip through the market, causing companies to adjust because of competition or because of obsolescence. We’re seeing the latter happen—the not-so invisible hand—right before our eyes.
A recent article in The Wall Street Journal described several companies getting leaner, from AT&T to Waste Management to Meta to Shopify. The takeaway is that little changes go a long way.
AT&T has saved its employees three million hours a year by eliminating needless tasks and 300 million clicks a year by eliminating one of two clicks to connect to its computer network. Waste Management found better routes for its trucks, allowing drivers to pick up one extra dumpster, a 20% improvement. Shopify deleted 12,000 events from its employees calendars, saving 322,000 hours.
In The Tao of Charlie Munger, Munger describes Costco’s obsession with cost-cutting initiatives, which is partly why Buffett and Munger love the company so much. Here’s a small example. You wouldn’t think grocery bags are very expensive for a company, but pennies add up quickly. By not using plastic grocery bags and opting to use the boxes in which the food was delivered, the company can save about $45 million per year.
AI and the resulting competition are having the same effect. If software engineers can output better code faster, their employers can either reduce headcount to maintain the same productivity or increase overall productivity while keeping costs the same. Ditto for writers, marketers, designers, and other knowledge workers’ output thriving because of new AI capabilities. Alphabet, the parent company of Google, is delivering more AI products because of new competition from Microsoft while also reducing headcount to stay ahead of the pack.
Conversely, a recent report citing the Government Accountability Office (GAO) shows that government programs classified as high-risk for being wasteful have more than doubled since 1990. That includes $60 billion lost during COVID insurance payouts, billions lost in inefficient Defense Department contracts, and more. In their defense, the GAO notes that their improvements have led to hundreds of billions saved over the years.
Why does any of this matter?
When people and companies are more productive, that aggregate productivity improves human well-being. It’s why the average American today is better off than the Sun King of France at the height of the country’s opulence. More productivity meant better, cheaper products for consumers, like oil for lamps or air conditioning for houses, or better, cheaper transportation via trains, planes, and automobiles. Better software products can ship faster, meaning our daily tools improve. More and better marketing services can improve a company’s overall revenue, and thus its value.
In theory, this should have an overall deflationary effect, as you can see with the declining cost of many manufactured goods like TVs, toys, furniture, and more, to say nothing of their simultaneous improved quality.
Sometimes theory doesn’t always work out in reality. Cars, housing, and food have all increased in price in recent years. But perhaps efficiency was key here too. As the money supply increased thanks to COVID stimulus, that money wasn’t moving efficiently through the economy, getting stuck in assets like housing or durable goods like cars, raising their overall prices. Too much money was chasing too few goods.
Perhaps if money moved efficiently from those who have it to those who need it, we wouldn’t have seen such inflation, logjams at America’s ports, or needless spending on needless trinkets. But then again, “the economy” is just a bunch of individual people all trading with each other. In a small way, I’m “the economy.” Perhaps the problem of efficiency lies closer to the human heart.