“What’s the difference between improvement and optimisation?”. This is a question I was asked by a Six Sigma Master Black Belt during a recent Business Process Improvement course. They said their managers seemed to use the words ‘improve’ and ‘optimise’ (or ‘optimize’ for our U.S. friends) to mean the same thing.
It is a good question. One of the common problems in organisations is the misuse of language. For example, a simple idea, tactic or plan can sound much more impressive if you describe it as a ‘strategy’.
Here’s the answer I gave, and it seemed to satisfy the questioner, but please feel free to challenge in the comments. I hope there may be better answers:
Improvement or Optimisation?
Improvement generally refers to trying to make something better. It is an action of some sort, either a single initiative in the form of a project, or it can refer to the continuous improvement of a process.
Within any improvement, there will be choices. For example, if you are working on sales processes, an aim may be to increase revenue. In a not-for-profit organisation, the equivalent goal might be to achieve an increase in funding. However, in order to do that it may become apparent that it requires an increase in cost. In this case, the better aim might be to maximise profit. In doing so, the work might reveal an optimum cost level for any given revenue that will deliver this. So, improvement can deliver optimisation, as either an immediate output or maybe a long-term outcome. The improvement activity delivers the optimisation. Therefore, the terms are not equivalent.
For most organisations, an important aim is usually to increase revenue (or funding). This is often a target for Sales teams, for example, but it is not a great choice of goal. If you step back and consider the bigger picture, the reason for wanting to increase revenue is normally to increase profit. and, therefore, increase the return on investment (ROI). Increasing profit and ROI result from increasing revenue at a faster rate than the associated costs.
The problem is that most revenue increases require higher related costs. Typically these will be ‘costs of sale’ or variable costs, but in some cases, this will also require an increase in fixed costs. So, a better aim might be to increase revenue with a minimum cost increase. As a result, the profit and, therefore, the ROI will increase as much as possible. An increase in revenue that causes an associated reduction in profit, profit margin, or return on investment, is clearly an increase that is not worth pursuing.
This leads on to settings the right goals and targets, which is a bigger topic that we will cover in a separate post. In theory, the sales example is quite simple. To greatest return, sales targets should be based on net profit. However, most organisations use the revenue. Why is this? In some cases, it will be because of precedent which is an aspect of the “that is how we have always done it” mindset. However, there are organisations that have tried to move from revenue-based sales targets to using profit, but it isn’t simple. Revenue is fairly easy to establish. It is usually defined in the sales agreement. However, profit is more complex. While direct costs may be relatively easy to identify, variable costs might not become clear until time has passed. There are also debates about the best way to allocate overheads.
In this sales example, it may be that the best compromise might be to use analytics to try to identify some correlation between eventual profit and another variable such as the specific product, service or market involved. Once the relationship has been identified, the compensation can be varied even though it is still linked directly to revenue.
An increase in revenue, funding, or delivery is only an improvement if the associated costs increase at a lower rate. Delivering the maximum increase for the lowest associated cost is the definition of optimisation. Understanding the difference between improvement and optimisation is important in many areas, not just operations management. Being clear about this distinction plus what your real goals are can also help with choosing the right measures and setting the right targets. The goals, measures and targets that managers use to assess performance will drive behaviours. Driving maximisation when what is needed is optimisation can lead to bad results.