What is the 80/20 principle? A minority of inputs lead to a majority of outputs
The 80/20 Principle asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards. Typically, causes, inputs or effort divide into 2 categories:
- the majority, that have little impact
- a small minority, that have a major, dominant impact.
e.g. 20% of products or customers or employees are really responsible for about 80% of profits
(A useful cousin to 80/20 is the 50/5 principle. Typically 50% of a company’s customers, products, components & suppliers will add less than 5% to revenues and profits)
For Consulting companies,
- 80% profits come from 20% Clients— Large clients and long-term clients. Large clients give large assignments; Long-term client have higher cost to switch to another consulting firm & they tend not to be price sensitive
- 80% results flow from concentrating on the 20% of most important issues
Realize the difference between the ‘vital few’ and the ‘trivial many’. The implication of 80/20 is that output cannot just be increased, it can be multiplied! Conventional wisdom is not to put all your eggs in one basket. 80/20 wisdom is to choose a basket carefully, load all your eggs into it, and then watch it like a hawk!
- How to think & use 80/20: Acting on a few key insights produced the goods
- 80/20 Analysis: Quantitative, Precise, requires investigation, provides facts, highly valuable
Gather data. Arrange the data in descending order of importance; take cumulative data & percentage. Make comparisons between percentages in the two sets of data. Use Bar charts to present data
Caution:
- When using the 80/20 Principle, be selective and be contrarian. Look at what really matters! g. Look at Distribution of profits, but not sales volume!
- 80/20 Analysis is based on a freeze-frame of the situation at a particular point and cannot provide a picture of the trend or of forces that could change profitability. Profitability analysis of the 80/20 type is a necessary but not a sufficient condition of good strategy
- 80/20 Thinking: Qualitative, fuzzy, requires thought, provides insight, highly valuable
Think deeply on any issue that is important to you. Make a judgement on whether 80/20 is working in that area. Act on the insight. Ask ‘What is the 20% that is leading to 80%? What are the vital few inputs or causes, as opposed to the trivial many?’
- Applying 80/20 to business: Generate the most money with the least expenditure of assets & effort
- 3 action implications
- Successful firms operate in markets where it is possible for that firm to generate the highest revenues from the least effort. A firm can’t be judged as successful unless it has a a high ROI, and higher margins
- It is always possible to raise the economic surplus by a large degree, by focusing on those market & customer segments where the largest surpluses are currently generated
- Raise the level of surplus by identifying the parts of the firm (people, factories, sales offices, countries) that generate the highest surpluses; Give them more power & resources
- If you can identify where your firm is getting back more than it is putting in, you can up the stakes and make a killing. (And, the converse too—where you get less, cut your losses.) The ‘where’ can be anything: a product, a market, a customer or type of customer, a technology, a distribution channel, a department, a type of transaction, an employee or team
- Do an 80/20 Analysis of Profits by different categories of business
- First, By product/product group/type
- Second, By customer/customer group/type
- By any other relevant ‘split’ having data e.g. geographical area, distribution channel
- By competitive segment
Two other questions, besides profitability, those are key to strategy:
- Is the segment an attractive market to be in?
- How well is the firm positioned in each segment?
- Segmentation: The greatest insights come from a combination of customers & products into ‘dollops’ of business defined with reference to your most important competitors. A competitive segment is a part of business where it faces a different competitor or different competitive dynamics. i.e.
- Do you face a different main competitor in this part of business compared to the rest of it? If yes, that part of the business is a separate segment
- Do you and your competitor have the same ratio of sales or market share in the 2 areas: or are they stronger in one area and you in another
- 4 steps to lock-in your core Customers
- Identify your key customers; and profile the heavy & frequent consumer
- Provide them exceptional or outrageous service—beyond the call of duty
- Target new products/services at this core customers, developing solely for & with them
- Keep your core customers forever by developing relationship (strength, length, depth)
‘Serving the core 20% of customers must be a company-wide obsession!’
- Increasing Salesperson performance
- Hang on to your high performers. Stay close to them
- Hire more of the same type of salesperson. Ask them to hire more people like them
- Identify what the top performers sell the most and what they do differently then
- Get everyone to adopt the methods that have the highest ratio of output to input
- Switch a successful team from one area with an unsuccessful team in another area
- In Salesforce training: Train only those who are likely to stay on for several years
Sales Managers should:
- Focus efforts on the 20% of products that generate 80% of sales. Reward Salespersons for selling the most profitable products
- Focus on the 20% of customers generating 80% of sales & 80% of profits. Get customers ranked by sales & profits. Insist Salespersons spend 80% of time on their 20% customers
- Put the highest vol. & profit accounts under 1 salesperson/team, regardless of geography
- Lower costs and use the phone for less important accounts
- Get Salespersons to revisit old customers who have provided good business in the past
- Five rules for decision taking with the 80/20 principle
- Not many decisions are very important. So, don’t waste time over the unimportant decisions
- The most important decisions are often those made only by default. So, occasionally step back to look for intuition and insight, rather than analysis. What you need are intuition and insight: to ask the right questions rather than getting the right answers to the wrong questions
- 80/20/100/100 rule: Gather 80% of the data and perform 80% of the relevant analysis in the first 20% of the time available, then make a decision 100% of the time and act decisively as if you were 100% confident that the decision is right
- If what you’ve decided isn’t working, change your mind early. Don’t fight the market!
- When something is working well, double your bets. Don’t settle for modest growth!
- Project Management: Focus all team members on the few things that really matter
- Simplify the Objective. Have one simple aim
- Impose an impossible time scale. This ensures the team focuses on the real value adding 20%.
- Plan before you act. In this phase:
- Write down all the critical issues to resolve (If more than 7, remove the least important)
- Construct hypotheses on what the answers are, even if pure guesswork
- Work out what info required or processes to complete to test your hypotheses
- Decide who is to do what and when
- Re plan after short intervals
- Design before you implement. Or there will be massive, costly rework
- Negotiation: Few points in a negotiation really matter. Don’t peak too early
- Applying 80/20 to Life: Work Less, Earn & Enjoy more
- Detonate Time-revolution: There is no shortage of time. We only make good use of 20% of our time
- Dissociate effort and reward. Think Productive laziness!
- Give up guilt. Doing what you like doing and making it your job is great, not wrong!
- Pursue those few things where you are amazingly better than others
- Identify the 20% that gives you 80%. Multiply that! Eliminate/reduce low value activities
- Aim to have a lot of money. Start investing early in life. But don’t get overboard
- Identify top relationships with allies & loved ones, nurture them. The best relationships are built on (a) Mutual enjoyment (b) Respect (c) Shared experience (d) Reciprocity & (5) Trust
- The 7 habits of happiness: Make happiness the choice
(a) Exercise (b) Mental stimulation (c) Spiritual/artistic stimulation/meditation (d) Doing a good turn (e) Taking a pleasure break with a friend (f) Giving yourself a treat &
(g) Congratulating yourself
- Simple is Beautiful! Progress requires simplicity. Simplicity requires ruthlessness
- 1/5th of a company’s revenues account for 4/5th of its profits & cash
- If you focus on the most profitable segments, you can grow them surprisingly fast. Harvest these segments- let go off the less profitable customers & products, cut off most support & sales effort, raise prices, and allow sales to decline and start making good profits!
- Larger firms losing Market Share to smaller firms—because of the cost of complexity. Additional scale without additional complexity will always give lower unit costs
- Outsource: Decide which is the part of the value-adding chain (R&D/manufacturing/ distribution/ selling/marketing/servicing) where your company has the greatest comparative advantage—and then ruthlessly outsource everything else
- Do not listen to Accountants who bleat about ‘exit costs’; a lot of these are just numbers on a page with no cash cost. Even where there is a cash cost, there is normally a very quick payback
- Go for the most ‘simple 20%!’ What is simple and most standardized is hugely productive & cost effective than what is complex
- Immense cost reduction can be achieved by reducing complexity. By winning the war between the trivial many and the vital few. Use three 80/20 insights:
- Simplification thro’ elimination of unprofitable activity
- Focus, on a few key drivers of improvements
- Comparison of performance
- A few key quotes:
- Most likely, you make 80% of profits and cash in 20% of activity, and in 20% of revenues. The trick is to work out which 20%
- Whenever you spot a 20% activity, run to it, immerse into it and use resources to exploit it
- True best-seller books never make it to the charts but sell a reliable quantity at high margin
- 01%of a person’s vocabulary sufficient for 50% of the things to do with a small hand-held!
- Market share gives scale to spread Fixed costs; helps raise prices
- The road to hell is paved with the pursuit of volume. Less is more
- A common excuse for not cutting the product-range by 80% is: ‘the firm will lose stature.’ In reality buyers aren’t interested in being distracted from the products they want to buy
- When reading a book: Read the conclusion Ò the intro Ò the conclusion, then dip lightly