80/20 is a business process used to improve operating earnings and to differentiate the company from the competition. It does that by focusing on high growth opportunities and by systematically reducing complexity and variation. The method has four basic and interrelated fronts:
There are different application methods and tools for area of 80/20. As an example, to gain the necessary focus on the select group of customers and products that make up the “sweet spot”, 80/20 utilizes a number of analytical tools, such as customers and products matrix (CP matrix) and quad analysis. These tools belong in the 80/20 toolbox or toolboxes, as different companies have unique tools and call their custom built processes by different names. And there is not a rigid prescription for how to apply them either. Some actually have a hybrid system comprised of 80/20 elements and of other Business Process Improvement (BPI) systems, like Danaher and GE for example. However, almost all common BPIs, including Lean, Six Sigma, Deming Cycle (PDCA), Business Process Reengineering, are built on natural cycles of problem recognition, healing, and improvement, which we can easily relate to, based on similar experiences in our personal lives, when we are faced with a problem of some magnitude. Before solving the problem, we ask questions, gather information and try to understand the nature and complexity of the issue. Then we instinctively prioritize the issues by focusing on the big ones first and putting aside minor problems for a while. Then we explore multiple alternatives, and once there is a viable solution, we look for ways to apply it with the least effort possible. As we solve problems, we learn from the experience and use it to either avoid a similar problem altogether or to solve it faster next time. In either case, we have reached a new level of performance through innovation and moved on to a new baseline. Below is a depiction of Lean and Six Sigma BPI’s steps, stacked against the natural phases of problem recognition, healing, improvement and sustaining. 80/20 is not the same as Lean or Lean Six Sigma. They have both different and symbiotic purposes at the same time. 80/20’s primary objective is to maximize shareholder value while lean’s primary objective is to maximize customer value. They are obviously complementary and interdependent goals, as you cannot achieve one without the other. Shareholder value will not be attained if the customer doesn’t receive value and a company cannot deliver customer value, if shareholders are not investing enough in the business, because it isn’t generating adequate returns. But there are real differences between 80/20 and lean and they reside in two areas: 1) in the way they accomplish their respective objectives and ultimately 2) in the scope or the breadth of the method.
Lean maximizes customer value by minimizing waste and doing more with less while 80/20 maximizes shareholder value by boosting focus on the “sweet spot” and by shifting resources from the “trivial many” to the “vital few”. And when you focus on the “sweet spot” of the business and physically segregate the good from the not so good, you know the true cost of complexity (and waste) and have an extra incentive to do something about it, since the financial metrics are segregated with the business. The second point has to do with the fact that lean is primarily an “inside-out” methodology, while 80/20 is an “outside-in” process. 80/20 starts with the customer and the market. Lean starts with a strategic intent or purpose from within the company and eventually becomes a transformation tool, which impacts the way people think and the way the processes work. Contrary to the popular misconception, lean can be applied to all areas of the organization and not only to manufacturing, in fact the term transformation or lean transformation is commonly used to characterize a way of thinking that goes beyond the shop floor. On the other hand, 80/20 starts with the analytics and the data, showing how the market actually pays for the company’s value proposition and evolves to create new ways of running the business. It starts with a real picture as opposed to management perception. 80/20 adjusts the portfolio to the “sweet spot” of the market, takes out complexity that the customer is not paying for, segments the customer base for accelerated growth and innovates based on market needs and pain points. Lean rarely deals with the business model while 80/20 has no “sacred cows”. But you should not think of 80/20 and lean as good or bad! Or you should not see them as opponents either. In fact, 80/20 has a clear role for lean, when it comes to complexity reduction. Lean is the right method to streamline the manufacturing of the “eighty” products and to optimize the flow of products and services through entire value streams and departments to customers, for example. Lean can also help the company respond to changing customer needs, high quality, low cost, and with very fast throughput times. Lean is a friend of 80/20! And as one of the foremost 80/20 experts used to say: “80/20 is lean on steroids”.
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In previous writings I’ve talked about the importance of 80/20 data analytics. Here I want to give you an application example and hopefully explain how effective this process can be, when you apply sales analytics in conjunction with 80/20 thinking and tolls in search of profitable growth. Sales analytics tools are used to compile data from different sources, but mainly related to customers and products, transforming the records into useful information and insight that sales leaders use to understand their business and develop improvement actions. Data can come from databanks and pipelines such as CRM (customer relationship management), commercial transaction files, product cost databases and so on. This multiple interfacing capability is called MDS for Multi-Data Source integration. Tools with MDS capability literally mine the data from different archives, cluster it together and enable visualization through dashboards and reports. The level of refinement is growing rapidly and most tools now offer predictive analysis, which looks for leading indicators. At a first glance, these indicators may not look like they are directly connected to sales events, however through further correlational analysis and multiple associations in the data, a connection can be established and the indicator becomes a viable predictor of sales. As an example, the number of visitors to certain websites might be a good predictor of future sales of products related to those specific websites. Marketing organizations are constantly mining data to look for hidden relationships and trends that can provide clues about customer’s wants and sales trends. Perhaps the most widely used sales analytics tool for ecommerce is Google Analytics. It is a service from Google that provides statistics and basic analytical tools for search engine optimization (SEO) and marketing purposes. Geared towards small and medium-sized retail websites, Google Analytics has many features such as data visualization (dashboards and scorecards), motion charts, segmentation analysis, as well as custom reports. In spite of this growing level of sophistication, the vast majority of these tools are multi-purpose, or designed to organize the output in generic ways that are easy to understand and track. Then it’s up to managers to create strategies and extract conclusions from the many dashboards and predictors. And since these are primarily off-the-shelf tools and every business is unique, customization not only costs a lot of money, but customization also puts a cast around the company’s analytical capability. Having said that, almost all basic software products offer interesting tools such as sales dashboards, order pipeline and territorial management, sales planning and productivity metrics. The more advanced products offer additional features like predictive analysis, sales forecasting, customer data segmentation and product profitability analysis, Off-the-shelf analytic tools are great to track the performance of the sales team, but they are not meant to be transformational tools on their own. Managers obtain useful information and clues about productivity issues and market penetration, for example, but they do not provide a roadmap to growth or increased profitability. It’s when you couple these tools with 80/20 analytics and mindset that you can develop a strategic plan to optimize the portfolio, increase profitability and grow. Below I make an attempt to stack these tools from the tactical or day-to-day dimension (level 1) to the most strategic dimension (level 5). The first two levels are what I call “performance” levels and the other three can be considered “transformational” levels. The higher you go, the more impactful and lasting the results will be. Level 3 or 80/20 analytics, allow us to use the data from levels 1 and 2 to execute on the notion that “some customers and products are more equal than others”, and apply a super high focus on a select group of customers within the existing market segment. The customers in this select group are the ones that are likely to pay more for your unique value proposition (UVP), compared to the trivial many, or the “twenty” customers. Tools such as quad analysis help you fine-tune the portfolio by reducing overhead and SKU count, better aligning them with the needs of the “eighty” customers. The misaligned overhead and the low-volume and low-margin products are only creating complexity (read cost) and these are the tools that help you simplify your sales processes and optimize your offering. But once you are happy (for a while) with the optimization and the simplification then comes growth.
Top-line growth is essential for the long-term viability of any business. Segmentation (level 4) is the best and the safest way to generate new revenue streams. You start by looking inside your current markets to find new growth avenues, before you branch out into unknown areas. You should first exhaust adjacent or incremental revenues, near the core business, and then look beyond the core for new markets and selective acquisitions as growth catalysts. Preferably focusing on new product lines that will enhance your UVP to existing and prospective “eighty” customers. Tools such as cluster analysis and marketing mix planning or 5 P’s (price, product, promotion, place and people) help validate the ideas or segmentation hypotheses that might have surfaced through sales analytics tools in level 2. But segmentation is not just about finding niches, but it’s mainly about the way you run the business, redirecting and specializing your sales and marketing organizations and eventually splitting them into new, expert business units. By using segment-focused business units, the expansion costs are kept closely coupled with the unit’s ability to deliver growth and to charge for the value of their UVP. Segmentation will lead to de-commoditization of your business, while empowering your best people to succeed in the refocused business units. But how do you sustain growth and profitability overtime? Innovation (level 5) is how businesses sustain market share and create moats, to defend against competitive attacks. You need to defend your market share and explore incremental opportunities, but you also need to be capable of developing new strategies that can lead to transformational growth. The key to new strategies is innovation, which is the driving force behind adaptability and the skill that yields direct change. Peter Drucker has a simple, elegant definition for innovation: “change that creates a new dimension of performance.” Sales innovation needs to go beyond products. It needs to solve problems for customers and markets. It starts with the analytics and requires an understanding of the problems or pain points faced by the “eighty” customers, within a specific market segment. Using ideation tools and techniques and problem solving methodologies, the pain points are converted into ideas and solutions. Market-segment-focused business units are better prepared than any other type of organization to find the pain points and deliver innovative solutions to known and unknown customer problems. Specialized sales organizations are closer to end users, hence they are best positioned to create a unique view of the market segment, using analytics as a microscope to slice and dice the customer base. This is where the majority of product and service innovation comes from—discovering pain points that customers might not even know they have and figuring out how to solve them in a collaborative way. Companies like General Electric and ITW have used this formula over and over to deliver outstanding performance. In summary, it takes more than sales analytics to grow and sustain profitable revenues. The data needs to be part of a framework that contains other strategic elements, such as those found in the 80/20 Business Process. An off-the-shelf software package will help you manage the effectiveness of your sales force and provide you with ideas, but it will not create a higher level of performance alone. To attain transformational growth, you need to combine sales analytics with a selective mindset and a sharp niche focus, provided by specialized sales teams and business units that are constantly trying to innovate beyond products. This combination represents a virtuous cycle that will create a strong moat and differentiate your company in the market over time. To become effective and successful as business leaders nowadays, we need to move beyond embracing change; we need to enjoy it. Bubbling economies, disrupted markets, complicated regulations, are all too common occurrences in our daily lives. We’re on our own and we better like adventure, or we need to find a different line of work. But on top of an adventurous spirit, we also need more than ever to have our very own personalized toolbox, which we can carry with us as we move from one challenge to the next. And one of the most important tools in our toolbox is the learned ability to pick the small number of resources and initiatives that give us the best results.
We begin creating this tool when we adopt what is called 80/20 mindset, as we are forced to make choices, in order to be more productive or to avoid being sucked into a vortex of unimportant issues. The thinking makes us a lot more selective and gives us the appetite to look for the few things that will tip the scales in our favor. Once we couple analysis with thinking, then we are better prepared to decide which are the vital few customers, the vital few metrics and the vital few people, for example. And finding out which are the vital few and relevant efforts in business, as in life, allows us to unburden ourselves from the tyranny of averageness and become free to create value for us and for others. As companies think of new ways to apply human capital, disrupting conventional employment rules, there is major and disproportional opportunity for leaders who behave as free agents. Contrary to traditional company lovers or company loyalists, the free agent sees his or her role in a company as a transformational one, with a mission to be accomplished, rather than a job to hold on to. They are people who can engage quickly and effectively in transformation work and serve as a consultative leader to the organization at the same time. Their missions typically last a couple of years, sometimes more, but certainly not a lifetime. They are more selective in picking their fights! Free agent leaders combine their individual work system with independence and 80/20 thinking, developing deep self-awareness. They know what they believe in and what makes them different from other executives. But in order to have freedom from averageness, you need to acquire the proper tools. Today, we get distracted by a profusion of things that were considered scarce just a couple of decades ago, such as access to information and to industrialized food products (at least in the developed world), to mention a few. Obesity, for example, has become a public health issue in most industrialized nations and is quickly becoming an issue in developing countries as well. It’s almost impossible not to draw a parallel between food that makes us obese and information that makes us unfocused. If you are not selective, you run the risk of getting obese with food and overwhelmed with insignificant information. A case in point is the obsessive use of social media. It’s easy to see why so much time and attention is spent on e-mail and social networks nowadays. People can lose their ability to distinguish between what is important and what is not, and become addicted to information and communication technologies that pump gigabytes of junk per minute into their brains! In the process, we can spend hours multitasking or focusing on useless and plainly false knowledge that comes along with the few nuggets that really matter. It does not seem like good management of the most precious resource we have in life—time. Instead of setting aside twenty percent of the workday for productive and uninterrupted focused thinking, as prescribed by Peter Drucker in The Effective Executive[i], more and more managers are averaging their attention span throughout the workday and giving the same or more quality attention to the trivial many as to the vital few. More managers have become so accustomed to relying on commoditized information sources that they almost completely disregard the importance of their own analytical capabilities and critical thinking skills to determine what is best for the business. Commoditization of information sources is another trend impacting all knowledge workers and managers these days. As industry expertise and skills become easily available through the Internet and other means, knowledge loses differentiation and value across the board, becoming a commodity. Knowledge has a shelf life and it continues to shrink. Relying on shelved knowledge to run the business can no longer guarantee a comparative advantage. To innovate and grow today, business leaders need to be capable of creating unique or differentiated knowledge, using all the common information methods available, augmented by firsthand knowledge and by 80/20 thinking. Leaders who are capable of discriminating their focus and attention to create distinguished knowledge will be able to capitalize the most from this new era. These people navigate through the information overload maze and take time every workday to perform focused thinking, even if only for ninety minutes. They embrace networking and analytics in the era of big data and mine nuggets of precious information, using their own mining methodologies and applying critical thinking. Peter Drucker called this exercise in 80/20 thinking, “ninety minutes of thinking time.” [ii] It is the smallest effective time slot required for meaningful knowledge work. It’s a period of time during the day of approximately ninety-six minutes when you are your most productive self. If you can fully concentrate on your most important work while avoiding distractions such as phone calls, e-mails, and other multitasking activities, you will generate the most impactful and productive work of the day. After you are done with the focused time, which is 20 percent of your workday, you can be sure you will have accomplished 80 percent of your day’s objectives. Capitalizing on imbalances in business is not always natural—it doesn’t come instinctively. Most of the time, it needs to be exercised and primed with data and hard work. People who are 80/20 thinkers have developed the ability to formulate estimates about possible imbalances between inputs and outputs. They visualize a ratio between effort and result, and then apply critical thinking to determine what matters most. And in life as in business, eighty percent of the time trivial issues will bombard you. Here are some well know examples and ideas about using 80/20 thinking:
“The philosophy of “10x” is woven into Google’s DNA. Instead of improving something by 10 percent, the company strives to work on projects that are 10 times better than anything else out there. “A big part of my job is to get people focused on things that are not just incremental,” CEO Larry Page told Wired in 2013. Getting to chase big ideas instead of simply one-upping competitors is one of the best parts about working for the company, employees have said. That mind-set has launched some of Google’s most amazingly ambitious projects, like self-driving cars, Internet-bearing balloons, and magnetic nanoparticles that can search the human body for disease.”
Rather than developing new technology up front and going after venture capital moneys to launch his company, Nick Woodman thought of unconventional ways to apply and package existing camera and data storage technologies, focusing on “high-adrenaline sports” market segments, such as skydiving, base jumping and white-water rafting. This approach was much more cost effective and kept the company from going after private equity money early on, which would have been a distraction. By limiting the scope at the beginning of the project, it helped bootstrap the company to have early successes that Nick was able to build upon.
“After CEO Reed Hastings made up his mind about where he would focus the company in the long run, he dropped everything else to build the new business. Including his legacy business of mailing DVDs to people’s homes. In classic 80/20 thinking, he selected his “eighty" strategy and started to “milk” his “twenty” business” to fund the “eighty” one. He shifted resources and focus to the “eighty” strategy.” “In 2011, he split Netflix into 2 businesses—DVD and streaming—and allowed them to price independently and compete with each other for customer business. He was trounced as the “dunce” of tech CEOs. His actions led to a price increase of sixty percent for anyone who decided to buy both Netflix products, and many customers chose to drop one. Analysts predicted this to be the end of Netflix. But in retrospect we can see the brilliance of this decision. CEO Hastings actually did what textbooks tell us to do—he began milking the installed, but outdated, DVD business. He did not kill it, but he began pulling profits and cash out of it to pay for building the faster growing, but lower margin, streaming business. This allowed Netflix to actually grow revenue, and grow profits, while making the market transition from one platform (DVD) to another (streaming).” “When you need to move into a new market, set up a new division to attack it. And give them permission to do whatever it takes, even if their actions aggravate existing customers and industry participants. Push them to learn fast, and grow fast—and even to attack old sacred cows (like bundled pricing).”[iii]
The people that can think 80/20 and leverage imbalances need more than a conventional job or career path. Choose them wisely! They need to be in positions that are impactful, such as running business units, and be made accountable for results. They thrive on challenges. If you do a great job selecting “eighty people”, then you are better off adopting a supportive leadership style and virtually working for them and concentrating yourself on what you do best. Let them do the work for you and focus on making them happy. They are the actual “vital few”, and they will have a positive multiplying influence on your bottom line.
“Fun is one of the most important and underrated components of any successful venture. If you’re not enjoying yourself, it’s probably time to call it quits and try something else. If your employees are engaged and having fun, and they genuinely care about your customers, they will enjoy their work more and do a better job. Hire people who look for the best in others, who lavish more praise than they dole out criticism, and who genuinely love what they do.”[v] In summary, if you have to decide which vital few tools to carry in your toolbox, I hope you decide for the ones that allow you to pursue the few relevant things in life, over the many insignificant ones that pop up continuously. Selectivity is a learned skill that needs to be exercised, with analysis and 80/20 thinking. Don’t be fooled by relying on intuitive thinking alone, especially in an era when we are being bombarded with menial knowledge. Work hard to deaverage the knowledge and find imbalances that can work for you. Once you’ve acquired a discernment method that works for you, you will become a lot more productive on what you set yourself to accomplish. You will become a free agent, in the sense that you can create value to yourself and to others, by doing only what you know best and enjoy most. [i] The Effective Executive: The Definitive Guide to Getting the Right Things Done (HarperBusiness Essentials) – Peter F. Drucker – HarperBusiness; Revised edition (1/3/2006). [ii] Peter Drucker, The Effective Executive, HarperBusiness; Revised edition (January 3, 2006). [iii] Netflix: The Turnaround Story of 2012 - www.forbes.com - Retrieved in January 2013. [iv] Sir Richard Charles Nicholas Branson, Kt (born 18 July 1950) is an English businessman and investor. He is best known as the founder of Virgin Group, which comprises more than 400 companies. [v] Richard Branson's Top 10 Tips for Succeeding at Business - www.entrepreneur.com - Retrieved in September 2015. You can measure the financial performance of your business in many different ways. And you probably do so. Operating income, EBITDA margins, free cash flow, ROIC and others. All of these metrics are quantifiable and understood by the different audiences that need to know the status of your company, such as investors and markets in general. The audiences understand these metrics and they can easily compare them with targets and benchmarks. They are important, but at the end of the day, these metrics represent only a static picture of a fiscal period, and can only tell you so much about the fitness level of the business, therefore managers should not rely on conventional financial metrics alone to grow profitably. Then there are the KPIs, or key performance indicators. These are considered process metrics and often used to track specific areas. They should tell you whether you are making headway towards attaining your targets or not. They are internal to the company, but the line between KPIs and financial metrics is not always clear. KPIs measure activities normally associated with customers, suppliers, internal processes, workforce and so on. The difficult part with KPIs is that you can easily have too many of them, diluting focus and creating effort in the direction of the trivial many, versus the vital few. Managers need to be selective when choosing KPIs. I propose there are two other critical and often neglected pointers, which lie between the internal workings of the company and the financial results. These are business productivity (or efficiency) and complexity. I call them the “vital few success indicators” but they could very well be called the forgotten metrics, since only a handful of companies use them to evaluate their strength or fitness level. Whether you classify these two indicators under financial metrics or KPIs, there are hardly any established standards to compare them with. They are dimensionless and can only be tracked over time versus a baseline. In spite of their non-conventional nature, productivity and complexity metrics can’t be neglected if you want to grow profits consistently overtime. Usual KPIs, EBITDA margins, ROIC, or any other financial metric alone, can only tell you how the business looks like today, or in the recent past. They can’t easily tell you about the company’s robustness level to endure market challenges in the long run. It’s like judging the internal health of the patient by looking at a photograph! On the other hand, superior productivity and reduced complexity have proven time-over-time to be the best predictors of profitable longevity. And here’s why. Productivity is generally defined as a measure of output per unit of input. Broadly stated, business productivity should be measured in terms of total value captured from the market over the total value of resources being applied to capture that value. In financial terms, it’s the ratio of your total contribution margin dollars over your total fixed cost or overhead dollars. It basically tells you if you are earning enough with your products and services to cover for all the non-variable expenses associated with running the business, including SG&A. A productivity index (PI) of one or less than one, tells you that your products and services are either not being valued enough by the market, are using resources in excess or a combination of both. A PI of two, means that you are 100% efficient in capturing value from the market and are less vulnerable to its ups and downs, and so on. This is a powerful concept, since contribution margin is a better correlation coefficient between the market environment and the internal structure of the company. The ability of a company to profit adequately from a product or service starts with sound contribution margins and there is little or nothing managers can do to improve the profitability of the business, if there are negligible contribution margins to begin with. Cutting overhead alone will not make it in the long run. PI is a true indication as to whether the company is succeeding or failing in its market environment. As examples, manufacturing companies with products delivering contribution margins in the upper 30’s or lower 40’s, and total overhead in the range of 15% of sales, tend to have productivity indices in the area of 2 to 3. On the other hand, if the contribution margins are between 20% and 30%, the company will have to reduce overhead to close to 10% of sales, in order to have a PI in the neighborhood of 2. If you don’t have high value-added products and higher contribution margins you will need to lean out your company’s overhead more aggressively, in order to stay within a PI of 2. In our experience, manufacturing companies with a PI between 2 and 3 are the ones that can be called truly “scaleable” and those that can maintain higher profit margins during a significant revenue downturn. These scaleable companies return far superior profit margins as they grow and stay between a PI of 2 to 3. Those companies that wait to fix the PI, only after it has dropped closer to 1, are the ones that spend more effort and money to get back in shape during a downturn. Evidently you want to work towards moving the productivity index well above one by increasing contribution margins and reducing fixed costs (read complexity). I know these are not trivial tasks, but this is where the 80/20 business process can play a major role by optimizing your portfolio to increase contribution margins and by simplifying your company to reduce complexity costs (read overhead). And here is where complexity metrics come into play. Complexity inevitably creeps into the company as the business grows. It hides in too many products, too many people, too many plants and so on. Complexity is what drives the excessive overhead; therefore we can say that business productivity is the inverse of business complexity. It looks obvious when you tie the amount of fixed costs to complexity, but unfortunately it is not that intuitive. Complexity is a “silent killer” and builds up extra costs slowly over time. It does to your business the opposite of capturing synergies and actually creates discord when you have multiple growth drivers at the same time. Add more sales people to deal with more customers and you will eventually add more customer support people, more products, more plants and so on, increasing complexity overtime along with extra marginal overhead, without even noticing. Guaranteed! Part of the answer to tackle complexity before it destroys your productivity is to make it visible to the organization, developing leading indicators. The good indicators will give the company a warning sign, to look closer into its overhead levels, even as productivity indices get better. Some examples of commonly used complexity indicators are: product line complexity (contribution margin dollars per SKU, number of SKUs added or deleted during the month), transactional complexity (contribution margin dollars per sales invoice), supply chain complexity (process cycle efficiency) and a global complexity index (GCI) that you can use to track a dimensionless number or a combination of multiple complexity factors. A GCI example is as follows: Overtime, growth in these leading indicators can point to a pile up of complexity costs, signaling it is time to use 80/20 data analytics to pin point where the costs are hiding. You will never get rid of complexity entirely, but you can always make things simpler, for example, using simplification tools in the 80/20 toolbox to simplify the product line, streamline business and manufacturing processes, therefore reducing overhead and boosting productivity. One can say that 80/20 helps identify the vital few and simplicity helps deal with the trivial many. As John Maeda defines in his book The Laws of Simplicity[i], simplicity is about “subtracting the obvious and adding the meaningful.” By embracing business productivity and complexity metrics you have a better chance of knowing what is really important and weeding out complexity before it impacts you financial results. [i] John Maeda - The Laws of Simplicity (Simplicity: Design, Technology, Business, Life) – The MIT Press, 2006 |
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