Over 100 years ago, an Italian economist by the name of Vilfredo Pareto made an important observation. By studying the land ownership records in his country, he found that 20% of the families owned approximately 80% of the land.
This observation on its own wasn’t that exciting, as it’s common knowledge that ownership of assets is unevenly distributed in many societies. But the repeated occurrence of the 80/20 distribution is what was the important discovery.
Pareto had also noticed that 20% of the pea plants in his garden produced approximately 80% of the peas. Just as wealth was distributed by a vital few owning most of the land, there were a vital few of his pea plants that were producing most of the peas.
Following his discovery of this distribution model, he published these findings in economic journals. And from it, the 80/20 principle, also known as the “Law of The Vital Few” and “The Pareto Principle” was born.
How 80/20 Works
As a type of power law, the 80/20 principle is a simple distribution model of variables. It states that 80% of the outcomes are produced by 20% of the inputs.
This means that not all outcomes are generated equally. A minority of your inputs will produce a majority of your outputs. Both good outcomes, like profitable sales. But also bad outcomes, like product defects in your process. In nearly all cases, you’ll find close to an 80/20 distribution in outcomes from inputs.
In the business world, here are some common examples of this in action:
- 80% of your leads come from 20% of your marketing sources.
- 80% of your profits come from 20% of your customers.
- 80% of your sales come from 20% of your sales reps.
- 80% of your defects come from 20% of your processes/machines.
- 80% of your costs come from 20% of your vendors.
And so on. I bet you could think of many other areas in your particular business that follow this principle.
The key takeaway is that not all inputs are created equally. And to truly focus on what’s important, your need to understand your “vital few” in any process.
Using 80/20 to Improve Your Business Process
So how do you use this concept to be a better manager? How do utilize statistical analysis and produce better business results? It all comes down to intentionally focusing on what’s most important.
When you implement a successful 80/20 analysis project, you can emphasize key factors that are contributing to positive outcomes like profitable sales, productivity, or sources of leads. Or conversely, you can fix negative outcomes that are causing a large number of your business issues.
Here are the basic steps.
Step 1 – Define The Process – What is that you are trying to track? Be specific about the process that you are planning to measure. Be sure that everyone working to collect data in the process uses the same definitions of what “it” is.
Step 2 – Run the Analysis – With the process defined, the next step is to run the actual analysis. This is often as easy as creating a simple excel spreadsheet that showcases the quantity and volume of variables. For instance, below is a real example of “lead sources” for a sales team.
|Lead Source||# of Leads||% of Total||Cumulative %|
You’ll see that the table is set up to showcase the number of instances for each variable, the percentage of total instances, and the cumulative percentage of the total. The “cumulative” number is your 80/20 analysis. This is where you see the critical threshold of the vital few or top 80% of variables that are contributing to the outcome.
In this example, our analysis is showing that the “website”, “existing clients”, and “phone calls” are the vital few lead sources that are generating leads for this sales team. Despite there being a total of 8 lead sources that are contributing to their funnel, these 3 sources are generating 80% of the leads!
Step 3 – Manage The Change – With the analysis complete, the next step is to determine the change you want to make. What’s the improvement that you think will make the process even better?
Sometimes this means adding resources to the vital few to make them even more impactful. In the example case above, it could be mean improving their website to generate even more leads through higher conversion rates or better SEO. Or maybe it means focusing on existing client retention and cross-selling.
Other times this means cutting out areas that are not producing results. Using this example case above, this might mean cutting all paid event sponsorships. As the “events” lead source only contributed to about 5% of their leads, it’s not one of the vital few inputs. The management of this company might decide that the money and time spent on events attendance could be better spent on digital advertising or internal sales team development.
The key in this step is to make a verifiable change to the process, based on your 80/20 analysis. Write down the change that is being made, and what measurements are being used to track its success (or failure).
Step 4 – Review and Iterate – After you’ve had time to run your change strategy, the final step is to review the data again. Essentially asking yourself, “did this change work?”.
The length of your experiment will depend on the change that is being impacted. Some processes can be tested in 10 days, while others could take a year. You must give yourself adequate time to meaningfully implement the change.
Review the data by comparing the trends from the before and after the change was made. Again using the example above, if the company decided to invest in existing customer selling, they could use existing account sales as their core data point. Tracking whether or not investing in cross-selling promotions or existing account reps were able to increase sales to existing accounts.
In an ideal scenario, you’d run statistical analysis on your data to show whether changes were “statistically significant”. However, even some simple data review with your management can oftentimes be sufficient to determine efficacy.
With the data review complete, the next question, “what do we do now?”. There are often three choices to choose from:
- Keep the change in place.
- Scrap the change and go back to the way it was.
- Try or tweak the change, and run another test.
Embracing the 80/20 Mindset
You may start to notice a mindset shift after you begin to implement 80/20 within your organization. Suddenly, everything begins to feel like it needs a quick 80/20 analysis.
What 20% of the clothing in your closet do you wear 80% of the time?
What 20% of your bills make up 80% of your household expenses?
What 20% of your tasks give you 80% of your productivity?
While some may see it as a burden to want to optimize everything… in reality, it’s a great way to simplify your business and personal life.
80/20 is a framework that can be used to focus on what’s important to you, your business, and your family. See if you can develop an “80/20 mindset” that helps you better understand the vital few in your life.