The 80/20 strategic tool

1. The 80/20 Strategic Tool
Chip Evans, Ph.D.
Nancy Thorn
Malcolm McAlpine
Brian Wax

2. Amongamyriadoftheoriesandmanagementpracticesusedinbusinesstoday,the80/20Rule
continuestostandoutasoneofthesimplestandmosteffectivetoolstounderstandtheunderlying
dynamicsofabusiness. OftencalledPareto’sPrinciple,orLawofTheVitalFew,thissimpleexercise
canhelpuncoverkeyareasofabusinessthatdriveperformanceobjectives,whileatthesametime
revealingareasthatmaybeunder-performingornotsignificantlycontributingtotheoverallsuccess
metricsorKPI’s.
Thepremisebehindthe80/20toolisderivedfromcauseandeffecttheory,orsimply,whatand
wherearetheareasofthebusinessthatarecreatingthemostpositiveornegativeimpact. Asthis
processofidentificationofimpactevolves,bothareasofthebusinessthathavemoreorless
significantimpactbegintobecomeveryevident. Utilizingthe80/20methodoftenrevealsaminority
ofcomponents(products,programs,customers,processes,etc.)thatareyieldingthemajorityof
impact(marketshare,profitability,revenue,etc.) Forexample,20%ofanorganization’sproducts
maydeliverover80%oftherevenue,or80%ofincomeisderivedfrom20%ofthecompany’s
servicesorcustomerbase. Inrealworldapplication,thetheoryrarelyresultsinadditivemath-for
example,10%ofthebugsinasoftwareprogrammaybethecausebehind50%ofcustomer
complaints-yettheprinciplestillappliesforuncoveringdriversofperformanceandareasofthe
businessthatareunderperforming. Abusinesscanhave100%shareinaverysmallmarket,but
delivermoretothebottomlinewitha20%shareinalargermarket.The80/20toolcanuncoverand
provideinsightsintoirregularitiessuchasthis.
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Introduction

3. Often criticized for being after-the-fact or not relevant for today’s fast-changing
business environment, the 80/20 tool is still one of the most effective methods to
understand what is happening within a business that creates either a positive or
negative impact. Certainly not intended as a universal panacea to solve day-to-day
problems, the practice on an ongoing basis, can serve to strengthen and support an
organization’s ability to compete more effectively.
Not only identifying key drivers of the business, but uncovering areas of lesser
impact that have potential to deliver more, is the key benefit of using the 80/20
tool. Whether it’s a sales team that needs additional training, a process that can be
refined to be more efficient, a service where costs can be reduced, or a product that
can be reformulated to deliver more features to the customer and margin to the
business, 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 that
need to be cut, sold, or otherwise disposed of, and that, by doing so, stops the drag
on the other, impact-producing areas.
Making the 80/20 tool a best practice can aid businesses of any size to identify key
factors to build on, develop, or reduce. This will result in more efficiency, more
margin, more satisfied customers and more sustainability to survive in today’s
digital and global business world, where companies are faced with constantly
adapting to emerging forces and competitive threats.
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4. Simple, Powerful Tool
Effective analytical theory for business
management
Uncovers impact drivers of the business (the
devil is in the detail)
Supports understanding and improving
Aids in strategic development
Still relevant and widely used
Can align with today’s more modern data
mining, analytical programs, dashboards, etc.
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5. History of the Principle
In 1906, Italian economist Vilfredo Pareto created a
mathematical formula to describe the unequal
distribution of wealth in his country, observing that
twenty percent of the people owned eighty percent of
the wealth. In the late 1940s, Dr. Joseph M. Juran
inaccurately 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 sometimes
called, can be a very effective tool to help you manage
effectively
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6. 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
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7. Classic Representation
0%
25%
50%
75%
100%
0
20
40
60
80
100
shrink porosity weld LOF shell inclusion hard alpha
inclusion
tungsten inclusion
Pareto Chart of Titanium Investment Casting Defects
DefectFrequency
CumulativePercentage
.
. . .
.
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8. Application of Pareto Principle
Identify a problem/quality issue
Identify data, create testable case with metrics,
interviews and analysis (testing for assumptions)
Examine results in contrast to perceived evidence
Use Pareto or other method
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9. 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
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10. How does 80/20 work
Identifies what makes impact or yields positive results
Helps business build on what’s working and improve
on what’s not
Can help streamline processes, product lines, systems,
to yield improvement, growth, margin
Allows fact based decision making to eliminate waste
and refine the business
Puts focus on efforts and activities that produce best
outcomes
Keys in on what is of value
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11. 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 to
the rest
Does not promote development of the non-focus
parts
Misses future forces impacting the business
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12. Expected Results
While implementing an 80/20 program is not a panacea
for all the problems at a company, it can help solve
several key business issues and ensure that many of the
following 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
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13. Example: Implementation and Results
LargeDairyCompany
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 created
an issue. The smaller direct buying customers were taking up a
disproportionate amount of time and resources.
The strategic decision was made to not completely drop the 595
smaller customers as they represented 28% of the margin, but move
them to an indirect relationship.
Smaller customers were moved to an indirect re-distributor program.
Approximately 90% of the customers and the associated volume was
retained through the indirect distribution program.
With Sales and Marketing focus on the top 105 customers, volume
and revenue growth was increased from 2% annually to 7% 1n 2011.
The 7% growth number was also achieved in 2012
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14. Example: Implementation and Results
LargeConsumerGoodsCompanyOperatingintheFoodandBeverageChannel
Away From Home business in 2004 had a total of 420 SKU’s. 200 of the
SKU’s delivered 87% of the volume and revenue and 90% of the profit.
Product write-offs, mainly due to expired shelf life, were running at
10%, driven almost entirely by the 220 poor-performing SKU’s.
Cross functional team formed in late 2004 and project plan with action
steps and milestones developed.
During 2005 and Q1 2006, 190 of the poor-performing SKU’s were
discontinued. 85% of the business and customers were retained by
switching to the SKU’s being retained.
The 30 remaining poor performing SKU’s were subject to a price
increase 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%
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15. Industrial Application
Materials management
Fault detection (field or MFG)
Revenue verses effort
Focus on resource management (sales)
Cost in contrast to revenue
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16. Quality Measure or Strategy
It is post-facto current state
Provides light and focus on problem against past
performance
It is not continuous performance measure unless
followed as a trend
Provides a valid point for analysis (deep dive)
Can support or become the basic strategy for operation
improvement
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17. Define, Measure, Analyze,
Improve, Control
In process and post facto metrics
Define in process metrics (SPC)
Measure both in process and result metrics
Analyze for changes and incremental improvement
Adjust as required
Identify feed back loops
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18. Addressing the “other parts”
With greater visibility of lesser performing areas, there
are opportunities to develop potential
Seize these opportunities by level of impact
Reduce costs
Use best sales people on underperforming accounts
Fix majority complaints
Selective distribution related to customers, products,
markets
Simplify forecasting and streamline systems
Eliminate unprofitable, low impact activities
Enhance contribution of underperforming areas
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19. Making the 80/20 Rule Effective
80/20 is counterintuitive
Recognizes all causes do not have the same significance, all
customers are not equal
Application can lead to growth, improved profitability, market
share
Needs to be done ongoing to reflect changes in business
Helps identify drivers of the business and negative forces that
otherwise might not be so noticeable
Use as tool for digging deeper and managing
Aids in justifying development of otherwise ignored areas that
have potential for further improvement and impact
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