For many businesses an 80/20 analysis can be very beneficial. What is it? And how could you use it in your business?
What Is It?
The idea behind the 80/20 principle is that the relationship between causes and effects is not balanced. That 80% of the results come from 20% of the effort. 80% of the consequences come from 20% of the causes. This is not perhaps what you would expect, but it has been proved to be remarkably accurate.
Why “80/20”?
The phrase ‘80/20’ has become a form of shorthand and the relationship is not necessarily exactly 80/20. It might be 90/10, 70/30 or something else, but it’s almost never 50/50.
Where Does The Idea Come From?
Vilfredo Pareto (1848-1923), an Italian economist, studied patterns of income distribution and discovered not only that the majority of income and wealth was being enjoyed by a minority of people, but that this unbalanced relationship was reliably predictable. As a result he developed a mathematical model to explain this relationship.
Later, Joseph Juran (1904-2008) noted in his work as an engineer that the majority of defects in products could be attributed to just a few causes. He coined the phrase ‘Pareto Principle’ which the 80/20 principle is also known as. He found application for this principle in quality management and became a leading expert and write in that field. His work initially found a great deal of success in Japan and many consider that Japan’s ascendance to become a leading nation in production quality was connected to the Pareto Principle and Juran’s application of this.
Many businesses have found that the 80/20 principle has a broad, universal application across all aspects of the business, not just quality control.
How Can I Use 80/20 To Grow My Business?
The essential idea is that in any area of your business there are a ‘vital few’ factors that are leading to the majority of your results. So, if you can consistently look to generate the most money with the least expenditure of assets and effort you are in a position to grow your business exponentially, enjoy your current income with a more relaxed lifestyle, or perhaps a bit of both.
There is no one-stop solution that will fit each business. Rather it is necessary to start looking at your business in the light of the 80/20 principle and determine how you can take advantage of what you discover.
Broadly you could consider your business in the light of these 3 areas:
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Are you in the right market?
The 80/20 principle suggests that 20% of the businesses in a particular market are achieving 80% of the profits. Are you one of those businesses? How can you make sure that you are one of the top 20% in your field? What are the most successful businesses in your field doing? Could you imitate that? What are successful businesses doing in other fields? Could you find some way to apply it to your business?
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Which of your customers are the most profitable to you?
The 80/20 principle suggests that 20% of your customers are generating 80% of your profit, which means you could be spending considerable time on customers who give you very little. Establish who those 20% are and consider why they are profitable. If there is a pattern to the 20% can you concentrate your efforts on winning more of those 20% type clients? Or could you give more focus to the 20% you already have to gain larger fees or more orders? If getting the time to do that is a problem, you could ‘sack’ some of your 80% customers to free yourself up. While it seems counter intuitive to let customers go, the effect to your bottom line could be negligible in the short-term but the long-term gain could be substantial.
A further application would be to consider more carefully your customer acceptance procedures. Rather than accepting all-comers, devise a process that enables you to identify if the customer will join your top 20% or not. If the answer is no, firmly resist the urge to take them on because they will just take up time for little profit.
If you operate across a number of market segments then it is also worth analysing your business by those segments. Are you more profitable in certain segments? If so, why is that? Why not target that segment to find more customers?
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Which areas of your business contribute the most to profit?
Breakdown your business into its various areas, perhaps the staff, different offices, products, marketing policies. Find where the 20% is that is generating the most results and consider what you can do to reinforce or give further support to that area, and what you could do to bring the 80% up towards the level of the 20%.
For instance, suppose you have a sales team of 5. The 80/20 principle suggests that 1 will be much better than the rest. Work out why that is. Perhaps it’s personality, in which case when recruiting could you look for that personality? Perhaps it’s the methods they use, in which case are there ways to encourage or train the others to copy those methods.
Or perhaps you use 10 different marketing methods. The likelihood is that only a couple are giving you the most results. Could you give more time and resources to those methods and perhaps reduce or even eliminate other methods?
Taking 80/20 Forwards
There are many applications and areas of business life where considering the 80/20 principle will help your business to grow. Among the top business applications of the 80/20 Principle are:
- Stock management.
- Cost reductions and improvement of service provided.
- Marketing
- Business strategy.
- The analysis of and then making decisions.
If you would like any help in seeing how applying the 80/20 principle might make your business grow please give Seamus Parfrey a call on 021 431 0266.