Idea 17 - The 80:20 principle (50 Management ideas you really need to know)


Idea 17 -  The 80:20 principle

Businesses, like life, become so much easier to manage with a few basic principles you can rely on. Management theorists spend much time trying to pin them down, to formulate them in such a way that they will work again and again. But once you move away from the factory floor, where the laws of physics and statistics prevail, things become far less predictable. So it is with some relief that managers can turn to the '80:20 principle', knowing that it is almost entirely dependable.

The 80:20 principle says that 20% of causes invariably produce 80% of the results, so 80% of what you achieve is due to 20% of the work you put in - and vice versa. It's that simple, but the implications, are many and various, for management and, so evangelists insist, for living itself.

It began life as the Pareto principle, uncovered by Italian economist and sociologist Vilfredo Pareto in 1897. Studying the patterns of wealth in England, he realised that 20% of the people had 80% of the money. Investigating further, he found the same proportion recurring everywhere else he looked, in different times and in different countries. And that was that. No one else took much notice. Not until after the Second World War, at least, when two American-based researchers - a philologist and an engineer - disinterred Pareto's findings.

The philologist was George K. Zipf, who restated what he called the 'principle of least effort' in 1949. This said that resources arrange themselves so as to minimize work, so that 20-30% of the resource accounted for 70-80% of the resulting activity. Next up was engineer Joseph M. Juran, who attached Pareto's name to the principle, though he sometimes called it the 'rule of the vital few'. 'When a long list of defects was arranged in the order of frequency, a relative few of the defects accounted for the bulk of the defectiveness', he wrote, and went on to apply this insight to statistical quality control-with seismic effect.
US industry did not leap at Juran's theories. Lecturing in Japan in 1953, however, he was welcomed with open arms and invited to stay. He did. Separately but in parallel with fellow expatriate W. Edwards Deming, he transformed Japan's shoddy manufacturing standards over time into world-beating quality. One of the great ironies of business history is that Americans, ignored in their own country, should have given Japanese industry the know-how to trounce US manufacturing - and that US industry would be forced to go to Japan to learn what they had spurned.
Predictable It is pointless to discuss the 80:20 principle with mathematicians, who will blind you with ifs and buts. It is not mathematically precise and the principle may manifest itself as 70:30 or even 90:10. The fact remains that there is, as management writer Richard Koch puts it in his very readable The 80/20 Principle, 'a predictable imbalance at work in the universe'.
In the crime industry, 20% of the criminals commit 80% of the crime. Accident statistics show that 20% of drivers cause 80% of the smashes. Even in matrimony, 20% of married couples deliver 80% of the divorces (this figure clearly conceals a high rate of multiple marriage-and-divorces).

After Juran had exported his ideas to an expectant Japan, IBM was one of the first US firms to pounce on Pareto, though not to reduce defects. In the early 1960s it realized that some 80% of a computer's time is spent executing some 20% of the operating code. It promptly rewrote the software so that the most-used 20% was quickly accessible and easy to use. Result? IBM computers became faster and more efficient than the competition, at least for most applications. The lesson was not lost on those who came after, such as Apple and Microsoft.

If you can produce 80% of your results from 20% of your efforts, so can a business, which makes it very appealing. Companies very much want to do what the principle implies, to generate the highest possible sales with the least possible effort.

What Koch calls the '80:20 law of competition' suggests that, in any market, over time 80% of it will be supplied by 20% or fewer of the suppliers though, in the real world, that kind of equilibrium is unlikely to persist for long. Someone will come along and disturb the pattern with a new product or a new twist on the old one. But as firms innovate and compete in more market segments, Pareto will manifest itself within the company - 80% of operating profits generated by 20% of segments, by 20% of customers and by 20% of products. What's more, 80% of operating profits will be produced by 20% of the employees.

One implication is that the company should always be able to raise profits by focusing only on those markets, and only on those customers, where it is already making the biggest profits. Alternatively, or in tandem, it can give more power and resources to that 20% of the firm - people, plants, sales teams or regions - that is producing those 80% of the earnings. At the same time it can starve, eliminate or greatly improve the other 80%.

Koch warns that the 80:20 principle should not be interpreted too rigidly. He points to the book trade as an example. In most bookshops, 20% of the titles - surprise, surprise - make up 80% of the sales. Should they dump the other 80%1 No, because buyers who visit proper bookshops want to find a wide range of books, even if they don't buy them. Cut the range and the customers will go elsewhere. Instead, Koch advises, they should pinpoint the 20% of customers who provide 80% of their profits and give them exactly what they want. Pareto still rules.
Reference: 50 Management Ideas You Really Need to Know

Book by Edward Russell-Walling

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