What To Do When Your Business Sucks Too Much
Who knew? It turns out 80 percent of everything we do in business creates a sucking sound. More specifically, our current businesses are being sucked of time, energy, resources and profits 80 percent of the time.
At least that’s what Peter Philippi told me. Peter is the owner of Strategex, a Chicago-based consulting firm. He’s also a part-time minister, so when he serves up shocking little factoids like, “You’re spending 80 percent of your efforts on things that don’t matter,” I feel compelled to believe what he is saying.
Peter starts friendships with challenging questions like: “What would you do if you learned that your company is grossly underserving your best customers, employees and ignoring its biggest opportunities?” Amazingly, he still has friends.
He goes on to explain:
- 20 percent of any company’s clients create 80 percent of the profit,
- 20 percent of a company’s people create 80 percent of the drama,
- 20 percent of what is in our closet is worn 80 percent of the time, and
- 20 percent of salespeople create 80 percent of the sales.
Eventually, Peter’s new friends become enlightened business leaders who recognize the truths in these statements, proven by their own data, and wind up with more closet space, less drama, a smaller sales staff and more money in their bank accounts.
It’s kind of like the Peter Principle, but this one has a much happier ending.
You’ve probably heard of the 80/20 rule, which is otherwise known as the Pareto Principle, after Italian economist Vilfredo Pareto who used to explain how wealth was distributed in his country. (Some 20 percent of the people owned 80 percent of the assets.) While many of us often use the 80/20 language to frame strategic arguments, our definitions of the rule and how we may apply it often vary widely.
In a business context, the 80/20 principle is pretty simple: Approximately 80 percent of a company’s revenue or profit value comes directly from 20 percent of its resources, like product lines, customers and even people. Although you may dismiss this as a cliché, the principle has been supported by numerous studies all with a gut-wrenching conclusion: It’s true.
The reason the conclusion should be gut wrenching is because it points to behavior in your company today. And if you misunderstand the behavior or misapply the principle, you may sink your business. Here are a just a few examples:
You are underserving your most valuable customers. Pareto called his principle the “law of the trivial many and the critical few.” It’s important to remember that the effort involved in acquiring, serving and retaining customers is virtually the same, whether they have a great, average or terrible effect on the bottom line. Put simply, most companies don’t realize that 20 percent of their customers require only 20 percent of their cost resources, yet they provide 80 percent of the revenue. Hence, they don’t realize how tremendously profitable these few customers are! Conversely, they don’t realize that 80 percent of their customers require 80 percent of their resources while providing only 20 percent of the revenue. Cue the sucking sound.
Growing yourself into profitability is a flawed strategy. Many established businesses, whether or not they are focused on the 80/20 rule, attempt to grow themselves into profitability, convincing themselves that they just need to get over an overhead hump. We’ve made this mistake. However, adding sales, products, customers, employees and expanded capabilities doesn’t change the underlying situation: A minority of your customers are responsible for the vast majority of your profitability.
Cutting your way to profitability won’t work either. On the flip side, simply getting leaner is an equally ineffective strategy when implemented without an underlying understanding of where and why your resources are being used. You’ll just wind up cutting your muscle along with your fat.
It’s hard to implement. According to Peter, “Business leaders who have heard about the 80/20 rule often botch the process because they get started and then stop because of internal objections. ‘We need a complete product line,’ ‘We need to absorb our fixed costs,’ and a long list of other excuses. When the going gets tough (as it always does), that’s when people give up on 80/20. I’m not saying that you shouldn’t grow, or that you shouldn’t reduce waste. Rather, I do suggest leaders focus their limited resources in the areas that offer the greatest return, and improve overall profitability—sensibly, incrementally and without alienating your most important customers and people.”
New products, services and business models matter. One reason I find the 80/20 rule so compelling is because research consistently shows that innovation is rewarded with higher margins, customer loyalty, brand relevancy and lower marketing expenses. You’re focusing on building muscle instead of maintaining older products and services that have become less significant over time.
In Brand New: Solving the Innovation Paradox, we outline how to create, manage and constantly rebalance a complete portfolio of new products and services. We note that most companies make the mistake of just focusing on evolutionary innovation—things you know your customers want and already know how to make. This is a safe but low-margin strategy. Peter would argue that these new products probably wouldn’t be part of your top 20 percent.
If you want a great example of a company that has mastered the use of 80/20 thinking, look no further than Illinois Tool Works (ITW). In the early ’80s, ITW found itself facing rising costs and decreasing profitability. Company leadership decided to use the 80/20 principles to drive a complete overhaul of its policies, techniques and rules of operation. They understood that this was a long-term—even lifetime—commitment. It’s where Strategex experts cut their teeth, and even helped create some of the 80/20 tools currently being employed by ITW. They made a difference. Over a span of 25 years, ITW not only perfected the application of the 80/20 rule, but the company enjoyed annual shareholder returns of 19 percent without fail—many times by acquiring companies and applying the principles of 80/20 to them.
I do a fair amount of flying. Last year, I switched from American Airlines to United after one too many travel hiccups. This year, United, which recently merged with Continental, has had its fair share of travel issues, many caused by reservation technology that doesn’t seem to want to be merged. Since an estimated 1 percent of frequent-flier membership accounts for about 25 percent of airline revenues, this is an opportunity for United to apply the principles of 80/20.
So should United focus on making everyone happy or focus a disproportionate amount of their resources to the small portion of customers who are responsible for most of their revenues? Well, apparently, business travelers like me will pay higher prices for tickets because of inflexible meetings and the desire to get home to our families. I suspect Peter would tell them that ignoring an 80/20 strategy here may lead to a bumpy landing.