This is a post for businesses to focus on what matters. This post highlights why discussing and making decisions based on averages could ruin your business.
This is an excellent guide for small business owners and SME investors and owners to consider the Pareto Principle in all their daily business undertakings.
Focusing on the details is important but is it wise to focus on the details that matters.
I am sure that most of you have heard and know about the Pareto principle or sometimes referred to as the Pareto efficiency. However, I have observed that day in and day out not many people actually give it thought, much less actually apply this “universal” cardinal principles in everyday life and business.
So who is this Pareto?
So what is the Pareto Principle and why is it so important? Let me first define what the Pareto principle is, and who Mr. Pareto was.
The Pareto principle (also known as the 80-20 rule, the law of the vital few, and the principle of factor sparsity) states that, for many events, roughly 80% of the effects come from 20% of the causes. Business management thinker Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who observed in 1906 that 80% of the land in Italy was owned by 20% of the population; he developed the principle by observing that 20% of the pea pods in his garden contained 80% of the peas. (Source: http://en.wikipedia.org/wiki/Pareto_principle)
The fallacy of averages
If you are like me, most of you have heard in everyday business, stuff like the average sales per day is so much, the average revenue per customer is this, the average score is that or the average age is this and so on.
Others often talk about the average returns of the stock market or the average height of the terrain is x and y.
Just take a moment and think about this. These averages mean nothing. They are fallacies in real life and I cannot fathom why it is so common in business.
Imagine a plane flying from a to b and the average terrain is 3000 feet, calculated from a low of 0 feet above sea level and a mountain peak of 6000 feet. You can just imagine if the pilot decides to plot his flight plan based on an average of 3000 feet. Or, imagine a person with no swimming skills trying to cross a lake just because some one said that the average depth is 3 feet. J
Therefore, discussing averages have no meaning if the average revenue derived from a few customers is exponentially bigger than the rest.
In my industry (telecommunications), I often hear folks speaking about the average revenue per customer, the average minutes of use, the average orders per channel or the average customer care service levels.
These averages are useless and baseless. They tell me nothing. The average revenue might be a result of having a few large customers versus the rest of the base. Not focusing your attention on these few large customers can sometimes mean the end of some businesses.
In most companies that I have worked for, 80% of the incremental sales (new sales) are generated through about 20% of the sales folks. Still most training investments are spread across the entire sales force. Just imagine the returns if a company can hone to the next 5th or 10th percentile. Imagine the savings and the focus and the tremendous results that can be achieved.
Imagine building capacity for a network, factory, hotel, restaurant and others based on averages. I have often been to restaurants that have excellent food but very poor service during peak times. I am pretty sure that the owners of the business have been misdirected to resource based on averages.
Trying saying to an employee that the average bonus payout is $X when he or she probably received one fifth of that $X.
The average is as close to the bottom as it is to the top
As the famous George Carlin said “just think of how stupid the average person is, and then realize half of them are even stupider!”
Alfred Sloan also once famously said that “If you do it right 51 percent of the time you will end up a hero”
As you would have noted by now, focusing on the averages really mean nothing.
Be laser focused using the “64-4” law.
If a result, problem, outcome or anything has 80% of effects coming from 20% of causes, it will follow that the 80% of that top 80% of effects coming from 20% of that top 20% of causes, and so on. (80% of 80% is 64%; 20% of 20% is 4%. So there is a “64/4″ law;
Often, just by knowing that 4% of customers, revenues, problems or issues could be much more worth your while than all the others.
What you would have noticed is that it does not always have to add up to 100 (80/20). It can be 64/4 or 70/40, like 70% of a company’s revenue comes from 40% of its customers. The key is to focus on what matters. Trying to solve all major issues at one time without focusing on a few critical ones often is costly, non attainable and almost always futile and a failure.
The “Pareto” as a way of life.
The application of the Pareto principles doesn’t just have to be restricted to business, but rather can be applied to everyday living.
Imagine if you are trying to save money or if something or some one annoys you or you feel “good” at times. Just focusing on the few issues or attributes or behaviors can help you address, alleviate or enhance the experience or relationship or whatever it is that you are trying to do.
The Pareto Principle is a “power law” relationship. A power law is a special kind of mathematical relationship between two quantities. When the frequency of an event varies as a power of some attribute of that event (e.g. its size), the frequency is said to follow a power law. The distribution of a wide variety of natural and man-made phenomena follow a power law, including frequencies of words in most languages, frequencies of family names, sizes of craters on the moon and of solar flares, the sizes of power outages, earthquakes, and wars, the popularity of books and music, and many other quantities.
Life is too short!
In conclusion, I salute and thank Mr. Pareto for this universal principle that can be applied in our everyday life. This might seem as something that is too obvious or easy, but remember that most folks ignore this principle day in and day out.
If you do not believe me just observe this at your work place tomorrow. The good folks from Finance, Sales, HR, Technology, Operations and Marketing will all be preaching to you about the average of this and that. Take note and decide if it makes sense. Force the discussions around stuff that matters. Stay focused, as life is too short.
John.firstname.lastname@example.org Twitter @lincolnjc