The 80/20 Principle: The Secret of Achieving More With Less

Free 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 Read Free Book Online
Authors: Richard Koch
Tags: Psychology, Self-Help, Non-Fiction, Philosophy, Business
profitability and cash generation.
    Unless your firm is very small and simple, it is almost certainly true that you make at least 80 percent of your profits and cash in 20 percent of your activity, and in 20 percent of your revenues. The trick is to work out which 20 percent.
    WHERE ARE YOU MAKING THE MOST MONEY?
     
    Identify which parts of the business are making very high returns, which are just about washing their faces, and which are disasters. To do this we will conduct an 80/20 Analysis of profits by different categories of business:
     
    • by product or product group/type
    • by customer or customer group/type
    • by any other split which appears to be relevant for your business for which you have data; for example, by geographical area or distribution channel
    • by competitive segment.
     
    Start with products. Your business will almost certainly have information by product or product group. For each, look at the sales over the last period, month, quarter, or year (decide which is most reliable) and work out the profitability after allocating all costs.
    How easy or difficult this will be depends on the state of your management information. What you need may all be readily available, but if not you will have to build it up yourself. You are bound to have sales by product or product line and almost certainly the gross margin (sales less cost of sales). You will also know the total costs for the whole business (all the overhead costs). What you then have to do is to allocate all the overhead costs to each product group on some reasonable basis.
    The crudest way is to allocate costs on a percentage of turnover. A moment’s thought, however, should convince you that this will not be very accurate. Some products take a great deal of salespeople’s time relative to their value, for example, and others take very little. Some are heavily advertised and others not at all. Some require a lot of fussing around in manufacturing whereas others are straightforward.
    Take each category of overhead cost and allocate it to each product group. Do this for all the costs, then look at the results.
    Typically some products, representing a minority of turnover, are very profitable; most products are modestly or marginally profitable; and some are really making large losses once you allocate all the costs.
    Figure 10 shows the numbers for a recent study I conducted of an electronic instrumentation group. Figure 11 gives the same data visually; look at this if you prefer pictures to numbers.
     
----
Product
$000 Sales
Income
Return on sales (%)
----
Product group A
3,750
1,330
35.5
Product group B
17,000
5,110
30.1
Product group C
3,040
601
25.1
Product group D
12,070
1,880
15.6
Product group E
44,110
5,290
12.0
Product group F
30,370
2,990
9.8
Product group G
5,030
(820)
(15.5)
Product group H
4,000
(3,010)
(75.3)
Total
119,370
13,380
11.2
----
     
    Figure 10 Electronic Instruments Inc. sales and profits table by product group
     
    We can see from the two figures that Product group A accounts for only 3 percent of sales, but for 10 percent of profits. Product groups A, B, and C account for 20 percent of sales, but for 53 percent of profits. This becomes very clear if we compile an 80/20 Table or an 80/20 Chart, as in Figures 12 and 13 respectively.
    We have not yet found the 20 percent of sales that account for 80 percent of profits, but we are on our way. If not 80/20, then 67/30: 30 percent of product sales account for almost 67 percent of profits. Already you may be thinking about what can be done to raise the sales of Product groups A, B, and C. For example, you might want to reallocate all sales effort from the other 80 percent of business, telling salespeople to concentrate on doubling the sales of Products A, B, and C and not to worry about the rest. If they succeeded in doing this, sales would only go up by 20 percent, but profits would rise more than 50 percent.
    You might also already be thinking about cutting costs, or

Similar Books

Lavender Lies

Susan Wittig Albert

Trust Me on This

Jennifer Crusie

Bigfoot War

Eric S Brown

Mesmerised

Michelle Shine

Taken In

Elizabeth Lynn Casey

The Family

Jeff Sharlet

The Book of Jonah

Joshua Max Feldman

Good Enough to Eat

Stacey Ballis