The 80/20 Principle: The Secret of Achieving More With Less by Richard Koch Page A
Book: The 80/20 Principle: The Secret of Achieving More With Less by Richard Koch
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Authors: Richard Koch
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hypothesis generally turns out to be correct, or not very far wide of the mark.
How can this be true? It is intuitively obvious that some business chunks may be considerably more profitable than others. But 16 times better? It almost beggars belief. And, routinely, executives who commission product-line profitability exercises often do refuse to believe the results when first presented with them. Even when they have checked the assumptions and verified them, they still end up baffled.
The next stage is often for managers to refuse to get rid of the 80 percent of business that is unprofitable, on the apparently reasonable grounds that the 80 percent makes a very large contribution to overheads. Removing the 80 percent, they say, would clearly decrease profits, because you simply couldn’t remove 80 percent of your overhead in any sensible time frame.
When faced with these objections, corporate analysts or consultants generally give way to the managers. Only the most horribly unprofitable business is removed. And only minor efforts are made to increase the extremely profitable business.
Yet all this is a dreadful compromise, based on a misunderstanding. Few people stop to ask why the unprofitable business is so bad. Even fewer stop to think whether you could in practice, as well as in theory, have a business solely composed of the most profitable chunks and get rid of 80 percent of the overhead.
The truth is that the unprofitable business is so unprofitable because it requires the overheads and because having so many different chunks of business makes the organization horrendously complicated. It is equally true that the very profitable business does not require the overheads, or only a very small portion of them. You could have a business solely composed of the profitable business and it could make the same absolute returns, provided that you organized things differently.
And why is this so? The reason is the same. It is that simple is beautiful. Business people seem to love complexity. No sooner is a simple business successful than its managers pour vast amounts of energy into making it very much more complicated. But business returns abhor complexity. As the business becomes more complex, its returns fall dramatically. This is not just because more marginal business is being taken. It is also because the act of making a business more complex depresses returns more effectively than any other means known to humanity.
It follows that the process can be reversed. A complex business can be made more simple and returns can soar. All it takes is an understanding of the costs of complexity (or the value of simplicity) and courage to remove at least four-fifths of lethal managerial overhead.
SIMPLE IS BEAUTIFUL—COMPLEX IS UGLY
Those of us who believe in the 80/20 Principle will never succeed in transforming industry until we can demonstrate that simple is beautiful and why. Unless people understand this, they will never be willing to give up 80 percent of their current business and overheads.
So we need to go back to basics and revise the common view of the roots of business success. To do so, we must get involved in a current controversy over whether size in business is a help or a hindrance. By resolving this dispute, we will also be able to show why simple is beautiful.
Something very interesting, and unprecedented, is happening to our industrial structure. Since the Industrial Revolution companies have become both bigger and more diversified. Until the end of the nineteenth century, nearly all companies were national or subnational, having the vast bulk of their revenues confined to their home country; and nearly all were in just one line of business. The twentieth century has seen a series of transformations, changing the nature both of business and of our daily lives. First, thanks largely to Henry Ford’s sensationally successful quest to “democratize” the automobile, there was the burgeoning power of the
How can this be true? It is intuitively obvious that some business chunks may be considerably more profitable than others. But 16 times better? It almost beggars belief. And, routinely, executives who commission product-line profitability exercises often do refuse to believe the results when first presented with them. Even when they have checked the assumptions and verified them, they still end up baffled.
The next stage is often for managers to refuse to get rid of the 80 percent of business that is unprofitable, on the apparently reasonable grounds that the 80 percent makes a very large contribution to overheads. Removing the 80 percent, they say, would clearly decrease profits, because you simply couldn’t remove 80 percent of your overhead in any sensible time frame.
When faced with these objections, corporate analysts or consultants generally give way to the managers. Only the most horribly unprofitable business is removed. And only minor efforts are made to increase the extremely profitable business.
Yet all this is a dreadful compromise, based on a misunderstanding. Few people stop to ask why the unprofitable business is so bad. Even fewer stop to think whether you could in practice, as well as in theory, have a business solely composed of the most profitable chunks and get rid of 80 percent of the overhead.
The truth is that the unprofitable business is so unprofitable because it requires the overheads and because having so many different chunks of business makes the organization horrendously complicated. It is equally true that the very profitable business does not require the overheads, or only a very small portion of them. You could have a business solely composed of the profitable business and it could make the same absolute returns, provided that you organized things differently.
And why is this so? The reason is the same. It is that simple is beautiful. Business people seem to love complexity. No sooner is a simple business successful than its managers pour vast amounts of energy into making it very much more complicated. But business returns abhor complexity. As the business becomes more complex, its returns fall dramatically. This is not just because more marginal business is being taken. It is also because the act of making a business more complex depresses returns more effectively than any other means known to humanity.
It follows that the process can be reversed. A complex business can be made more simple and returns can soar. All it takes is an understanding of the costs of complexity (or the value of simplicity) and courage to remove at least four-fifths of lethal managerial overhead.
SIMPLE IS BEAUTIFUL—COMPLEX IS UGLY
Those of us who believe in the 80/20 Principle will never succeed in transforming industry until we can demonstrate that simple is beautiful and why. Unless people understand this, they will never be willing to give up 80 percent of their current business and overheads.
So we need to go back to basics and revise the common view of the roots of business success. To do so, we must get involved in a current controversy over whether size in business is a help or a hindrance. By resolving this dispute, we will also be able to show why simple is beautiful.
Something very interesting, and unprecedented, is happening to our industrial structure. Since the Industrial Revolution companies have become both bigger and more diversified. Until the end of the nineteenth century, nearly all companies were national or subnational, having the vast bulk of their revenues confined to their home country; and nearly all were in just one line of business. The twentieth century has seen a series of transformations, changing the nature both of business and of our daily lives. First, thanks largely to Henry Ford’s sensationally successful quest to “democratize” the automobile, there was the burgeoning power of the
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