The 80/20 Principle: The Secret of Achieving More With Less (8 page)

The 80/20 Principle is also being increasingly applied to product design and development. For example, a review of the use that the Pentagon has made of total quality management explains that

decisions made early in the development process fix the majority of life-cycle costs. The 80/20 rule describes this outcome, since 80 percent of the life-cycle costs are usually locked in after only 20 percent of the development time.
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The impact of the quality revolution on customer satisfaction and value, and on the competitive positions of individual firms and indeed of whole nations, has been little noted but is truly massive. The 80/20 Principle was clearly one of the “vital few” inputs to the quality revolution. But the underground influence of the 80/20 Principle does not stop there. It also played a key role in a second revolution that combined with the first to create today’s global consumer society.

THE SECOND 80/20 WAVE:
THE INFORMATION REVOLUTION

The information revolution that began in the 1960s has already transformed work habits and the efficiency of large tracts of business. It is just beginning to do more than this: to help change the nature of the organizations that are today’s dominant force in society. The 80/20 Principle was, is, and will be a key accessory of the information revolution, helping to direct its force intelligently.

Perhaps because they were close to the quality movement, the computing and software professionals behind the information revolution were generally familiar with the 80/20 Principle and used it extensively. To judge by the number of computing and software articles that refer to the 80/20 Principle, most hardware and software developers understand and use it in their daily work.

The information revolution has been most effective when using the 80/20 Principle’s concepts of selectivity and simplicity. As two separate project directors testify:

Think small. Don’t plan to the nth degree on the first day. The return on investment usually follows the 80/20 rule: 80 percent of the benefits will be found in the simplest 20 percent of the system, and the final 20 percent of the benefits will come from the most complex 80 percent of the system.
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Apple used the 80/20 Principle in developing the Apple Newton Message Pad, an electronic personal organizer:

The Newton engineers took advantage of a slightly modified version [of 80/20]. They found that .01 percent of a person’s vocabulary was sufficient to do 50 percent of the things you want to do with a small handheld computer.
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Increasingly, software is substituting for hardware, using the 80/20 Principle. An example is the RISC software invented in 1994:

RISC is based on a variation of the 80/20 rule. This rule assumes that most software spends 80 percent of its time executing only 20 percent of the available instructions. RISC processors…optimize the performance of that 20 percent, and keep chip size and cost down by eliminating the other 80 percent. RISC does in software what CISC [the previously dominant system] does in silicon.
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Those who apply software know that, even though it is incredibly efficient, usage follows 80/20 patterns. As one developer states:

The business world has long abided by the 80/20 rule. It’s especially true for software, where 80 percent of a product’s uses take advantage of only 20 percent of its capabilities. That means that most of us pay for what we don’t want or need. Software developers finally seem to understand this, and many are betting that modular applications will solve the problem.
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Design of software is crucial, so that the most used functions are the easiest to use. The same approach is being used for new database services:

How do WordPerfect and other software developers [do] it? First, they identify what customers want most of the time and how they want to do it—the old 80/20 rule (people use 20 percent of a program’s functions 80 percent of the time). Good software developers make high-use functions as simple and automatic and inevitable as possible.

Translating such an approach to today’s database services would mean looking at key customer use all the time…How many times do customers call search service support desks to ask which file to pick or where a file can be found? Good design could eliminate such calls.
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Wherever one turns, effective innovations in information—in data storage, retrieval, and processing—focus heavily on the 20 percent or fewer of key needs.

THE INFORMATION REVOLUTION HAS A LONG WAY TO RUN

The information revolution is the most subversive force business has ever known. Already the phenomenon of “information power to the people” has given knowledge and authority to front-line workers and technicians, destroying the power and often the jobs of middle management who were previously protected by proprietary knowledge. The information revolution has also decentralized corporations physically: the phone, the fax, the PC, the modem, and the increasing miniaturization and mobility of these technologies have already begun to destroy the power of corporate palaces and those who sit, or increasingly sat, in them. Ultimately, the information revolution will help to destroy the profession of management itself, thus enabling much greater direct value creation by “doers” in corporations for their key customers.
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The value of automated information is increasing exponentially, much faster than we can use it. The key to using this power effectively, now and in the future, lies in selectivity: in applying the 80/20 Principle.

Peter Drucker points the way:

A database, no matter how copious, is not information. It is information’s ore…The information a business most depends on is available, if at all, only in a primitive and disorganized form. For what a business needs the most for its decisions—especially its strategic ones—are data about what goes on outside of it. It is only outside the business where there are results, opportunities, and threats.
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Drucker argues that we need new ways of measuring wealth creation. Ian Godden and I call these new tools “automated performance measures”
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they are just beginning to be created by some corporations. But well over 80 percent (probably around 99 percent) of the information revolution’s resources are still being applied to counting better what we used to count (“paving over the cowpats”) rather than creating and simplifying measures of genuine corporate wealth creation. The tiny proportion of effort that uses the information revolution to create a different sort of corporation will have an explosive impact.

THE 80/20 PRINCIPLE IS STILL THE BEST-KEPT BUSINESS SECRET

Considering the importance of the 80/20 Principle and the extent to which it is known by managers, it remains extremely discreet. Even the 80/20 term itself caught on very slowly and without any visible landmarks. Given the piecemeal use and gradual spread of the 80/20 Principle, it remains underexploited, even by those who recognize the idea. It is extremely versatile. It can be profitably applied to any industry and any organization, any function within an organization and any individual job. The 80/20 Principle can help the chief executive, line managers, functional specialists, and any knowledge worker, down to the lowest level or the newest trainee. And although its uses are manifold, there is an underlying, unifying logic that explains why the 80/20 Principle works and is so valuable.

WHY THE 80/20 PRINCIPLE WORKS IN BUSINESS

The 80/20 Principle applied to business has one key theme—to generate the most money with the least expenditure of assets and effort.

The classical economists of the nineteenth and early twentieth centuries developed a theory of economic equilibrium and of the firm that has dominated thinking ever since. The theory states that under perfect competition firms do not make excess returns, and profitability is either zero or the “normal” cost of capital, the latter usually being defined by a modest interest charge. The theory is internally consistent and has the sole flaw that it cannot be applied to real economic activity of any kind, and especially not to the operations of any individual firm.

The 80/20 theory of the firm

In contrast to the theory of perfect competition, the 80/20 theory of the firm is both verifiable (and has, in fact, been verified many times) and helpful as a guide to action. The 80/20 theory of the firm goes like this:

• In any market, some suppliers will be much better than others at satisfying customer needs. These suppliers will obtain the highest price realizations and also the highest market shares.

• In any market, some suppliers will be much better than others at minimizing expenditure relative to revenues. In other words, these suppliers will cost less than other suppliers for equivalent output and revenue or, alternatively, be able to generate equivalent output with lower expenditure.

• Some suppliers will generate much higher surpluses than others. (I use the phrase “surpluses” rather than “profits,” because the latter normally implies the profit available for shareholders. The concept of surplus implies the level of funds available for profits or reinvestment, over and above what is needed normally to keep the wheels turning.) Higher surpluses will result in one or more of the following: (1) greater reinvestment in product and service, to produce greater superiority and appeal to customers; (2) investment in gaining market share through greater sales and marketing effort, and/or takeovers of other firms; (3) higher returns to employees, which will tend to have the effect of retaining and attracting the best people in the market; and/or (4) higher returns to shareholders, which will tend to raise share prices and lower the cost of capital, facilitating investment and/or takeovers.

• Over time, 80 percent of the market will tend to be supplied by 20 percent or fewer of the suppliers, who will normally also be more profitable.

At this point it is possible that the market structure may reach an equilibrium, although it will be a very different kind of equilibrium from that beloved of the economists’ perfect competition model. In the 80/20 equilibrium, a few suppliers, the largest, will offer customers better value for money and have higher profits than smaller rivals. This is frequently observed in real life, despite being impossible according to the theory of perfect competition. We may term our more realistic theory the 80/20 law of competition.

But the real world does not generally rest long in a tranquil equilibrium. Sooner or later (usually sooner), there are always changes to market structure caused by competitors’ innovations. Both existing suppliers and new suppliers will seek to innovate and obtain a high share of a small but defensible part of each market (a “market segment”). Segmentation of this kind is possible by providing a more specialized product or service ideally suited to particular types of customer. Over time, markets will tend to comprise more market segments.

Within each of these segments, the 80/20 law of competition will operate. The leaders in each specialist segment may either be firms operating largely or exclusively in that segment or industry generalists, but their success will be dependent, in each segment, on obtaining the greatest revenue with the lowest expenditure of effort. In each segment, some firms will be much better than others at doing this and will tend to accumulate segment market share as a result.

Any large firm will operate in a large number of segments, that is, in a large number of customer/product combinations where a different formula is required to maximize revenue relative to effort and/or where different competitors are met. In some of these segments, the individual large firm will generate large surpluses and in other segments much lower surpluses (or even deficits). It will tend to be true, therefore, that 80 percent of surpluses or profits are generated by 20 percent of segments and by 20 percent of customers and by 20 percent of products.
The most profitable segments will tend to (but will not always) be where the firm enjoys the highest market shares and where the firm has the most loyal customers (loyalty being defined by being longstanding and least likely to defect to competitors).

• Within any firm, as with all entities dependent on nature and human endeavour, there is likely to be an inequality between inputs and outputs, an imbalance between effort and reward. Externally, this is reflected in the fact that some markets, products, and customers are much more profitable than others. Internally, the same principle is reflected by the fact that some resources, be they people, factories, machines, or permutations of these will produce very much more value relative to their cost than will other resources. If we were able to measure it (as we can with some jobs, such as those of salespeople), we would find that some people generate a very large surplus (their attributable share of revenue is very much greater than their full cost), whereas many people generate a small surplus or a deficit. Firms that generate the largest surpluses also tend to have the highest average surplus per employee, but in all firms the true surplus generated by each employee tends to be very unequal: 80 percent of the surplus is usually generated by 20 percent of employees.