The 80/20 strategic tool

The 80/20 Strategic Tool

Chip Evans, Ph.D.Nancy Thorn

Malcolm McAlpineBrian Wax

Amongamyriadoftheoriesandmanagementpracticesusedinbusinesstoday,the80/20Rulecontinuestostandoutasoneofthesimplestandmosteffectivetoolstounderstandtheunderlyingdynamicsofabusiness. OftencalledPareto’sPrinciple,orLawofTheVitalFew,thissimpleexercisecanhelpuncoverkeyareasofabusinessthatdriveperformanceobjectives,whileatthesametimerevealingareasthatmaybeunder-performingornotsignificantlycontributingtotheoverallsuccessmetricsorKPI’s.

Thepremisebehindthe80/20toolisderivedfromcauseandeffecttheory,orsimply,whatandwherearetheareasofthebusinessthatarecreatingthemostpositiveornegative impact. Asthisprocessofidentificationofimpactevolves,bothareasofthebusinessthathavemoreorlesssignificant impactbegintobecomeveryevident. Utilizingthe80/20methodoftenrevealsaminorityofcomponents(products,programs,customers,processes,etc.)thatareyieldingthemajorityofimpact(marketshare,profitability, revenue,etc.) Forexample,20%ofanorganization’sproductsmaydeliverover80%oftherevenue,or80%ofincomeisderivedfrom20%ofthecompany’sservicesorcustomerbase. Inrealworldapplication,thetheoryrarelyresults inadditivemath-forexample,10%ofthebugsinasoftwareprogrammaybethecausebehind50%ofcustomercomplaints-yettheprinciplestillappliesforuncoveringdriversofperformanceandareasofthebusinessthatareunderperforming. Abusinesscanhave100%shareinaverysmallmarket,butdelivermoretothebottomlinewitha20%shareinalargermarket.The80/20toolcanuncoverandprovideinsights intoirregularitiessuchasthis.

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Introduction

Often criticized for being after-the-fact or not relevant for today’s fast-changingbusiness environment, the 80/20 tool is still one of the most effective methods tounderstand what is happening within a business that creates either a positive ornegative impact. Certainly not intended as a universal panacea to solve day-to-dayproblems, the practice on an ongoing basis, can serve to strengthen and support anorganization’s ability to compete more effectively.

Not only identifying key drivers of the business, but uncovering areas of lesserimpact that have potential to deliver more, is the key benefit of using the 80/20tool. Whether it’s a sales team that needs additional training, a process that can berefined to be more efficient, a service where costs can be reduced, or a product thatcan be reformulated to deliver more features to the customer and margin to thebusiness, the 80/20 process aids in identifying areas that have untapped potential.On the other hand, the exercise can also reveal those segments of the business thatneed to be cut, sold, or otherwise disposed of, and that, by doing so, stops the dragon the other, impact-producing areas.

Making the 80/20 tool a best practice can aid businesses of any size to identify keyfactors to build on, develop, or reduce. This will result in more efficiency, moremargin, more satisfied customers and more sustainability to survive in today’sdigital and global business world, where companies are faced with constantlyadapting to emerging forces and competitive threats.


Simple, Powerful Tool

Effective analytical theory for businessmanagement

Uncovers impact drivers of the business (thedevil is in the detail)Supports understanding and improvingAids in strategic developmentStill relevant and widely usedCan align with today’s more modern datamining, analytical programs, dashboards, etc.


History of the Principle

In 1906, Italian economist Vilfredo Pareto created amathematical formula to describe the unequaldistribution of wealth in his country, observing thattwenty percent of the people owned eighty percent ofthe wealth. In the late 1940s, Dr. Joseph M. Juraninaccurately attributed the 80/20 Rule to Pareto,calling it Pareto's Principle. While it may be misnamed,Pareto's Principle or Pareto's Law as it is sometimescalled, can be a very effective tool to help you manageeffectively


Brief Description of The Rule

What it is

Cause and effect theory

Identifies issues and opportunities

Can be a “search flare”

Creates focus on impact areas

What it is not

May be 30/70, 40/60, not additive math,imbalanced distribution

Not intended to solve all day-to-day problems

Will not act as universal panacea for all business ills


Classic Representation

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25%

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75%

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40

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Pareto Chart of Titanium Investment Casting Defects

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Application of Pareto Principle

Identify a problem/quality issueIdentify data, create testable case with metrics,interviews and analysis (testing for assumptions)Examine results in contrast to perceived evidenceUse Pareto or other method


Some Likely Scenarios

80% of revenue derived from 20% of customers

20% of products generate 80% of profit

20% of sales force produces 80% of sales

80% of complaints come from 20% of products

20% of bugs in a system produce 80% of the problems

80% of the output gets done by 20% of the workers

20% of the effort produces 80% of the results

80% of supplies come from 20% of supplier base


How does 80/20 work

Identifies what makes impact or yields positive results

Helps business build on what’s working and improveon what’s not

Can help streamline processes, product lines, systems,to yield improvement, growth, margin

Allows fact based decision making to eliminate wasteand refine the business

Puts focus on efforts and activities that produce bestoutcomes

Keys in on what is of value


Common Objections

Controversies

Not relevant for today

Always in the past, hindsight

Business moving too fast today to be useful

Limited due to evolving circumstances

Our digital world changing 80/20 to 90/10, etc.

Focus on 20% may not give proper attention tothe rest

Does not promote development of the non-focusparts

Misses future forces impacting the business


Expected ResultsWhile implementing an 80/20 program is not a panaceafor all the problems at a company, it can help solveseveral key business issues and ensure that many of thefollowing benefits are obtained.

Improve revenue and margin

Reduce costs – manufacturing, operations, sales/marketing,customer service, other areas

Reduce complexity in manufacturing, improve economies

Improve quality and reduce product write-offs

Enhance sales/marketing focus

Improve customer service

Drive sustainable strategic growth – business planning

Improved productivity in all departments – focus on products,process, strategies, customers and other areas that drive growth


Example: Implementation and ResultsLargeDairyCompany

Study in mid-2010 showed that out of 700 direct buying customers,105 accounted for 76% of the revenue and volume.

With limited field sales and customer service personnel, this createdan issue. The smaller direct buying customers were taking up adisproportionate amount of time and resources.

The strategic decision was made to not completely drop the 595smaller customers as they represented 28% of the margin, but movethem to an indirect relationship.

Smaller customers were moved to an indirect re-distributor program.

Approximately 90% of the customers and the associated volume wasretained through the indirect distribution program.

With Sales and Marketing focus on the top 105 customers, volumeand revenue growth was increased from 2% annually to 7% 1n 2011.

The 7% growth number was also achieved in 2012


Example: Implementation and ResultsLargeConsumer GoodsCompany Operating intheFoodandBeverage Channel

Away From Home business in 2004 had a total of 420 SKU’s. 200 of theSKU’s delivered 87% of the volume and revenue and 90% of the profit.

Product write-offs, mainly due to expired shelf life, were running at10%, driven almost entirely by the 220 poor-performing SKU’s.

Cross functional team formed in late 2004 and project plan with actionsteps and milestones developed.

During 2005 and Q1 2006, 190 of the poor-performing SKU’s werediscontinued. 85% of the business and customers were retained byswitching to the SKU’s being retained.

The 30 remaining poor performing SKU’s were subject to a priceincrease of between 5 and 12%

Product write-offs reduced to 1.5% of revenue

Profit increased by 3.3%

Manufacturing and Operations costs were reduced by 5.7%www.theevansgroupllc.com 14

Industrial Application

Materials management

Fault detection (field or MFG)

Revenue verses effort

Focus on resource management (sales)

Cost in contrast to revenue


Quality Measure or Strategy

It is post-facto current state

Provides light and focus on problem against pastperformance

It is not continuous performance measure unlessfollowed as a trend

Provides a valid point for analysis (deep dive)

Can support or become the basic strategy for operationimprovement


Define, Measure, Analyze,Improve, Control

In process and post facto metricsDefine in process metrics (SPC)

Measure both in process and result metrics

Analyze for changes and incremental improvement

Adjust as required

Identify feed back loops


Addressing the “other parts”

With greater visibility of lesser performing areas, thereare opportunities to develop potential

Seize these opportunities by level of impactReduce costsUse best sales people on underperforming accountsFix majority complaintsSelective distribution related to customers, products,marketsSimplify forecasting and streamline systemsEliminate unprofitable, low impact activitiesEnhance contribution of underperforming areas


Making the 80/20 Rule Effective80/20 is counterintuitive

Recognizes all causes do not have the same significance, allcustomers are not equal

Application can lead to growth, improved profitability, marketshare

Needs to be done ongoing to reflect changes in business

Helps identify drivers of the business and negative forces thatotherwise might not be so noticeable

Use as tool for digging deeper and managing

Aids in justifying development of otherwise ignored areas thathave potential for further improvement and impact


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