by Richard Koch, Nicholas Brealey, 1997.
Pareto devised the metaphor that 80% of results come from 20% of causes. Businesses should concentrate on the 20%; the rest is relatively trivial. We should employ resources where the yield is highest. We need to generate maximum money from minimum effort, with most of that effort spent on the most profitable customers.
(Reviewed by Kevin Barham in August 2001)
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Here’s a book that might change your life - if you are persuaded by its basic premise. This says that 80% of results flow from just 20% of the causes. In other words, most of what we do has trivial results while a little of what we do really matters. Only a few things ever produce important results. According to Richard Koch, entrepreneur, investor and strategy consultant, this is the one true principle of highly effective people and organisations. If we use the 80/20 principle, he says, we can achieve a great deal more with much less effort, time and resources, simply by concentrating on the all-important 20%.
The pattern of ‘predictable imbalance’ underlying the 80/20 principle was first discovered by the Italian economist Vilfredo Pareto. As he studied income and wealth patterns, he found that whatever the country or time period, the pattern of predictable imbalance was exactly the same: roughly 80% of money went to 20% of people. Koch suggests that the pattern of predictable imbalance actually crops up throughout modern life. Generally, 20% of products account for 80% of sales value and profits; so do 20% of customers; 20% of criminals account for 80% of stolen goods; 20% of motorists cause 80% of accidents; 20% of your carpets get 80% of the wear; and 20% of your clothes are worn 80% of the time. Most good events happen because of a small minority of highly productive forces; most bad things happen because of a small minority of highly destructive forces.
The 80/20 principle is the key to controlling our lives, says Koch. If we focus on the 20%, we can control events instead of being controlled by them, and can achieve several times the results. This is not time management, he says. It is ‘time revolution’, dramatically raising the quality of our lives and demonstrating that relaxation and achievement are compatible. The 80/20 principle can raise personal effectiveness and happiness. It can also multiply the profitability of corporations and the effectiveness of any organisation. It even holds the key to raising the quality of public services while cutting their cost. It is the best way of dealing with and transcending the pressures of modern life. This is an exuberant claim but Koch seems to have made it work for himself, at least.
According to Koch, 80% of what you achieve in your job comes from 20% of the time spent. Thus, four-fifths of the effort is largely irrelevant. That’s either a worrying or a comforting thought, depending on how you look at it. But it is certainly contrary to what most people normally expect. The reason that the 80/20 principle is so valuable, Koch believes, is just that it is so counterintuitive. We tend to expect that all causes will have roughly the same significance. That all customers are equally valuable. That every bit of business, every product and every pound of sales revenue is as good as any other. That all employees in a particular category have roughly equivalent value. That each day or week or year we spend has the same significance. Koch seeks to demonstrate that this is not so.
His 80/20 principle asserts that when two sets of data relating to causes and results are analysed, the most likely result is that there will be a pattern of imbalance. (The exact relationship may not be 80/20; this is a convenient metaphor.) We are likely to be surprised at how unbalanced it is but whatever the actual level of imbalance, it is likely to exceed our prior estimate. Managers may suspect that some customers and some products are more profitable than others, but when the extent of the difference is proved, they are likely to be surprised and sometimes ‘dumbfounded’.
The implication of the 80/20 principle is that output can be not just increased but multiplied, if we can make the low-productivity inputs nearly as productive as the high-productivity inputs. There are two ways to do this. One is to reallocate the resources from unproductive to productive uses, ‘the secret of all entrepreneurs down the ages’. What you have to do is find a round hole for a round peg, a square hole for a square peg, and a perfect fit for any shape in between. Every resource has its ideal arena, where the resource can be tens or hundreds of times more effective than in most other arenas.
The other route to progress - ‘the method of scientists, doctors, teachers, computer systems designers, educationalists and trainers’ - is to find ways to make the unproductive resources more effective, even in their existing applications. Or, to make the weak resources behave as though they were their more productive cousins; to mimic the highly productive resources. The few things that work fantastically well should be identified, cultivated, nurtured and multiplied. At the same time, the wasteful majority of things should be abandoned or severely cut back.
Accordingly, resources that have weak effects in any particular use are not used, or are used sparingly. Resources that have powerful effects are used as much as possible. Every resource is ideally used where it has the greatest value. One implication of the 80/20 principle drawn by Koch is how far businesses and markets still are from producing optimal solutions. The implication that 80% of products, or customers or employees, are only contributing 20% of profits means there is great waste. The most powerful resources of the company are being held back by a majority of much less effective resources. It also implies that profits could be multiplied if more of the best sort of products could be sold, employees hired or customers attracted (or convinced to buy more from the firm).
So why continue to make the 80% of products that only generate 20% of profits? Companies rarely ask these questions, says Koch, because to answer them would mean very radical action: to stop doing four-fifths of what you are doing is hardly a trivial change. Organisations and individuals are generally very poor at shifting resources from where they have weak results to where they have powerful results, or at cutting off low value resources and buying more high value resources. If we realised the difference between the ‘vital few and the trivial many’ in all aspects of our lives, and if we did something about it, we could multiply anything that we valued.
As described by Koch, the 80/20 principle has wide application in business, including strategy, quality, cost reduction and service improvement, marketing, sales, information technology, decision taking and analysis, inventory management, project management, and negotiation. There is one key theme here - to generate the most money with the least expenditure of assets and effort. Unless you have used the 80/20 principle to redirect your strategy, says Koch, ‘you can be pretty sure that the strategy is badly flawed’. Almost certainly, you don’t have an accurate picture of where you make and lose the most money, and you are almost inevitably doing too many things for too many people. To develop a useful business strategy, you need to look carefully at the different parts of your business, particularly at their profitability and cash generation. Unless your firm is very small and simple, you almost certainly make at least 80% of your profits and cash in 20% of your activity, and in 20% of your revenues. The trick is to work out which 20%.
There are three action implications:
Koch also shows how the 80/20 principle can be used to enhance one’s personal life. Here, he says, 80% of the typical person’s happiness or achievement occurs in a small proportion of that life. The peaks of great personal value can usually be greatly expanded, however. While the common view is that we are short of time, Koch suggests the reverse: that we are actually awash with time but profligate in its abuse.
80/20 thinking therefore requires us to spot the few really important things that are happening and ignore the mass of unimportant things. ‘It teaches us to see the wood for the trees.’ It implies that we should exercise control over our lives with the least possible effort by doing the following:
Koch is right to warn us not to interpret 80/20 too rigidly or deterministically. We need to think carefully where his ideas might help. Take his approach to investment, for example. Koch tells us that 80% of the increase in wealth from long-term portfolios comes from fewer than 20% of the investments. So it is crucial to pick this 20% well and then concentrate as much investment as possible into it. Conventional wisdom (or portfolio theory) is not to put all your eggs in one basket but to spread the risks. 80/20 wisdom, according to Koch, is to ‘choose a basket carefully, load all your eggs into it, and then watch it like a hawk’. This approach may have worked for him, but not all investors have the nerve for such a strategy.
Still, the 80/20 principle does have a beguiling quality. And Koch produces lots of examples and statistics to make us think there really is something to it. As he says, while events cannot be predicted, predictable patterns tend to recur. Control is impossible but it is possible to influence events and to detect irregularities and benefit from them. The art of using the 80/20 principle is ‘to identify which way the grain of reality is currently running and to exploit that as much as possible’. If, in your business life, you can identify where your firm is getting back more than it is putting in, you can increase the stakes and make a killing. Similarly, if you can work out where your firm is getting back much less than it is investing, you can cut your losses. The game is to spot the few places you are making great surpluses and to maximise them; and to identify the places where you are losing and get out.
This is certainly a book that is worth investigating more closely to see how its ideas could work for you. We are sometimes told that the secret of success is working smarter, not harder, the doctrine of the vital few and the trivial.