What is X-inefficiency?
The term was introduced by economist Harvey Leibenstein in 1966. He argued that firms don't always minimise costs, as traditional theory assumes. When competition is weak, such as for monopolies, protected industries or state-owned businesses, managers and staff face less pressure to be efficient, and costs drift upward.
Causes
- Lack of competition or regulatory protection
- Weak incentives or accountability
- Poor processes and outdated systems
- Overstaffing and duplicated work
- Little monitoring of costs and performance
Signs in a business
- Rising [overhead](/glossary/overhead) as a share of revenue with no clear reason
- Costs well above industry benchmarks
- Manual, repetitive processes that could be automated
- Slow decision-making and approvals
How to reduce it
- Benchmark costs against peers using [KPIs](/glossary/key-performance-indicators-kpis)
- Use [zero-based budgeting](/glossary/zero-based-budgeting) to challenge every cost
- Automate bookkeeping, invoicing and reporting
- Link incentives to efficiency and results
Example
A company that dominates its local market keeps three approval layers for every small purchase and still reconciles accounts by hand. Its costs per transaction are double those of competitors in more competitive markets. That gap is X-inefficiency.