We usually hear the expression "value added" associated with the amount of enhancement and aggregation of materials and labor that a company applies to its products during manufacturing. However, adding value to products and services is only one element of creating value to customers and shareholders. The other important element is “separation”. Both Lean and 80/20 use separation as a way to purify processes (just like in chemistry) and deliver more value. Lean principles are based on value creation from the customer’s point of view. As you identify the work steps, you eliminate barriers that prevent a smooth production flow. Continuous flow is characterized by rhythm or “takt time” and is dictated by customer demand (pull). Throughout the process, you isolate and remove steps that do not add value or create waste (“muda”). In other words, you must have a free-of-interferences, undisturbed, customer-focused process to achieve lean. You need to separate waste from value-adding steps. Similarly, the 80/20 Business Process places an ultra-high focus on select groups of customers and products, avoiding distractions to the core work. The extreme focus helps capitalize on natural imbalances, implied by the 80/20 Principle. The separation part keeps the complexity created by the “trivial many” from contaminating the “vital few”. It turns the “eighty” into a center of attention. Separation is what keeps the “chaff away from the wheat”. It’s an important management concept and is applied to create focus, as well to impart autonomy. It’s not meant to build walls and create isolated fiefdoms. The main reasons to apply separation are:
Managers should understand (and make up their minds about) what is important and what is not. At a minimum, they should select the core segments to compete, the key customers to partner, the central products to lead with and the fundamental business processes to deliver value. Once they select the vital few, managers can separate and nurture these core areas, by asking the following question: how to increase the separation degrees between the core and the rest? To separate a core market segment from all others, for example, you can start by creating a dedicated sales and marketing organization for that segment. You can also set up distinct production lines and generate a “core segment P&L” to monitor progress. These are all part of what I call the first separation stage or degree. It’s one framework to build centers of attention around core activities. Add another separation degree and create autonomous business units, focusing on the core segments. The third stage is to operate with completely separate and autonomous companies, such as Berkshire Hathaway and most private equity firms do. Separation stages are closely coupled with the way companies grow. Stage three companies grow like a forest, spreading out and diversifying. Stage one companies bloom and expand like a shrub. In the same vein, we can say that stage two companies grow like trees, or they branch out into new market segments. Forests grow in fractal ways, or in patterns that repeat themselves at different scales (self similarity). We can see the resemblance of a forest to stage three companies, diversifying into different segments and industries, while keeping the value-creation model intact throughout different companies (self similarity). Call it satellite companies, divisions, business units, focused plants or service centers, the distributed and decentralized organization is better prepared to deliver value over the long haul. If executed with methodologies such as lean and 80/20, separation and decentralization have the potential to transform the business into a network of value-creating nodes. The benefits of this operating model are reflected in this quote from the 1979 letter from Warren Buffett to investors, which talks about his faith and confidence in the independence and empowerment of business units. The thinking can be summarized in this statement: “If you love the management, set them free”. “To the Shareholders of Berkshire Hathaway Inc.: Your company is run on the principle of centralization of financial decisions at the top (the very top, it might be added), and rather extreme delegation of operating authority to a number of key managers at the individual company or BU level. We could just field a basketball team with our corporate headquarters group (which utilizes only about 1,500 square feet of space). This approach produces an occasional major mistake that might have been eliminated or minimized through closer operating controls. But it also eliminates large layers of costs and dramatically speeds decision-making. Because everyone has a great deal to do, a very great deal gets done. Most important of all, it enables us to attract and retain some extraordinarily talented individuals—people who simply can’t be hired in the normal course of events—who find working for Berkshire to be almost identical to running their own show. We have placed much trust in them—and their achievements have far exceeded that trust.” [i] Some of the best performing companies in the world are decentralized: Berkshire Hathaway, GE, ITW, J&J and many others. They’ve evolved from conventional and monolithic structures to networks of companies and business units, while keeping their original values intact. The leaders realized early on that they needed to move from the “top of the hierarchy to the center of the network”. They went from “command and control” to “influence and connectivity”. They fostered segmentation and enabled value-creating nodes in the network to grow and to multiply. But let’s not get lost in the debate about centralization versus decentralization. You don’t need to wait until you are completely decentralized to start applying separation, as a management principle. You can start right away by selecting core areas and deciding how many degrees of separation to apply. The separation mentality can at a minimum be applied to customers, products and process, as shown in the table below. The key when applying separation to customers is to identify and place an extreme focus on the few customers that account for eighty percent of sales and margins, as well as on the few “twenty” ones that have strategic value to the business. Know everything there is to know about your “eighty” customers. Walk in their shoes frequently to understand their pain points and needs, and involve them in your product innovation efforts. The degrees of separation amongst customers start with sales and support differentiation, passing by the application of unique commercial policies, all the way to rechanneling and firing “twenty” customers, if necessary.
Many companies already treat their “eighty” customers special. At least they should. But the vast majority doesn’t clearly define the borders between core and the others, lacking defined ways to create separation, such as dedicated account teams and unique commercial policies. All customers need to be treated fairly, but treating all customers equally can lead to disaster. Stage three companies have separate value chains that align distinctly with “eighty” and “twenty” customers. The value created by each separate chain is proportional to what they deliver and to the complexity (overhead) each business has to live with. In most cases, customers are clearly told the difference between these different chains and appreciate getting a fair value for what they are buying. When it comes to products and processes, there are many ways to create separation. Starting from an extreme focus on “eighty” products, all the way to investing in separate businesses to distinctly deal with core and non-core. It means separating the mainstream, with less variation, from the infrequent products, which have greater complexity. Detached businesses have different value chains and are uniquely positioned in the market. Another separation technique is to outsource non-core products to specialized suppliers. Outsourcing makes it simpler to place a value on these items. The costs to make them available to customers come listed in the supplier invoice, while the internal costs of low-volume or specialty products are not always accurate, due to hidden complexity. The first separation degree at the shop floor is to distinguish the production methods between core and non-core. The “eighty” needs to be made in the most efficient way possible. This can be attained with lean manufacturing techniques, such as one-piece-flow, takt time and pull systems. A separation method used in lean, is to uncouple customer demand (pull) from orders to suppliers, improving production flow and rhythm. At a higher degree, companies use 80/20 techniques, such as inlining of high-volume products and MRD (market rate of demand) to further optimize and simplify production of the “eighty”. 80/20 also separates period costs from variable costs, when building products, improving the accuracy of contribution margins. Third separation degree is achieved by investing in discrete business units, or separate companies, to manufacture the core away from the low-volume or specialty. By having isolated plants and P&Ls for low-volume and specialty, it’s possible to understand the real cost of complexity, thus pricing correctly in the market. As the business expands, it will segment further and separate more complexity away from the core. But when we carve out a new business, plant or production line, it’s important to consider its ability to add value as a stand-alone unit. In order to do this, I have four types of questions that I ask the team and myself, which I consider the pillars for creating a new node in the network:
To finalize, I believe that most companies know the difference between core and trivial businesses. The problem is that managers don’t take steps to separate them, allowing the trivial to contaminate the core. The word “focus” is constantly used (or misused), but in many cases, there is no action behind it. What does it mean to increase focus? What is needed? Separation works because it forces the opportunity to stand out. It places a new visible node in the value-creation network. So let’s put some meaning behind the word “focus” and enhance value-creation not only by adding parts and labor to our products, but also by simplifying our business and putting some distance between what makes it great and what makes it go. [i] Warren E. Buffett, 1979 letter to Berkshire Hathaway investors (published March 3, 1980), http://www.berkshirehathaway.com/letters/1979.html - Retrieved on October, 2015.
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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”. 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. |
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