Lessons from a 19th Century Italian Economist
Vilfredo Pareto was an Italian engineer, philosopher and economist. He made several important contributions to economics, and was later credited with what is called the Pareto Principle. The Pareto Principle, often referred to as the 80/20 rule, is the idea that 80 percent of the results come from 20 percent of the causes. This principle can be applied to almost all areas of life.
Here are some examples of the Pareto Principle:
¨ 80% of wealth is held by 20% of people
¨ 20% of motorists cause 80% of accidents
¨ 80% of books are read by 20% of people
¨ 20% of your clothes are worn 80% of the time
The numbers may not always be exactly 80/20. They may be 70/30, 85/15, or something slightly different than 80/20. However, the principle is sound and extremely valuable.
The reason this principle is so valuable is that it is counterintuitive. We tend to believe that all resources have roughly the same significance. That all customers, for example, are the same. That each working hour of your day is as effective as the next. That all our friends have roughly equal value to us.
When we realize that only certain efforts produce the most results, we can greatly improve our lives and our businesses. This is done by the process of substitution. Resources that produce weak effects are reduced or eliminated. That effort is then put into the resources that produce the most return.
Businesses have used this process for many years. Some 80/20 rules of business are:
¨ 20% of the company’s salespeople are responsible for 80% of its sales
¨ 80% of a company's complaints come from 20% of its customers
¨ 20% of customers are responsible for 80% of a company’s profits
¨ 80% of a company's sales come from 20% of its products
How can you put the Pareto Principle to work in your business? Start by finding out what the 80/20 ratios are for multiple areas within your company. That information presents opportunities for radical improvement. What changes can you make that will improve your results? Where can you shift resources from non-productive areas to those vital few areas that have the biggest impact?
If you are a homebuilder, then 20% of your Trade contractors are causing you 80% of your problems. Identify that 20% and rehabilitate or replace them.
For production builders, 20% of your home plans/models are chosen by 80% of your homebuyers. And, 20% of your subdivisions make up 80% of your total sales. These are opportunities to learn, analyze, reduce, and improve.
For the busy business owner, 80% of your daily tasks only account for 20% of your profits. Work toward eliminating, delegating or outsourcing much of those tasks. Then, you are able to spend more time on the 20% of work that produces 80% of your profits.
One of the ways we’ll apply this principle at Herbert Construction is by looking more closely at the 20% of our clients that produce 80% of our profits. First, we’ll concentrate on keeping those 20% clients happy. Then, we will look to add more clients that fit the same profile as that of our profitable 20%.
For more information on the process of focusing on the vital few and reducing the trivial many, I recommend Richard Koch’s excellent book, The 80/20 Principle: The Secret to Success by Achieving More with Less.
To Your Success,
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