The 80/20 Principle: The Secret of Achieving More With Less (15 page)

Yet the truth is that you don’t need to wait. “If your eye offends you, pluck it out!” Just remove the offending overhead. If your will is strong, you can always do it. The less profitable segments can sometimes be sold, with or without their overheads, and always be closed. (Do not listen to accountants who bleat about “exit costs” a lot of these are just numbers on a page with no cash cost. Even where there is a cash cost, there is normally a very quick payback, one that will be much quicker, because of the value of simplicity, than the bean counters will ever tell you.) A third option, often the most profitable, is to harvest these segments, deliberately losing market share. You let go of the less profitable customers and products, cut off most support and sales effort, raise prices, and allow sales to decline at 5–20 percent while you laugh all the way to the bank.

GO FOR THE MOST SIMPLE 20 PERCENT

What is most simple and standardized is hugely more productive and cost effective than what is complex. The simplest messages are the most appealing and universal: to colleagues, consumers, and suppliers. The simplest structures and process flows are at once the most attractive and the lowest cost. Letting the customer access your business system—as with all forms of self-service—creates choice, economy, speed, and spend.

Always try to identify the simplest 20 percent of any product range, process, marketing message, sales channel, product design, product manufacture, service delivery, or customer feedback mechanism. Cultivate the simplest 20 percent. Refine it until it is as simple as you can make it. Standardize delivery of a simple product or service on as universal and global a basis as possible. Pass up thrills, bells, and whistles. Make the simplest 20 percent as high quality and consistent as imaginable. Whenever something has become complex, simplify it; if you cannot, eliminate it.

REDUCING COMPLEXITY AT CORNING

How can a business in trouble use the 80/20 Principle to reduce complexity and raise profits? An excellent case study is provided by Corning, which produces ceramic substrates for automobile exhaust systems in Greenville, Ohio, and Kaiserslautern, Germany.
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In 1992 the U.S. business was doing badly and the next year the German market fell sharply. Instead of panicking, the Corning executives took a long, hard look at the profitability of all their products.

As in almost every firm around the world, the Corning executives had used a standard cost approach to decide what to produce. But standard cost systems are one of the most important reasons the 80/20 Principle has so much to add: standard cost systems make it impossible to know true product profitability, largely because they do not differentiate between high-and low-volume products. When variable costs—such as overtime, training, equipment modifications, and downtime—were fully allocated at Corning, the results caused astonishment.

Take two products made at Kaiserslautern: a high-volume, simple, symmetrically shaped ceramic substrate, disguised here as the R10; and a much lower-volume product, the R5, an odd-shaped substrate. The standard cost of the R5 was 20 percent more than that of the R10. But when the extra engineering and shopfloor effort to produce the R5 were fully costed, it turned out to have an incredible cost, around 500,000 percent greater than the R10!

Yet, on reflection, the data could be believed. The R10 virtually made itself. The R5 required expensive engineers to hover over it, nudging it to keep within specification. Therefore, if only R10s were made, far fewer engineers would be needed. And that is what happened. By eliminating low-volume, unprofitable products, which contributed little to revenues and negative amounts of profit, engineering capacity was reduced by 25 percent.

The 50/5 Principle

The Corning analysis kept gravitating toward a very useful cousin of the 80/20 Principle—the 50/5 Principle.

The 50/5 Principle asserts that, typically, 50 percent of a company’s customers, products, components, and suppliers will add less than 5 percent to revenues and profits. Getting rid of the low-volume (and negative value) 50 percent of items is the key to reducing complexity.

The 50/5 Principle worked at Corning. Out of 450 products produced at Greenville, half produced 96.3 percent of revenue; the other 50 percent yielded just 3.7 percent. Depending on the period analyzed, the German plant showed that the low-volume 50 percent of products produced only 2–5 percent of sales. In both locations, the bottom 50 percent made losses.

More is worse

The road to hell is paved with the pursuit of volume. Volume leads to marginal products, marginal customers, and greatly increased managerial complexity. Since complexity is both interesting and rewarding to managers, it is often tolerated or encouraged until it can no longer be afforded. At Corning, they had filled up the plants with loss-making, complicating business. The solution was to cut the number of products by more than half. Instead of dealing with 1,000 suppliers, purchases were consolidated through the 200 suppliers who comprised 95 percent of total supplies (a 95/20 Principle). The organization was streamlined and flattened.

At the heart of the market meltdown, Corning turned away business. This might seem perverse, but it worked. A simpler, smaller operation rapidly restored profits. Less was more.

MANAGERS LOVE COMPLEXITY

At this point it is worth asking: why do supposedly profit-maximizing organizations become complex, when this plainly destroys value?

One important answer, alas, is that managers love complexity. Complexity is stimulating and intellectually challenging; it leavens boring routine; and it creates interesting jobs for managers. Some people believe that complexity obtrudes when no one is looking. No doubt—but complexity is also sponsored by managers, just as it sponsors them. Most organizations, even ostensibly commercial and capitalist ones, are conspiracies of management against the interests of customers, investors, and the outside world generally. Unless firms are facing an economic crisis, or have an unusual leader who favors investors and customers rather than his or her own managers, excess management activity is virtually guaranteed. It is in the interests of the managerial class in charge.
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COST REDUCTION THROUGH SIMPLICITY

There is thus a natural tendency for business, like life in general, to become overcomplex. All organizations, especially large and complex ones, are inherently inefficient and wasteful. They do not focus on what they should be doing. They should be adding value to their customers and potential customers. Any activity that does not fulfill this goal is unproductive. Yet most large organizations engage in prodigious amounts of expensive, unproductive activity.

Every person and every organization is the product of a coalition and the forces within the coalition are always at war. The war is between the trivial many and the vital few. The trivial many comprise the prevalent inertia and ineffectiveness. The vital few are the breakthrough streaks of effectiveness, brilliance, and good fit. Most activity results in little value and little change. A few powerful interventions have massive impact. The war is difficult to observe: it is the same person, the same unit, and the same organization that produces both a mass of weak (or negative) output and a smattering of highly valuable output. All we can discern is the overall result; we miss both the garbage and the gems.

It follows that any organization always has great potential for cost reduction and for delivering better value to customers: by simplifying what it does and by eliminating low- or negative-value activities.

Be mindful that:

• waste thrives on complexity; effectiveness requires simplicity

• the mass of activity will always be pointless, poorly conceived, badly directed, wastefully executed, and largely beside the point to customers

• a small portion of activity will always be terrifically effective and valued by customers; it is probably not what you think it is; it is opaque and buried within a basket of less effective activity

• all organizations are a mix of productive and unproductive forces: people, relationships, and assets

• poor performance is always endemic, hiding behind and succored by a smaller amount of excellent performance

• major improvements are always possible, by doing things differently and by doing less.

Always recall the 80/20 Principle: if you study the output your firm generates, the chances are that a quarter to a fifth of the activity accounts for three-quarters or four-fifths of profits. Multiply that quarter or fifth. Multiply the effectiveness of the rest, or cut it out.

REDUCING COSTS USING THE 80/20 PRINCIPLE

All effective techniques to reduce costs use three 80/20 insights:
simplification,
through elimination of unprofitable activity;
focus,
on a few key drivers of improvements; and
comparison of performance.
The last two deserve elaboration.

Be selective

Do not tackle everything with equal effort. Cost reduction is an expensive business!

Identify the areas (perhaps only 20 percent of the whole business) that have the greatest cost-reduction potential. Concentrate 80 percent of your efforts here.

You don’t want to get too bogged down in microanalysis. It can help to apply the 80/20 rule. Ask yourself what are the major time sinks that you can cut out, where are the 80 per cent of the time delays and costs in your current processes that you could target, and understand how you would attack those.
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To be successful, one has to measure what really counts…most organizations fit Pareto’s rule: 80 percent of what is important is supported by 20 percent of the costs…For example, a study in Pacific Bell’s customer payment center found that 25 percent of the center’s work was devoted to processing 0.1 percent of the payments. A third of the payments were processed twice, and occasionally several times.
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In reducing cost or raising product and service quality, remember above all that equal cost does not lead to equal customer satisfaction. A few parts of cost are tremendously productive; but most cost has little or no relationship to what customers value. Identify, treasure, and multiply the few productive costs, and get rid of the rest.

Using 80/20 Analysis to pinpoint improvement areas

80/20 Analysis can establish why particular problems arise and focus attention on the key areas for improvement. To take a simple example, let’s imagine that you are running a book publishing firm and that your typesetting costs are 30 percent above budget. Your product manager tells you that there are 1,001 reasons for the overrun: sometimes the authors are late with the manuscript, sometimes the proofreaders or index compilers take longer than planned, in many cases the book is longer than planned, the charts and other figures often need correction, and there are many other special causes.

One thing you can do is to take a particular time period, say three months, and carefully monitor the causes of all the typesetting cost overruns. You should record the main reason for each overrun and also the financial cost penalty involved.

Figure 32 displays the causes in a table, ranking the most frequent cause at the top and so on.