Главная The 80/20 Principle: The Secret of Achieving More With Less
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Praise for The 80/20 Principle ‘Congratulations! The 80/20 Principle is terrific.’ Al Ries, bestselling author of Focus and Positioning ‘Koch is a passionate 80/20er. Read this and you will be too’. Andrew Campbell, Ashridge Strategic Management Centre ‘Both astute and entertaining, this is an intriguing book to help people concentrate on not wasting their lives’. Professor Theodore Zeldin, St Anthony’s College, Oxford ‘Through multiple examples, and a punchy down-to-earth commentary, Koch offers the first really useful advice we’ve seen in a management book for years.’ Business Age The 80/20 Principle The Secret of Achieving More with Less Richard Koch NICHOLAS BREALEY PUBLISHING LONDON To Lee This revised edition first published by Nicholas Brealey Publishing Limited in 1998 Reprinted 1998 36 John Street London WC1N 2AT, UK Tel: +44 (0) 171 430 0224 Fax: +44 (0) 171 404 8311 671 Clover Drive Santa Rosa California 95401, USA Tel: (707) 566 8006 Fax: (707) 566 8005 http://www.nbrealey-books.com First published in hardback in 1997 Reprinted (with corrections) 1997, 1998 ©Richard Koch 1997, 1998 The right of Richard Koch to be identified as the author of this work has been asserted in accordance with the Copyright, Designs and Patents Act 1988. ISBN 1-85788-167-2 HB ISBN 1-85788-168-0 PB British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the publishers. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form, binding or cover other than that in which it is published, without the prior consent of the publishers. Printed in Finland by Werner Soderstrom Oy. Although the author expresses a view on the likely future performance of certain investme; nt instruments, this should not be taken as an incitement to deal in any of them, nor is it to be regarded as investment advice. Each individual should consider their investment position in relation to their own circumstances with the benefit of professional advice. No responsibility can be assumed by either the author or the publisher for investment or any other decisions taken on the basis of views expressed in this book. Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the relevant copyright, designs and patents acts, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publisher. eBooks Corporation For a very long time, the Pareto law [the 80/20 Principle] has lumbered the economic scene like an erratic block on the landscape: an empirical law which nobody can explain. Josef Steindl God plays dice with the Universe. But they’re loaded dice. And the main objective is to find out by what rules they were loaded and how we can use them for our own ends. Joseph Ford We cannot be certain to what height the human species may aspire. . . We may therefore safely acquiesce in the pleasing conclusion that every age of the world has increased, and still increases, the real wealth, the happiness, the knowledge, and perhaps the virtue, of the human race. Edward Gibbon Contents Revised Acknowledgements ix Part One. Overture 1 Welcome to the 80/20 Principle 2 How to Think 80/20 3 21 Part Two. Corporate Success Needn’t Be a Mystery 3 The Underground Cult 45 4 Why Your Strategy is Wrong 61 5 Simple is Beautiful 89 6 Hooking the Right Customers 108 7 The Top 10 Business Uses of the 80/20 Principle 124 8 The Vital Few Give Success to You 136 Part Three. Work Less, Earn and Enjoy More 9 Being Free 147 10 Time Revolution 158 11 You Can Always Get What You Want 179 12 With a Little Help From Our Friends 191 13 Intelligent and Lazy 204 14 Money, Money, Money 224 15 The Seven Habits of Happiness 238 Part Four: Crescendo 16 Progress Regained 257 Notes and References 285 Index 299 Revised Acknowledgements This has been the most painful and well-researched book I have ever written. There is a certain irony here, since the 80/20 Principle tells us that I could have obtained a book 80 per cent as good in 20 per cent of the time. This would certainly have been my inclination and only the reader can tell whether the extra effort has been worthwhile. I think it has, but I have lost all objectivity. The effort involved has been much more collective than for any of my previous books. Don’t believe the false modesty of those who write generously that their books have been ‘team efforts’. In the end only an author (or authors) can write a book. But I want to thank some individuals without whom this book would either not have existed or would have been vastly inferior. First is Mark Allin, then at Pitman Publishing and now my partner in Capstone Publishing, who first had the idea of the book. Second is Nicholas Brealey. He has put terrific insight into the book. I am glad that the sales are rewarding this! According to the Von Manstein principle (see Chapter 13), people like Nicholas who are smart and industrious will not be as successful as those who are smart and lazy. To become a real star, Nicholas must work a great deal less. I have a theory that if he published half the number of books, and put all his effort into these, he’d make even more money. I hope my next book will not be one to get the axe! I am very grateful for his persistence on this book. Sally Lansdell has been the ‘third person’ collaborating to get the structure and text right. She is clearly a gifted publisher in her own right. Next, my researcher on the book, Nick Oosterlinck, did a terrific job of reconstructing the history of the 80/20 Principle from 1897 to 1997. He has now disappeared from my radar screen, but if he would like to get in touch I would be delighted to dispense some champagne his way. I should also thank not only Mr Pareto for originating the 80/20 Principle, but also Mr Juran, Mr Zipf, Mr Krugman and the unsung heroes at IBM in the 1960s for elaborating it. And also the hundreds of people from all walks of life and disciplines who have written magazine articles about the 80/20 Principle, many of whom I have quoted extensively as evidence of the way in which the principle can be used. I have made every effort to acknowledge these people in the references, but if there are any omissions please accept my apologies and let me know so that correction can by made in any future editions. I am particularly grateful to David Parker, lecturer in managerial economics and business strategy at the University of Birmingham Business School, whose work on the application of chaos theory to business strategy is full of brilliant insights, many of which I have appropriated. Finally, every true believer needs his trusted sceptics. Patrick Weaver and Lee Dempsey have fulfilled this role admirably, and it is much appreciated. Richard Koch Cape Town January 1998 Part One Overture The universe is wonky! What is the 80/20 Principle? The 80/20 Principle tells us that in any population, some things are likely to be much more important than others. A good benchmark or hypothesis is that 80 per cent of results or outputs flow from 20 per cent of causes, and sometimes from a much smaller proportion of powerful forces. Everyday language is a good illustration. Sir Isaac Pitman, who invented shorthand, discovered that just 700 common words make up two-thirds of our conversation. Including the derivatives of these words, Pitman found that these words account for 80 per cent of common speech. In this case, fewer than I per cent of words (the New Oxford Shorter Oxford English Dictionary lists over half a million words) are used 80 per cent of the time. We could call this an 80/1 principle. Similarly, over 99 per cent of talk uses fewer than 20 per cent of words: we could call this a 99/20 relationship. The movies illustrate the 80/20 Principle. A recent study shows that 1.3 per cent of movies earn 80 per cent of box office revenues, producing virtually an 80/1 rule (see pages 17–18). The 80/20 Principle is not a magic formula. Sometimes the relationship between results and causes is closer to 70/30 than to 80/20 or 80/1. But it is very rarely true that 50 per cent of causes lead to 50 per cent of results. The universe is predictably unbalanced. Few things really matter. Truly effective people and organizations batten on to the few powerful forces at work in their worlds and turn them to their advantage. Read on to find out how you can do the same . . . 1 Welcome to the 80/20 Principle For a very long time, the Pareto law [the 80/20 Principle] has lumbered the economic scene like an erratic block on the landscape; an empirical law which nobody can explain. Josef Steindl1 The 80/20 Principle can and should be used by every intelligent person in their daily life, by every organization, and by every social grouping and form of society. It can help individuals and groups achieve much more, with much less effort. The 80/20 Principle can raise personal effectiveness and happiness. It can multiply the profitability of corporations and the effectiveness of any organization. It even holds the key to raising the quality and quantity of public services while cutting their cost. This book, the first ever on the 80/20 Principle, 2 is written from a burning conviction, validated in personal and business experience, that this principle is one of the best ways of dealing with and transcending the pressures of modern life. 4 OVERTURE What is the 80/20 Principle? The 80/20 Principle asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards. Taken literally, this means that, for example, 80 per cent of what you achieve in your job comes from 20 per cent of the time spent. Thus for all practical purposes, fourfifths of the effort—a dominant part of it—is largely irrelevant. This is contrary to what people normally expect. So the 80/20 Principle states that there is an inbuilt imbalance between causes and results, inputs and outputs, and effort and reward. A good benchmark for this imbalance is provided by the 80/20 relationship: a typical pattern will show that 80 per cent of outputs result from 20 per cent of inputs; that 80 per cent of consequences flow from 20 per cent of causes; or that 80 per cent of results come from 20 per cent of effort. Figure 1 shows these typical patterns. In business, many examples of the 80/20 Principle have been validated. 20 per cent of products usually account for about 80 per cent of dollar sales value; so do 20 per cent of customers. 20 per cent of products or customers usually also account for about 80 per cent of an organization’s profits. In society, 20 per cent of criminals account for 80 per cent of the value of all crime. 20 per cent of motorists cause 80 per cent of accidents. 20 per cent of those who marry comprise 80 per cent of the divorce statistics (those who consistently remarry and redivorce distort the statistics and give a lopsidedly pessimistic impression of the extent of marital fidelity). 20 per cent of children attain 80 per cent of educational qualifications available. In the home, 20 per cent of your carpets are likely to get 80 per cent of the wear. 20 per cent of your clothes will be worn 80 per cent of the time. And if you have an intruder alarm, 80 per cent of the false alarms will be set off by 20 per cent of the possible causes. The internal combustion engine is a great tribute to the 80/20 Principle. 80 per cent of the energy is wasted in combustion and only 20 per cent gets to the wheels; this 20 per cent of the input generates 100 per cent of the output! 3 WELCOME TO THE 80/20 PRINCIPLE Figure 1. The 80/20 Principle 5 6 OVERTURE Pareto’s discovery: systematic and predictable lack of balance The pattern underlying the 80/20 Principle was discovered in 1897, exactly 100 years ago, by Italian economist Vilfredo Pareto (1848–1923). His discovery has since been called many names, including the Pareto Principle, the Pareto Law, the 80/20 Rule, the Principle of Least Effort and the Principle of Imbalance; throughout this book we will call it the 80/20 Principle. By a subterranean process of influence on many important achievers, especially business people, computer enthusiasts and quality engineers, the 80/20 Principle has helped to shape the modern world. Yet it has remained one of the great secrets of our time—and even the select band of cognoscenti who know and use the 80/20 Principle only exploit a tiny proportion of its power. So what did Vilfredo Pareto discover? He happened to be looking at patterns of wealth and income in nineteenth-century England. He found that most income and wealth went to a minority of the people in his samples. Perhaps there was nothing very surprising in this. But he also discovered two other facts that he thought highly significant. One was that there was a consistent mathematical relationship between the proportion of people (as a percentage of the total relevant population) and the amount of income or wealth that this group enjoyed.4 To simplify, if 20 per cent of the population enjoyed 80 per cent of the wealth,5 then you could reliably predict that 10 per cent would have, say, 65 per cent of the wealth, and 5 per cent would have 50 per cent. The key point is not the percentages, but the fact that the distribution of wealth across the population was predictably unbalanced. Pareto’s other finding, one that really excited him, was that this pattern of imbalance was repeated consistently whenever he looked at data referring to different time periods or different countries. Whether he looked at England in earlier times, or whatever data were available from other countries in his own time or earlier, he found the same pattern repeating itself, over and over again, with mathematical precision. Was this a freak coincidence, or something that had great importance WELCOME TO THE 80/20 PRINCIPLE 7 for economics and society? Would it work if applied to sets of data relating to things other than wealth or income? Pareto was a terrific innovator, because before him no one had looked at two related sets of data—in this case, the distribution of incomes or wealth, compared to the number of income earners or property owners—and compared percentages between the two sets of data. (Nowadays this method is commonplace, and has led to major breakthroughs in business and economics.) Sadly, although Pareto realized the importance and wide range of his discovery, he was very bad at explaining it. He moved on to a series of fascinating but rambling sociological theories, centring on the role of élites, which were hijacked at the end of his life by Mussolini’s fascists. The significance of the 80/20 Principle lay dormant for a generation. While a 6 few economists, especially in the US, realized its importance, it was not until after the Second World War that two parallel yet completely different pioneers began to make waves with the 80/20 Principle. 1949: Zipf’s Principle of Least Effort One of these pioneers was the Harvard professor of philology, George K Zipf. In 1949 Zipf discovered the ‘Principle of Least Effort’, which was actually a rediscovery and elaboration of Pareto’s principle. Zipf’s principle said that resources (people, goods, time, skills or anything else that is productive) tended to arrange themselves so as to minimize work, so that approximately 20–30 per cent of any resource accounted for 70–80 per cent of the activity related to that resource.7 Professor Zipf used population statistics, books, philology and industrial behaviour to show the consistent recurrence of this unbalanced pattern. For example, he analysed all the Philadelphia marriage licences granted in 1931 in a 20-block area, demonstrating that 70 per cent of the marriages occurred between people who lived within 30 per cent of the distance. Incidentally, Zipf also provided a scientific justification for the messy desk for justifying clutter with another law: frequency of use draws near 8 OVERTURE to us things that are frequently used. Intelligent secretaries have long known that files in frequent use should not be filed! 1951: Juran’s Rule of the Vital Few and the rise of Japan The other pioneer of the 80/20 Principle was the great quality guru, Romanian-born US engineer Joseph Moses Juran (born 1904), the man behind the Quality Revolution of 1950–90. He made what he alternately called the ‘Pareto Principle’ and the ‘Rule of the Vital Few’ virtually synonymous with the search for high product quality. In 1924, Juran joined Western Electric, the manufacturing division of Bell Telephone System, starting as a corporate industrial engineer and later setting up as one of the world’s first quality consultants. His great idea was to use the 80/20 Principle, together with other statistical methods, to root out quality faults and improve the reliability and value of industrial and consumer goods. Juran’s path-breaking Quality Control Handbook was first published in 1951 and extolled the 80/20 Principle in very broad terms: The economist Pareto found that wealth was non-uniformly distributed in the same way [as Juran’s observations about quality losses]. Many other instances can be found—the distribution of crime amongst criminals, the distribution of accidents among hazardous processes, etc. Pareto’s principle of unequal distribution applied to distribution of wealth and to distribution of quality losses.8 No major US industrialist was interested in Juran’s theories. In 1953 he was invited to Japan to lecture, and met a receptive audience. He stayed on to work with several Japanese corporations, transforming the value and quality of their consumer goods. It was only once the Japanese threat to US industry had become apparent, after 1970, that Juran was taken seriously in the West. He moved back to do for US industry what he had done for the Japanese. The 80/20 Principle was at the heart of this global quality revolution. WELCOME TO THE 80/20 PRINCIPLE 9 From the 1960s to the 1990s: progress from using the 80/20 Principle IBM was one of the earliest and most successful corporations to spot and use the 80/20 Principle, which helps to explain why most computer systems specialists trained in the 1960s and 1970s are familiar with the idea. In 1963, IBM discovered that about 80 per cent of a computer’s time is spent executing about 20 per cent of the operating code. The company immediately rewrote its operating software to make the most used 20 per cent very accessible and user friendly, thus making IBM computers more efficient and faster than competitors’ machines for the majority of applications. Those who developed the personal computer and its software in the next generation, such as Apple, Lotus and Microsoft, applied the 80/20 Principle with even more gusto to make their machines cheaper and easier to use for a new tranche of customers, including the now celebrated ‘dummies’ who would previously have given computers a very wide berth. Winner take all A century after Pareto, the implications of the 80/20 Principle have surfaced in a recent controversy over the astronomic and ever-rising incomes going to superstars and those very few people at the top of a growing number of professions. Film director Steven Spielberg earned $165 million in 1994. Joseph Jamial, the most highly paid trial lawyer, was paid $90 million. Merely competent film directors or lawyers, of course, earn a tiny fraction of these sums. The twentieth century has seen massive efforts to level incomes, but inequality, removed in one sphere, keeps popping up in another. In the USA from 1973 to 1995, average real incomes rose by 36 per cent, yet the comparable figure for non-supervisory workers fell by 14 per cent. During the 1980s, all of the gains went to the top 20 per cent of earners, and a mind-boggling 64 per cent of the total increase went to the top 10 OVERTURE 1 per cent! The ownership of shares in the US is also heavily concentrated within a small minority of households: 5 per cent of US households own about 75 per cent of the household sector’s equity. A similar effect may be seen in the role of the dollar: almost 50 per cent of world trade is invoiced in dollars, far above America’s 13 per cent share of world exports. And, while the dollar’s share of foreign exchange reserves is 64 per cent, the ratio of American GDP to global output is just over 20 per cent. The 80/20 Principle will always reassert itself, unless conscious, consistent and massive efforts are made and sustained to overcome it. Why the 80/20 Principle is so important The reason that the 80/20 Principle is so valuable is that it is 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 dollar of sales revenue is as good as another. That all employees in a particular category have roughly equivalent value. That each day or week or year we spend has the same significance. That all our friends have roughly equal value to us. That all enquiries or phone calls should be treated in the same way. That one university is as good as another. That all problems have a large number of causes, so that it is not worth isolating a few key causes. That all opportunities are of roughly equal value, so that we treat them all equally. We tend to assume that 50 per cent of causes or inputs will account for 50 per cent of results or outputs. There seems to be a natural, almost democratic, expectation that causes and results are generally equally balanced. And, of course, sometimes they are. But this ‘50/50 fallacy’ is one of the most inaccurate and harmful, as well as the most deeply rooted, of our mental maps. The 80/20 Principle asserts that when two sets of data, relating to causes and results, can be examined and analysed, the most likely result is that there will be a pattern of WELCOME TO THE 80/20 PRINCIPLE 11 imbalance. The imbalance may be 65/35, 70/30, 75/25, 80/20, 95/5, or 99.9/0.1, or any set of numbers in between. However, the two numbers in the comparison don’t have to add up to 100 (see page 23). The 80/20 Principle also asserts that when we know the true relationship, we are likely to be surprised at how unbalanced it is. Whatever the actual level of imbalance, it is likely to exceed our prior estimate. Executives 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. Teachers may know that the majority of their disciplinary troubles or most truancy arises from a minority of pupils, but if records are analysed the extent of the imbalance will probably be larger than expected. We may feel that some of our time is more valuable than the rest, but if we measure inputs and outputs the disparity can still stun us. Why should you care about the 80/20 Principle? Whether you realize it or not, the principle applies to your life, to your social world and to the place where you work. Understanding the 80/20 Principle gives you great insight into what is really happening in the world around you. The overriding message of this book is that our daily lives can be greatly improved by using the 80/20 Principle. Each individual can be more effective and happier. Each profit-seeking corporation can become very much more profitable. Each non-profit organization can also deliver much more useful outputs. Every government can ensure that its citizens benefit much more from its existence. For everyone and every institution, it is possible to obtain much more that is of value, and avoid what has negative value, with much less input of effort, expense or investment. At the heart of this progress is a process of substitution. 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. Wherever possible, weak resources are developed so that they can mimic the behaviour of the stronger resources. Business and markets have used this process, to great effect, for hundreds of years. The French economist J-B Say coined the word 12 OVERTURE around 1800, saying that ‘the entrepreneur shifts economic resources out of an area of lower productivity into an area of higher productivity and yield’. But one fascinating implication of the 80/20 Principle is how far businesses and markets still are from producing optimal solutions. For example, the 80/20 Principle asserts that 20 per cent of products, or customers or employees, are really responsible for about 80 per cent of profits. If this is true—and detailed investigations usually confirm that some such very unbalanced pattern exists— the state of affairs implied is very far from being efficient or optimal. The implication is that 80 per cent of products, or customers or employees, are only contributing 20 per cent of profits. That there is great waste. That the most powerful resources of the company are being held back by a majority of much less effective resources. 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). In this kind of situation one might well ask: why continue to make the 80 per cent of products that only generate 20 per cent of profits? Companies rarely ask these questions, perhaps because to answer them would mean very radical action: to stop doing four-fifths of what you are doing is not a trivial change. What J-B Say called the work of entrepreneurs, modern financiers call arbitrage. International financial markets are very quick to correct anomalies in valuation, for example between exchange rates. But business organizations and individuals are generally very poor at this sort of entrepreneurship or arbitrage, 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. Most of the time, we do not realize the extent to which some resources, but only a small minority, are super-productive—what Joseph Juran called the ‘vital few’—while the majority—the ‘trivial many’—exhibit little productivity or else actually have negative value. If we did realize 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. WELCOME TO THE 80/20 PRINCIPLE 13 The 80/20 Principle and chaos theory Probability theory tells us that it is virtually impossible for all the applications of the 80/20 Principle to occur randomly, as a freak of chance. We can only explain the principle by positing some deeper meaning or cause that lurks behind it. Pareto himself grappled with this issue, trying to apply a consistent methodology to the study of society He searched for ‘theories that picture facts of experience and observation’, for regular patterns, social laws or ‘uniformities’ that explain the behaviour of individuals and society. Pareto’s sociology failed to find a persuasive key. He died long before the emergence of chaos theory, which has great parallels with the 80/20 Principle and helps to explain it. The last third of the twentieth century has seen a revolution in the way that scientists think about the universe, overturning the prevailing wisdom for the past 350 years. That prevailing wisdom was a machine-based and rational view, which itself was a great advance on the mystical and random view of the world which was held in the Middle Ages. The machine-based view converted God from being an irrational and unpredictable force into a more user-friendly clockmaker-engineer. The view of the world held from the seventeenth century and still prevalent today, except in advanced scientific circles, was immensely comforting and useful. All phenomena were reduced to regular, predictable, linear relationships. For example, a causes b, b causes c, and a + c cause d. This world view enabled any individual part of the universe—the operation of the human heart, for example, or of any individual market—to be analysed separately, because the whole was the sum of the parts and vice versa. But in the second half of the twentieth century it seems much more accurate to view the world as an evolving organism where the whole system is more than the sum of its parts, and where relationships between the parts are non-linear. Causes are difficult to pin down, there are complex interdependencies between causes, and causes and effects are blurred. The snag with linear thinking is that it doesn’t always work, it is OVERTURE 14 an oversimplification of reality. Equilibrium is illusory or fleeting. The universe is wonky. Yet chaos theory, despite its name, does not say that everything is a hopeless and incomprehensible mess. Rather, there is a self-organizing logic lurking behind the disorder, a predictable non-linearity—something which economist Paul Krugman has called ‘spooky’, ‘eerie’ and ‘terrifyingly exact’.9 The logic is more difficult to describe than to detect, and is not totally dissimilar to the recurrence of a theme in a piece of music. Certain characteristic patterns recur, but with infinite and unpredictable variety. Chaos theory and the 80/20 Principle illuminate each other What have chaos theory and related scientific concepts got to do with the 80/20 Principle? Although no one else appears to have made the link, I think the answer is: a great deal. ! The principle of imbalance The common thread between chaos theory and the 80/20 Principle is the issue of balance—or, more precisely, imbalance. Both chaos theory and the 80/20 Principle assert (with a great deal of empirical backing) that the universe is unbalanced. They both say that the world is not linear; cause and effect are rarely linked in an equal way. Both also place great store by selforganization: some forces are always more forceful than others and will try to grab more than their fair share of resources. Chaos theory helps to explain why and how this imbalance happens by tracing a number of developments over time. ! The universe is not a straight line The 80/20 Principle, like chaos theory, is based around the idea of non- WELCOME TO THE 80/20 PRINCIPLE 15 linearity. A great deal of what happens is unimportant and can be disregarded. Yet there are always a few forces that have an influence way beyond their numbers. These are the forces that must be identified and watched. If they are forces for good, we should multiply them. If they are forces we don’t like, we need to think very carefully about how to neutralize them. The 80/20 Principle supplies a very powerful empirical test of non-linearity in any system: we can ask, do 20 per cent of causes lead to 80 per cent of results? Is 80 per cent of any phenomenon associated with only 20 per cent of a related phenomenon? This is a useful method to flush out non-linearity, but it is even more useful because it directs us to identifying the unusually powerful forces at work. ! Feedback loops distort and disturb balance The 80/20 Principle is also consistent with, and can be explained by reference to, the feedback loops identified by chaos theory, whereby small initial influences can become greatly multiplied and produce highly unexpected results, which nevertheless can be explained in retrospect. In the absence of feedback loops, the natural distribution of phenomena would be 50/50—inputs of a given frequency would lead to commensurate results. If is only because of positive and negative feedback loops that causes do not have equal results. Yet it also seems to be true that powerful positive feedback loops only affect a small minority of the inputs. This helps to explain why those small minority of inputs can exert so much influence. We can see positive feedback loops operating in many areas, explaining how it is that we typically end up with 80/20 rather than 50/50 relationships between populations. For example, the rich get richer, not just (or mainly) because of superior abilities, but because riches beget riches. A similar phenomenon exists with goldfish in a pond. Even if you start with goldfish almost exactly the same size, those that are slightly bigger become very much bigger, because, even with only slight initial advantages in stronger propulsion and larger mouths, they are able to capture and gobble up disproportionate amounts of food. OVERTURE 16 ! The tipping point Related to the idea of feedback loops is the concept of the tipping point. Up to a certain point, a new force—whether it is a new product, a disease, a new rock group or a new social habit such as jogging or roller-blading— finds it difficult to make headway. A great deal of effort generates little by way of results. At this point many pioneers give up. But if the new force persists and can cross a certain invisible line, a small amount of additional effort can reap huge returns. This invisible line is the tipping point. The concept comes from the principles of epidemic theory. The tipping point is ‘the point at which an ordinary and stable phenomenon—a lowlevel flu outbreak—can turn into a public-health crisis’,10 because of the number of people who are infected and can therefore infect others. And since the behaviour of epidemics is non-linear and they don’t behave in the way we expect, ‘small changes—like bringing new infections down to thirty thousand from forty thousand—can have huge effects. . . It all depends when and how the changes are made.’11 ! First come, best served Chaos theory advocates ‘sensitive dependence on initial conditions’12— what happens first, even something ostensibly trivial, can have a disproportionate effect. This resonates with, and helps to explain, the 80/20 Principle. The latter states that a minority of causes exert a majority of effects. One limitation of the 80/20 Principle, taken in isolation, is that it always represents a snapshot of what is true now (or, more precisely, in the very recent past when the snapshot was taken). This is where chaos theory’s doctrine of sensitive dependence on initial conditions is helpful. A small lead early on can turn into a larger lead or a dominant position later on, until equilibrium is disturbed and another small force then exerts a disproportionate influence. A firm that, in the early stages of a market, provides a product that is 10 per cent better than its rivals may end up with 100 or 200 per cent greater market share, even if the rivals later provide a better product. In WELCOME TO THE 80/20 PRINCIPLE 17 the early days of motoring, if 51 per cent of drivers or countries decide to drive on the right rather than the left of the road, this will tend to become the norm for nearly 100 per cent of road users. In the early days of using a circular clock, if 51 per cent of clocks go what we now call ‘clockwise’ rather than ‘counter-clockwise’, this convention will become dominant, although clocks could just as logically have moved to the left. In fact, the clock over Florence cathedral moves counterclockwise and shows 24 hours.13 Soon after 1442 when the cathedral was built, the authorities and clockmakers standardized on a 12-hour, ‘clockwise’ clock, because the majority of clocks had those features. Yet if 51 per cent of clocks had ever been like the clock over Florence cathedral, we would now be reading a 24hour clock backwards. These observations regarding sensitive dependence on initial conditions do not exactly illustrate the 80/20 Principle. The examples given involve change over time, whereas the 80/20 Principle involves a static breakdown of causes at any one time. Yet there is an important link between the two. Both phenomena help to show how the universe abhors balance. In the former case, we see a natural flight away from a 50/50 split of competing phenomena. A 51/49 split is inherently unstable and tends to gravitate towards a 95/5, 99/1 or even 100/0 split. Equality ends in dominance: that is one of the messages of chaos theory. The 80/20 Principle’s message is different yet complementary It tells us that, at any one point, a majority of any phenomenon will be explained or caused by a minority of the actors participating in the phenomenon. 80 per cent of the results come from 20 per cent of the causes. A few things are important; most are not. The 80/20 Principle sorts good movies from bad One of the most dramatic examples of the 80/20 Principle at work is with movies. Two economists14 have just made a study of the revenues and lifespans of 300 movies released over an 18-month period. They found that four movies— just 1.3 per cent of the total—earned 80 per cent of box office revenues; the other 296 movies or 98.7 per cent earned only 18 OVERTURE 20 per cent of the gross. So movies, which are a good example of unrestricted markets at work, produce virtually an 80/1 rule, a very clear demonstration of the principle of imbalance. Even more intriguing is why. It transpires that movie goers behave just like gas particles in random motion. As identified by chaos theory, gas particles, pingpong balls or movie goers all behave at random, but produce a predictably unbalanced result. Word of mouth, from reviews and the first audiences, determines whether the second set of audiences will be large or small, which determines the next set and so on. Movies like Independence Day or Mission Impossible continue to play to packed houses, while other ‘star-studded and expensive movies, like Waterworld or Daylight, very quickly play to smaller and smaller houses, and then none at all. This is the 80/20 Principle working with a vengeance. A guide to this guidebook Chapter 2 explains how you can put the 80/20 Principle into practice and explores the distinction between 80/20 Analysis and 80/20 Thinking, both of which are useful methods derived from the 80/20 Principle. 80/20 Analysis is a systematic, quantitative method of comparing causes and effects. 80/20 Thinking is a broader, less precise and more intuitive procedure, comprising the mental models and habits that enable us to hypothesize what are the important causes of anything important in our lives, to identify these causes, and to make sharp improvements in our position by redeploying our resources accordingly. Part Two: Corporate Success Needn’t be a Mystery summarizes the most powerful business uses of the 80/20 Principle. These uses have been tried and tested and found to be of immense value, yet remain curiously unexploited by most of the business community. There is little in my summary that is original, but anyone seeking major profit improvement, whether for a small or large business, should find this a very useful primer WELCOME TO THE 80/20 PRINCIPLE 19 and the first ever to appear in a book. Part Three: Work Less, Earn and Enjoy More shows how the 80/20 Principle can be used to raise the level at which you are operating in both your work and personal life. This is a pioneering attempt to apply the 80/20 Principle on a novel canvas; and the attempt, although I am sure it is imperfect and incomplete in many ways, does lead to some surprising insights. For example, 80 per cent of the typical person’s happiness or achievement in life occurs in a small proportion of that life. The peaks of great personal value can usually be greatly expanded. The common view is that we are short of time. My application of the 80/20 Principle suggests the reverse: that we are actually awash with time and profligate in its abuse. Part Four: Crescendo—Progress Regained draws the themes together and positions the 80/20 Principle as the greatest secret engine of progress available to us all. It hints at the uses that could be made of the 80/20 Principle for the public good as well as for corporate wealth creation and personal advancement. Why the 80/20 Principle brings good news I want to end this introduction on a personal rather than a procedural note. I believe that the 80/20 Principle is enormously hopeful. Certainly, the principle brings home what may be evident anyway: that there is a tragic amount of waste everywhere, in the way that nature operates, in business, in society and in our own lives. If the typical pattern is for 80 per cent of results to come from 20 per cent of inputs, it is necessarily typical too that 80 per cent, the great majority, of inputs are having only a marginal—20 per cent—impact. The paradox is that such waste can be wonderful news, if we can use the 80/20 Principle creatively, not just to identify and castigate low productivity but to do something positive about it. There is enormous scope for improvement, by rearranging and redirecting both nature and our 20 OVERTURE own lives. Improving on nature, refusing to accept the status quo, is the route of all progress: evolutionary, scientific, social and personal. George Bernard Shaw put it well: ‘The reasonable man adapts himself to the world. The unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.’15 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. Successful experiments with the 80/20 Principle in the business arena suggest that, with creativity and determination, this leap in value can usually be made. There are two routes to achieving this. One is to reallocate the resources from unproductive to productive uses, the secret of all entrepreneurs down the ages. Find a round hole for a round peg, a square hole for a square peg, and a perfect fit for any shape in between. Experience suggests that 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, preachers, computer systems designers, educationalists and trainers—is to find ways to make the unproductive resources more effective, even in their existing applications; to make the weak resources behave as though they were their more productive cousins; to mimic, if necessary by intricate rote-learning procedures, the highly productive resources. The few things that work fantastically well should be identified, cultivated, nurtured and multiplied. At the same time, the waste—the majority of things that will always prove to be of low value to man and beast—should be abandoned or severely cut back. As I have been writing this book and observed thousands of examples of the 80/20 Principle, I have had my faith reinforced: faith in progress, in great leaps forward, and in mankind’s ability, individually and collectively, to improve the hand that nature has dealt. Joseph Ford comments: ‘God plays dice with the universe. But they’re loaded dice. And the main objective is to find out by what rules they were loaded and how we can use them for our own ends.’16 The 80/20 Principle can help us achieve precisely that. 2 How to Think 80/20 Chapter 1 explained the concept behind the 80/20 Principle; this chapter will discuss how the 80/20 Principle works in practice and what it can do for you. Two applications of the principle, 80/20 Analysis and 80/20 Thinking, provide a practical philosophy which will help you understand and improve your life. Definition of the 80/20 Principle The 80/20 Principle states that there is an inbuilt imbalance between causes and results, inputs and outputs, and effort and reward. Typically, causes, inputs or effort divide into two categories: ! ! the majority, that have little impact a small minority, that have a major, dominant impact. 22 OVERTURE Typically also, results, outputs or rewards are derived from a small proportion of the causes, inputs or effort aimed at producing the results, outputs or rewards. The relationship between causes, inputs or efforts on the one hand, and results, outputs or rewards on the other, is therefore typically unbalanced. When this imbalance can be measured arithmetically, a good bench mark for the imbalance is the 80/20 relationship—80 per cent of results, outputs or rewards are derived from only 20 per cent of the causes, inputs or effort. About 80 per cent of the world’s energy is consumed by 15 per cent of the ‘world’s population, for example.1 80 per cent of the world’s wealth is possessed by 25 per cent of the world’s people.2 In health care, ‘20 percent of your population base and/or 20 percent of its disease elements will consume 80 percent of your resources’.3 Figures 2 and 3 show this 80/20 pattern. Let us imagine that a company has 100 products and has found out that the most profitable 20 products account for 80 per cent of all profits. In Figure 2, the bar on the left comprises the 100 products, each occupying an equal hundredth of the space. Figure 2. HOW TO THINK 80/20 23 In the bar on the right are the total profits of the company from the 100 products. Imagine that the profits from the one most profitable product are filled in from the top of the right-hand bar downwards. Let us say that the most profitable product makes 20 per cent of total profits. Figure 2 therefore shows that one product, or 1 per cent of the products, occupying one hundredth of the space on the left, makes 20 per cent of the profits. The shaded areas represent this relationship. If we continue counting the next most profitable product and so on down the bar, until we have the profits from the top 20 products, we can then shade in the right-hand bar according to how much of the total profit these top 20 products make. We show this in Figure 3, where we see (in our fictitious example) that these 20 products, 20 per cent of the number of products, comprise 80 per cent of the total profits (in the shaded area). Conversely, in the white area, we can see the flip side of this relationship: 80 per cent of the products only make, in total, 20 per cent of the profits. The 80/20 numbers are only a benchmark, and the real relationship may be more or less unbalanced than 80/20. The 80/20 Principle asserts, Figure 3. A typical 80/20 pattern 24 OVERTURE however, that in most cases the relationship is much more likely to be closer to 80/20 than to 50/50. If all of the products in our example made the same profit, then the relationship would be as shown in Figure 4. The curious but crucial point is that, when such investigations are conducted, Figure 3 turns out to be a much more typical pattern than Figure 4. Nearly always, a small proportion of total products produces a large proportion of profits. Of course, the exact relationship may not be 80/20. 80/20 is both a convenient metaphor and a useful hypothesis, but it is not the only pattern.’ Sometimes, 80 per cent of the profits come from 30 per cent of the products; sometimes 80 per cent of the profits come from 15 per cent or even 10 per cent of the products. The numbers compared do not have to add up to 100, but the picture usually looks unbalanced, much more like Figure 3 than Figure 4. It is perhaps unfortunate that the numbers 80 and 20 add up to 100. This makes the result look elegant (as, indeed, would a result of 50/50, 70/30, 99/1 or many other combinations) and it is certainly memorable, but it makes many people think that we are dealing with just one set of data, one 100 per cent. This is not so. If 80 per cent of people are right-handed and 20 Figure 4. An unusual 50/50 pattern HOW TO THINK 80/20 25 per cent are left-handed, this is not an 80/20 observation. To apply the 80/20 Principle you have to have two sets of data, both adding up to 100 per cent, and one measuring a variable quantity owned, exhibited or caused by the people or things making up the other 100 per cent. What the 80/20 Principle can do for you Every person I have known who has taken the 80/20 Principle seriously has emerged with useful, and in some cases life-changing, insights. You have to work out your own uses for the principle: they will be there if you look creatively. Part Three (Chapters 9 to 15) will guide you on your odyssey, but I can illustrate with some examples from my own life. How the 80/20 Principle has helped me When I was a raw student at Oxford, my tutor told me never to go to lectures. ‘Books can be read far faster” he explained. ‘But never read a book from cover to cover, except for pleasure. When you are working, find out what the book is saying much faster than you would by reading it through. Read the conclusion, then the introduction, then the conclusion again, then dip lightly into any interesting bits. ‘What he was really saying was that 80 per cent of the value of a book can be found in 20 per cent or fewer of its pages, and absorbed in 20 per cent of the time most people would take to read it through. I took to this study method and extended it. At Oxford there is no system of continuous assessment and the class of degree earned depends entirely on Finals, the examinations taken at the end of the course. I discovered from the ‘form book’, that is by analysing past examination papers, that at least 80 per cent (sometimes 100 per cent) of an examination could be well answered with knowledge from 20 per cent or fewer 26 OVERTURE of the subjects that the exam was meant to cover. The examiners could therefore be much better impressed by a student who knew an awful lot about relatively little, rather than a fair amount about a great deal. This insight enabled me to study very efficiently. Somehow, without working very hard, I ended up with a congratulatory First Class degree. I used to think this proved that Oxford dons were gullible. I now prefer to think, perhaps improbably, that they were teaching us how the world worked. I went to work for Shell, serving my time at a dreadful oil refinery. This may have been good for my soul, but I rapidly realized that the best-paying jobs, for young and inexperienced people such as I lay in management consultancy. So I went to Philadelphia, and picked up an effortless MBA from Wharton (scorning the boot-camp style so-called learning experience from Harvard). I joined a leading US consultancy that on day one paid me four times what Shell had paid me when I left. No doubt 80 per cent of the money to be had by people of my tender age was concentrated in 20 per cent of the jobs. Since there were too many colleagues in the consultancy who were smarter than me, I moved to another US strategy ‘boutique’. I identified it because it was growing faster than the firm I had joined, yet had a much smaller proportion of really smart people. Who you work for is more important than what you do Here I stumbled across many paradoxes of the 80/20 Principle. 80 per cent of the growth in the strategy consultancy industry—then, as now, growing like gangbusters—was being appropriated by firms that then had, in total, fewer than 20 per cent of the industry’s professional staff. 80 per cent of rapid promotions were also available in just a handful of firms. Believe me, talent had very little to do with it. When I left the first strategy firm and joined the second, I raised the average level of intelligence in both. Yet the puzzling thing was that my new colleagues were more effective than my old ones. Why? They didn’t work any harder. But they HOW TO THINK 80/20 27 followed the 80/20Principle in two key ways. First, they realized that for most firms, 80 per cent of profits come from 20 per cent of clients. In the consulting industry that means two things: large clients and long-term clients. Large clients give large assignments, which means you can use a higher proportion of lower-cost, younger consultants. Long-term client relationships create trust and raise the cost to the client of switching to another consulting firm. Long-term clients tend not to be price sensitive. In most consulting firms, the real excitement comes from winning new clients. In my new firm, the real heroes were those who worked on the largest existing clients for the longest possible time. They did this by cultivating the top bosses of those client corporations. The second key insight the consulting firm had was that in any client, 80 per cent of the results available would flow from concentrating on the 20 per cent of most important issues. These were not necessarily the most interesting ones from a curious consultant’s viewpoint. But, whereas our competitors would look superficially at a whole range of issues and then leave them for the client to act (or not) on the recommendations, we kept plugging away at the most important issues until we had bludgeoned the client into successful action. The clients’ profits often soared as a result, as did our consulting budgets. Are you working to make others rich or is it the reverse? I soon became convinced that, for both consultants and their clients, effort and reward were at best only loosely linked. It was better to be in the right place than to be smart and work hard. It was best to be cunning and focus on results rather than inputs. Acting on a few key insights produced the goods. Being intelligent and hard working did not. Sadly, for many years, guilt and conformity to peer-group pressure kept me from fully acting on this lesson; I worked far too hard. By this time, the consulting firm had several hundred professional staff and about 30 people, including myself, who were called partners. But 80 per cent of the profits went to one man, the founder, even though 28 OVERTURE numerically he constituted less than 4 per cent of the partnership and a fraction of 1 per cent of the consulting force. Instead of continuing to enrich the founder, two other junior partners and I spun off to set up our own firm doing exactly the same thing. We in turn grew to have hundreds of consultants. Before long, although the three of us, on any measure, did less than 20 per cent of the firm’s valuable work, we enjoyed over 80 per cent of the profits. This, too, caused me guilt. After six years I quit, selling my shares to the other partners. At this time, we had doubled our revenues and profits every year and I was able to secure a good price for my shares. Shortly after, the recession of 1990 hit the consulting industry. Although I will counsel you later to give up guilt, I was lucky with my guilt. Even those who follow the 80/20 Principle need a bit of luck, and I have always enjoyed far more than my share. Wealth from investment can dwarf wealth from working With 20 per cent of the money received, I made a large investment in the shares of one corporation, Filofax. Investment advisers were horrified. At the time I owned about 20 shares in quoted public companies, but this one stock, 5 per cent of the number of shares I owned, accounted for about 80 per cent of my portfolio. Fortunately, the proportion proceeded to grow still further, as over the next three years Filofax shares multiplied several times in value. When I sold some shares, in 1995, it was at nearly 18 times the price I had paid for my first stake. I made two other large investments, one in a start-up restaurant called Belgo and the other in MSI, a hotel company that at the time owned no hotels. Together, these three investments at cost comprised about 20 per cent of my net worth. But they have accounted for more than 80 per cent of my subsequent investment gains, and now comprise over 80 per cent of a much larger net worth. As Chapter 14 will show, 80 per cent of the increase in wealth from most long-term portfolios comes from fewer than 20 per cent of the investments. It is crucial to pick this 20 per cent well and then HOW TO THINK 80/20 29 concentrate as much investment as possible into it. Conventional wisdom is not to put all your eggs in one basket. 80/20 wisdom is to choose a basket carefully, load all your eggs into it, and then watch it like a hawk. How to use the 80/20 Principle There are two ways to use the 80/20 Principle, as shown in Figure 5. Traditionally, the 80/20 Principle has required 80/20 Analysis, a quantitative method to establish the precise relationship between causes/input/effort and results/outputs/rewards. This method uses the Figure 5. Two ways to use the 80/20 Principle 30 OVERTURE possible existence of the 80/20 relationship as a hypothesis and then gathers the facts so that the true relationship is revealed. This is an empirical procedure which may lead to any result ranging from 50/50 to 99.9/0.1. If the result does demonstrate a marked imbalance between inputs and outputs (say a 65/35 relationship or an even more unbalanced one), then normally action is taken as a result (see below). A new and complementary way to use the 80/20 Principle is what I call 80/20 Thinking. This requires deep thought about any issue that is important to you, and asks you to make a judgement on whether the 80/20 Principle is working in that area. You can then act on the insight. 80/20 Thinking does not require you to collect data or actually test the hypothesis. Consequently, 80/20 Thinking may on occasion mislead you—it is dangerous to assume, for example, that you already know what the 20 per cent is if you identify a relationship—but I will argue that 80/20 Thinking is much less likely to mislead you than is conventional thinking. 80/20 Thinking is much more accessible and faster than 80/20 Analysis, although the latter may be preferred when the issue is extremely important and you find it difficult to be confident about an estimate. We look first at 80/20 Analysis, and then at 80/20 Thinking. 80/20 Analysis 80/20 Analysis examines the relationship between two sets of comparable data. One set of data is always a universe of people or objects, usually a large number of 100 or more, that can be turned into a percentage. The other set of data relates to some interesting characteristic of the people or objects, that can be measured and also turned into a percentage. For example, we might decide to look at a group of 100 friends, all of whom are at least occasional beer drinkers, and compare how much beer they drank last week. So far, this method of analysis is common to many HOW TO THINK 80/20 31 statistical techniques. What makes 80/20 Analysis unique is that the measurement ranks the second set of data in descending order of importance, and makes comparisons between percentages in the two sets of data. In our example, then, we will ask all our 100 friends how many glasses of beer they drank last week and array the answers in a table in descending order. Figure 6 shows the top 20 and bottom 20 from the table. 80/20 Analysis can compare percentages from the two sets of data (the friends and the amount of beer drunk). In this case, we can say that 70 per cent of the beer was drunk by just 20 per cent of the friends. This would therefore give us a 70/20 relationship. Figure 7 introduces an 80/20 frequency distribution chart (or 80/20 chart for short) to summarize the data visually. Why is this called 80/20 Analysis? When comparing these relationships, the most frequent observation, made long ago (probably in the 1950s), was that 80 per cent of the quantity being measured came from 20 per cent of the people or objects. 80/20 has become shorthand for this type of unbalanced relationship, whether or not the precise result is 80/20 (statistically, an exact 80/20 relationship is unlikely). It is the convention of 80/20 that it is the top 20 per cent of causes that is cited, not the bottom. 80/20 Analysis is my name for the way that the 80/20 Principle has generally been used to date, that is in a quantitative and empirical way, to measure possible relationships between inputs and outputs. We could equally well observe from the data on our beer-drinking friends that the bottom 20 per cent of people only consumed 30 glasses, or 3 per cent of the total. It would also be perfectly legitimate to call this a 3/20 relationship, although this is rarely done. The emphasis is nearly always on the heavy users or causes. If a brewery was conducting a promotion, or wanted to find out what beer drinkers thought about their range of beers, it would be most useful to go to the top 20. We might also want to know what percentage of our friends 32 Figure 6. OVERTURE HOW TO THINK 80/20 33 Figure 7. 80/20 frequency distribution chart of beer drinkers combined to account for 80 per cent of total beer consumption. In this case, inspection of the part of the table not displayed (the middle part) would show that Mike G, the 28th biggest drinker with 10 glasses, took the cumulative total to 800 glasses. We could express this relationship, therefore, as 80/28: 80 per cent of total beer was drunk by just 28 per cent of our friends. It should be clear from this example that 80/20 Analysis may result in any set of findings. Clearly, individual findings are more interesting and potentially more useful where there is an imbalance. If, for example, we had found that all of our friends had drunk exactly eight glasses each, the brewery would not have been very interested in using our group for a promotion or research. In this case, we would have had a 20/20 relationship (20 per cent of beer was drunk by the ‘top’ 20 per cent of friends) or an 80/80 relationship (80 per cent of beer was drunk by 80 per cent of friends). 34 OVERTURE Bar charts show 80/20 relationships best An 80/20 Analysis is best displayed pictorially, by looking at two bars—as is particularly appropriate for our example! (Figures 2–4 above were bar charts.) The first bar in Figure 8 contains our 100 beer-drinking friends, each filling 1 per cent of the space, starting with the biggest beer drinker at the top and ending with the smallest beer drinkers at the bottom. The second bar contains the total amount of beer drunk by each (and all) of our friends. At any point, we can see for a given percentage of our friends, how much beer they accounted for. Figure 8 shows what we discovered from the table (and could also see from Figure 7): that the top 20 per cent of beer drinkers accounted for 70 per cent of the beer drunk. The simple bars in Figure 8 take the data from Figure 7 and display them from top to bottom instead of from left to right. It doesn’t matter which display you prefer. If we wanted to illustrate what percentage of our friends drank 80 per cent of the beer, we would draw the bar charts slightly differently, as in Figure 9, to show the 80/28 relationship: 28 per cent of our friends drank 80 per cent of the beer. Figure 8. HOW TO THINK 80/20 35 Figure 9. What is 80/20 Analysis used for? Generally, to change the relationship it describes, or to make better use of it! One use is to concentrate on the key causes of the relationship, the 20 per cent of inputs that lead to 80 per cent (or whatever the precise number is) of the outputs. If the top 20 per cent of beer drinkers account for 70 per cent of beer consumed, this is the group that a brewery should concentrate on reaching, in order to attract as high a share as possible of the business from the 20 per cent, and possibly also to increase their beer consumption still further. For all practical purposes, the brewery may decide to ignore the 80 per cent of beer drinkers who only consume 30 per cent of the beer; this simplifies the task immensely. Similarly, a firm that finds that 80 per cent of its profits come from 20 per cent of its customers should use this information to concentrate on keeping that 20 per cent happy and increasing the business carried out with them. This is much easier, as well as more rewarding, than paying 36 OVERTURE equal attention to the whole customer group. Or, if the firm finds that 80 per cent of its profits come from 20 per cent of its products, it should put most of its efforts behind selling more of those products. The same idea applies to non-business applications of 80/20 Analysis. If you analysed the enjoyment you derived from all your leisure activities and found that 80 per cent of the enjoyment derived from 20 per cent of the activities, which currently took only 20 per cent of your leisure time, it would make sense to increase the time allocation from 20 to at least 80 per cent. Take transport as another example. 80 per cent of traffic jams occur on 20 per cent of roads. If you drive on the same route to work each day, you will know that roughly 80 per cent of delays usually occur at 20 per cent of the intersections. A sensible reaction would be for traffic authorities to pay particular attention to traffic phasing on those 20 per cent of jam-creating intersections. While the expense of such phasing might be too much for 100 per cent of junctions 100 per cent of the time, it would be money well spent in the key 20 per cent of locations for 20 per cent of the day. The second main use of 80/20 Analysis is to do something about the ‘underperforming’ 80 per cent of inputs that contribute only 20 per cent of the output. Perhaps the occasional beer drinkers can be persuaded to drink more, for example by providing a blander product. Perhaps you could work out ways to get greater enjoyment out of the ‘underperforming’ leisure activities. In education, interactive teaching systems now replicate the technique used by college professors where questions are addressed randomly to any student, in order to combat the 80/20 rule, where 80 percent of classroom participation comes from 20 percent of the trainees. In US shopping malls it has been found that women (some 50 per cent of the population) account for 70 per cent of the dollar value of all purchases.4 One way to increase the 30 per cent of sales to men might be to build stores specifically designed for them. Although this second application of 80/20 Analysis is sometimes very useful, and has been put to great effect in industry in improving the productivity of underperforming factories, it is generally harder work and less rewarding than the first use. HOW TO THINK 80/20 37 Don’t apply 80/20 Analysis in a linear way In discussing the uses of 80/20 Analysis, we must also briefly address its potential abuses. Like any simple and effective tool, 80/20 Analysis can also be misunderstood, misapplied and, instead of being the means to an unusual insight, serve as the justification for conventional thuggery. 80/20 Analysis, applied inappropriately and in a linear way, can also lead the innocent astray—you need constantly to be vigilant against false logic. Let me illustrate this with an example from my own new profession, the book trade. It is easy to demonstrate that, in most times and places, about 20 per cent of book tides comprise about 80 per cent of books sold. For those who are steeped in the 80/20 Principle, this is not surprising. It might seem a short hop to the conclusion that bookshops should cut the range of books they stock or, indeed, that they should concentrate largely or exclusively on ‘bestsellers’. Yet what is interesting is that in most cases, instead of sending profits up, restricting range has sent profits down. This does not invalidate the 80/20 Principle, for two reasons. The key consideration is not the distribution of books sold, but what customers want. If customers go to the trouble of visiting a bookstore they want to find a reasonable range of books (as opposed to a kiosk or supermarket, where they don’t expect range). Bookstores should concentrate on the 20 per cent of customers who account for 80 per cent of their profits and find out what those 20 per cent of customers want. The other reason is that what matters even when considering books (as opposed to customers) is not the distribution of sales—the 20 per cent of books that represent 80 per cent of sales—but the distribution of profits—the 20 per cent of titles that generate 80 per cent of profits. Very often, these are not the socalled bestsellers, books written by well-known authors. In fact, a study in the US revealed that ‘best sellers rep- resent about 5% of total sales’.5 The true bestsellers are often those books that never make it into the charts but sell a reliable quantity year in and year out, often at high margins. As the same US research comments, ‘Core inventory represents those books that sell season-in and season-out. They are the “80” in the 80/20 rule, often accounting for the lion’s share of 38 OVERTURE sales in a particular subject.’ This illustration is salutary. It does not invalidate 80/20 Analysis at all, since the key questions should always be which customers and products generate 80 per cent of profits. But it does show the danger of not thinking clearly enough about how the analysis is applied. When using the 80/20 Principle, be selective and be contrarian. Don’t be seduced into thinking that the variable that everyone else is looking at—in this case, the books on the latest bestseller list—is what really matters. This is linear thinking. The most valuable insight from 80/20 Analysis will always come from examining non-linear relationships that others are neglecting. In addition, because 80/20 Analysis is based on a freezeframe of the situation at a particular point rather than incorporating changes over time, you must be aware that if you inadvertently freeze the wrong or an incomplete picture, you will get an inaccurate view. 80/20 Thinking and why it is necessary 80/20 Analysis is extremely useful. But most people are not natural analysts, and even analysts cannot stop to investigate the data every time they have to make a decision—it would bring life to a shuddering halt. Most important decisions have never been made by analysis and never will be, however clever our computers become. Therefore, if we want the 80/20 Principle to be a guide in our daily lives, we need something less analytical and more instantly available than 80/20 Analysis. We need 80/20 Thinking. 80/20 Thinking is my phrase for the application of the 80/20 Principle to daily life, for non-quantitative applications of the principle. As with 80/20 Analysis, we start with a hypothesis about a possible imbalance between inputs and outputs but, instead of collecting data and analysing them, we estimate them. 80/20 Thinking requires, and with practice enables, us to spot the few really important things that are happening HOW TO THINK 80/20 39 and ignore the mass of unimportant things. It teaches us to see the wood for the trees. 80/20 Thinking is too valuable to be confined to causes where data and analysis are perfect. For every ounce of insight generated quantitatively, there must be many pounds of insight arrived at intuitively and impressionistically. This is why 80/20 Thinking, although helped by data, must not be constrained by it. To engage in 80/20 Thinking, we must constantly ask ourselves: what is the 20 per cent that is leading to 80 per cent? We must never assume that we automatically know what the answer is, but take some time to think creatively about it. What are the vital few inputs or causes, as opposed to the trivial many? Where is the haunting melody being drowned by the background noise? 80/20 Thinking is then used in the same way as the results from 80/20 Analysis: to change behaviour and, normally, to concentrate on the most important 20 per cent. You know that 80/20 Thinking is working when it multiplies effectiveness. Action resulting from 80/20 Thinking should lead us to get much more from much less. When we are using the 80/20 Principle we do not assume that its results are good or bad or that the powerful forces we observe are necessarily good. We decide whether they are good (from our own perspective), and either determine to give the minority of powerful forces a further shove in the right direction, or work out how to frustrate their operation. The 80/20 Principle turns conventional wisdom upside down Application of the 80/20 Principle implies that we should do the following: 40 OVERTURE celebrate exceptional productivity, rather than raise average efforts look for the short cut, rather than run the full course exercise control over our lives with the least possible effort. be selective, not exhaustive strive for excellence in few things, rather than good performance in many ! delegate or outsource as much as possible in our daily lives and be encouraged rather than penalized by tax systems to do this (use gardeners, car mechanics, decorators and other specialists to the maximum, instead of doing the work ourselves) ! choose our careers and employers with extraordinary care, and if possible employ others rather than being employed ourselves ! only do the thing we are best at doing and enjoy most ! look beneath the normal texture of life to uncover ironies and oddities ! in every important sphere, work out where 20 per cent of effort can lead to 80 per cent of returns ! calm down, work less and target a limited number of very valuable goals where the 80/20 Principle will work for us, rather than pursuing every available opportunity ! make the most of those few ‘lucky streaks’ in our life where we are at our creative peak and the stars line up to guarantee success. ! ! ! ! ! There are no boundaries to the 80/20 Principle No sphere of activity is immune from the influence of the 80/20 Principle. Like the six wise, blind Indian men who tried to discern the shape of an elephant, most users of the 80/20 Principle only know a fraction of its scope and power. Becoming an 80/20 thinker requires active participation and creativity on your part. If you want to benefit from 80/20 Thinking, you have to do it! Now is a good time to start. If you want to begin with applications HOW TO THINK 80/20 41 for your organization, go straight on to Part Two, which documents most of the important business applications of the 80/20 Principle. If you are more immediately interested in using the principle to make major improvements in your life, skip to Part Three, a novel attempt to relate the 80/20 Principle to the fabric of our daily lives. Part Two Corporate Success Needn’t Be a Mystery 3 The Underground Cult Now we see in a mirror dimly, but then we shall see face to face. Now I know in part; then I shall understand fully. 1 Corinthians 13:12 It is difficult to gauge the extent to which the 80/20 Principle is already known in business. This is almost certainly the first book on the subject, yet in my research I was easily able to find several hundred articles referring to the use of 80/20 in all kinds of businesses, all over the world. Many successful firms and individuals swear by the use of the 80/20 Principle, and most holders of MBAs have heard of it. Yet considering that the 80/20 Principle has affected the lives of hundreds of millions of people even though they may be unaware of it, it remains strangely uncelebrated. It is time to put this right. 46 CORPORATE SUCCESS NEEDN’T BE A MYSTERY The first 80/20 wave: the quality revolution The quality revolution which took place between 1950 and 1990 transformed the quality and value of branded consumer goods and other manufactures. The quality movement has been a crusade to obtain consistently higher quality at lower cost, by the application of statistical and behavioural techniques. The objective, now almost reached with many products, is to obtain a zero rate of product defects. It is possible to argue that the quality movement has been the most significant driver of higher living standards throughout the world since 1950. The movement has an intriguing history. Its two great messiahs, Joseph Juran (born 1904) and W Edwards Deming (born 1900), were both Americans (although Juran was born in Romania). Respectively an electrical engineer and a statistician, they developed their ideas in parallel after the Second World War, but found it impossible to interest any major US corporation in the quest for extraordinary quality. Juran published the first edition of his Quality Control Handbook, the bible of the quality movement, in 1951, but it received a very flat reception. The only serious interest came from Japan and both Juran and Deming moved there in the early 1950s. Their pioneering work took an economy known at the time for shoddy imitations and transformed it into a powerhouse of high quality and productivity. It was only when Japanese goods, such as motorcycles and photocopiers, began to invade the US market that most American (and other western) corporations began to take the quality movement seriously. From 1970, and especially after 1980, Juran, Deming and their disciples undertook an equally successful transformation of western quality standards, leading to huge improvements in the level and consistency of quality, dramatic reductions in fault rates, and large falls in manufacturing costs. The 80/20 Principle was one of the key building blocks of the quality movement. Joseph Juran was the most enthusiastic messiah of the principle, although he called it ‘the Pareto Principle’ or ‘the Rule of the Vital Few’. In the first edition of the Quality Control Handbook, Juran THE UNDERGROUND CULT 47 commented that ‘losses’ (that is, manufactured goods that have to be rejected because of poor quality) do not arise from a large number of causes: Rather, the losses are always maldistributed in such a way that a small percentage of the quality characteristics always contributes a high percentage of the quality loss. * The footnote commented that: *The economist Pareto found that wealth was non-uniformly distributed in the same way. Many other instances can be found— the distribution of crime amongst criminals, the distribution of accidents among hazardous processes, etc. Pareto’s principle of unequal distribution applied to distribution of wealth and to distribution of quality losses.1 Juran applied the 80/20 Principle to statistical quality control. The approach is to identify the problems causing lack of quality and to rank them from the most important—the 20 per cent of defects causing 80 per cent of quality problems—to the least important. Both Juran and Deming came to use the phrase 80/20 increasingly, encouraging diagnosis of the few defects causing most of the problems. Once the ‘vital few’ sources of off-quality product have been identified, effort is focused on dealing with these issues, rather than trying to tackle all the problems at once. As the quality movement has progressed from an emphasis on quality ‘control through to the view that quality must be built into products in the first place, by all operators, and to total quality management and increasingly sophisticated use of software, the emphasis on 80/20 techniques has grown, so that today almost all quality practitioners are familiar with 80/20. Some recent references illustrate the ways in which the 80/20 Principle is now being used. In a recent article in the National Productivity Review, Ronald J Recardo asks: 48 CORPORATE SUCCESS NEEDN’T BE A MYSTERY Which gaps adversely affect your most strategic consumers? As with many other quality problems, Pareto’s Law prevails here too: if you remedy the most critical 20 percent of your quality gaps, you will realize 80 percent Of the benefits. This _first 80 percent typically includes your breakthrough improvements.2 Another writer, focusing on corporate turnarounds, comments: For every step in your business process, ask yourself. If it adds value or provides essential support. If it does neither, it’s waste. Cut it. [This is] the 80/20 rule, revisited: You can eliminate 80 percent of the waste by spending only 20 percent of what it would cost you to get rid of 100 percent Of the waste. Go for the quick gain now.3 The 80/20 Principle was also used by Ford Electronics Manufacturing Corporation in a quality program that won the Shingo prize: Just-in-time programs have been applied using the 80/20 rule (80 percent of the value is spread over 20 percent of the volume) and top-dollar usages are analyzed constantly. Labor and overhead performance were replaced by Manufacturing Cycle Time analysis by product line, reducing product cycle time by 95 percent.4 New software incorporating the 80/20 Principle is being used to raise quality: [With the ABC DataAnalyzer] the data is entered or imported into the spreadsheet area, where you highlight it and click on your choice of six graph types: histograms, control charts, run charts, scatter diagrams, pie charts and Pareto charts. The Pareto chart incorporates the 80 to 20 rule, which might show, for instance, that out of 1,000 customer complaints roughly 800 can be eliminated by correcting only 20 per cent of the causes.5 THE UNDERGROUND CULT 49 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.6 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 50 CORPORATE SUCCESS NEEDN’T BE A MYSTERY 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.7 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 computer8 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.9 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 THE UNDERGROUND CULT 51 don’t want or need. Software developers finally seem to understand this, and many are betting that modular applications will solve the problem.10 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.11 Wherever one turns, effective innovations in information—in data storage, retrieval and processing—focus heavily on the 20 per cent or fewer of keyneeds. 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 52 CORPORATE SUCCESS NEEDN’T BE A MYSTERY corporate palaces and those who sit, or used to sit, 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.12 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.13 Drucker argues that we need new ways of measuring wealth creation. Ian Godden and I call these new tools ‘automated performance measures’14; they are just beginning to be created by some corporations. But well over 80 per cent (probably around 99 per cent) 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 THE UNDERGROUND CULT 53 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: 54 CORPORATE SUCCESS NEEDN’T BE A MYSTERY In any market, some suppliers will be much better than others at satisfying customer needs. These suppliers will obtain the highest price realizations andalso 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’ products will cost less than other suppliers, for equivalent output and revenue; or, alternatively, they will 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 per cent of the market will tend to be supplied by 20 per cent 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 ! THE UNDERGROUND CULT 55 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 per cent of surpluses or profits are generated by 20 per cent of segments, and by 20 per cent of customers and by 20 per cent 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 56 CORPORATE SUCCESS NEEDN’T BE A MYSTERY 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 per cent of the surplus is usually generated by 20 per cent of employees. ! At the lowest level of aggregation of resources within the firm, for example an individual employee, 80 per cent of the value created is likely to be generated in a small part, approximately 20 per cent, of the time when, through a combination of circumstances including personal characteristics and the exact nature of the task, the employee is operating at several times his or her normal level of effectiveness. ! The principles of unequal effort and return therefore operate at all levels of business: markets, market segments, products, customers, departments and employees. It is this lack of balance, rather than a notional equilibrium, that characterizes all economic activity. Apparently small differences create large consequences. A product has only to be 10 per cent better value than that of a competing product to generate a sales difference of 50 per cent and a profit difference of 100 per cent. Three action implications One implication of the 80/20 theory of firms is that successful firms operate in markets where it is possible for that firm to generate the highest revenues with the least effort. This will be true both absolutely, that is, relative to monetary profits; and relatively, that is, in relation to competition. A firm cannot be judged successful unless it has a high absolute surplus (in traditional terms, a high return on investment) and also a higher surplus than its competitors (higher margins). A second practical implication for all firms is that it is always possible to raise the economic surplus, usually by a large degree, by focusing only on those market and customer segments where the largest surpluses are THE UNDERGROUND CULT 57 currently being generated. This will always imply redeployment of resources into the most surplus-generating segments, and will normally also imply a reduction in the total level of resource and expenditure (in plain words, fewer employees and other costs). Firms rarely reach the highest level of surplus that they could attain, or anywhere near it, both because managers are often not aware of the potential for surplus and because they often prefer to run large firms rather than exceptionally profitable ones. A third corollary is that it is possible for every corporation to raise the level of surplus by reducing the inequality of output and reward within the firm. This can be done by identifying the parts of the firm (people, factories, sales offices, overhead units, countries) that generate the highest surpluses and reinforcing these, giving them more power and resources; and, conversely, identifying the resources generating low or negative surpluses, facilitating dramatic improvements and, if these are not forthcoming, stopping the expenditure on these resources. These principles constitute a useful 80/20 theory of the firm, but they must not be interpreted too rigidly or deterministically. The principles work because they are a reflection of relationships in nature, which are an intricate mixture of order and disorder, of regularity and irregularity. Look for ‘irregular’ insights from the 80/20 Principle It is important to try to grasp the fluidity and force driving 80/20 relationships. Unless you appreciate this, you will interpret the 80/20 Principle too rigidly and fail to exploit its full potential. The world is full of small causes that, when combined, can have momentous consequences. Think of a saucepan of milk that, when heated above a certain temperature, suddenly changes form, swelling up and bubbling over. One moment you have a nice, orderly pan of hot 58 CORPORATE SUCCESS NEEDN’T BE A MYSTERY milk; the next moment you can either have a wonderful cappucino or, if you are a second too late, a mess on top of your stove. Things take a little more time in business, but one year you can have an excellent and very profitable IBM dominating the computer industry and, before long, a combination of small causes results in a blinded monolith staggering to avoid destruction. Creative systems operate away from equilibrium. Cause and effect, input and output, operate in a non-linear way. You do not usually get back what you put in; you may sometimes get very much less and sometimes get very much more. Major alterations in a business system can flow from apparently insignificant causes. At any one time, people of equal intelligence, skill and dedication can produce quite unequal results, as a result of small structural differences. Events cannot be predicted, although predictable patterns tend to recur. Identify lucky streaks Control is therefore impossible. But it is possible to influence events and, perhaps even more important, it is possible 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. Imagine you are in a crazy casino, full of unbalanced roulette wheels. All numbers pay odds of 35 to 1, but individual numbers come up more or less frequently at different tables. At one, number five comes up one time in twenty, at another table it only comes up one time in fifty. If you back the right number at the right table, you can make a fortune. If you stubbornly keep backing number five at a table where it comes up one time in fifty, your money will all disappear, regardless of how high your starting bank. If you can identify where your firm is getting back more than it is putting in, you can up 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 UNDERGROUND CULT 59 In this context, the ‘where’ can be anything. It can be a product, a market, a customer or type of customer, a technology, a channel of distribution, a department or division, a country, a type of transaction or an employee, type of employee or team. The game is to spot the few places where you are making great surpluses and to maximize them; and to identify the places where you are losing and get out. We have been trained to think in terms of cause and effect, of regular relationships, of average levels of return, of perfect competition and of predictable outcomes. This is not the real world. The real world comprises a mass of influences, where cause and effect are blurred, and where complex feedback loops distort inputs; where equilibrium is fleeting and often illusory; where there are patterns of repeated but irregular performance; where firms never compete head to head and prosper by differentiation; and where a few favoured souls are able to corner the market for high returns. Viewed in this light, large firms are incredibly complex and constantly changing coalitions of forces, some of which are going with the grain of nature and making a fortune, while others are going against the grain and stacking up huge losses. All this is obscured by our inability to disentangle reality and by the calming, averaging and highly distorting effects of accounting systems. The 80/20 Principle is rampant but largely unobserved. What we