Great Business

Efficiency Improvement

80/20 Theory of the Firm

Vadim Kotelnikov, founder of 1000ventures - personal logo   Business e-Coach   Innompic Games icon

Vadim Kotelnikov

Major source: The 80/20 Principle and 80/20 Revolution, Richard Koch


How to create a greatest stakeholder value with the least expenditure of assets and efforts




"80% of the results come from 20% of the causes. A few things are important; most are not."

~ Richard Koch,
the author of The 80/20 Principle and 80/20 Revolution



Applications of the 80/20 Theory of the Firm

  • Internally, some resources, be they people, factories, or machines, will produce very much more value relative to their cost than will other resources:

    • 80% of the surplus is usually generated by 20% of employees;

    •  80% of the value created is likely to be generated in 20% of time when, through a combination of circumstances, the employee is operating at his/her highest level of effectiveness.

    Action Implications:

    Any corporation can raise the level of surplus by reducing the inequality of output and reward within the firm. They can do it by identifying the parts of the firm that generate the highest surpluses and reinforcing these, giving them more power and resources; and, conversely, reducing or stopping the expenditure on non-performing resources.

  • Externally, some markets, products or customers are much more profitable than others:

    • 80% of any industry's profits come from 20% of its customers;

    • 80% of the profits made in any industry are made by 20% of firms.

    Action Implications:

    Successful firms operate in markets where it is possible for that firm to generate the highest revenues with the least effort. They raise the economic surplus, usually by a large degree, by focusing only on those market and customer segments where the largest surpluses are currently being generated. This will always imply redeployment of corporate resources in favor of the most surplus-generating segments.

80/20 Analysis of Profits

To achieve sustainable growth through effective reallocation of resources, conduct continuously an 80/20 Analysis of profits by its different categories:

  • by product or product group/type... More


80/20 Principle and Your Business

The key theme of the 80/20 Principle applied to business is how to create the greatest stakeholder value and generate most money with the least expenditure of assets and efforts. Any individual business can gain immensely through practical application of this Principle. The most important use of the 80/20 Principle is "to isolate where you are really making the profits and, just as important, where you are loosing money. Every business person thinks they know this already, and nearly all are wrong. If they had the right picture, their whole business would be transformed."

The game is to spot the few places where you are making great surpluses be that a product, a market, a customer type, a technology, a distribution channel, a department, a country, a type of transaction, an employee, or a team and to maximize them; and to identify the places where you are loosing and get out.

 Case in Point  Warren Buffett

Warren Buffett the richest man in the world and the most successful investor said his companies ability to generate such large profits is the result of being able to focus on what is important, and not paying attention to things that would distract the company... More

 Case in Point  Ford Electronic Manufacturing Corporation

The 80/20 Principle is used in many corporate quality management programs. In Ford Electronic Manufacturing Corporation's quality program that won the Shingo prize, just-in-time programs have been applied using the 80/20 rule (80% of the value is spread over 20% of the volume) and top-dollar usages are analyzed constantly. "Labor and overhead performance were replaced by Manufacturing Cycle Time analysis by product line, reducing product cycle time by 95%."

Simple is Beautiful

"Because business is wasteful, and because complexity and waste feed on each other, a simple business will always be better than a complex business." To succeed in managing change and transforming your organization or business by applying the 80/20 Theory of the Firm, you need to demonstrate that simple is beautiful and why. Unless you understand this, you will never be willing to give up underperforming 80% of your current business and overheads... More

Effective Selling and Competing

80/20 Principle helps you to direct your attention where the real threat of competition exists. 80% of your revenue comes from 20% of your customers. Know who your top revenue-producing customers are and make sure you meet their needs to win their loyalty. "Focusing on 20% of your customers is a great deal easier than focusing on 100% of them." Being customer centered on all your customers is impossible. "But cherishing the core 20% is both feasible and highly rewarding."

The four steps to lock in your core customers:

  1. Know who they are

  2. Provide exceptional or even outrageous service to them

  3. Ground innovation in the relationship with this group target new products and services at the core 20% of customers, developing them for and with this group

  4. Aim to keep your core customers for ever.

Improving Your Margins

"Margins between value and cost, between effort and reward are always highly variable". High-margin activities constitute 20% of total activities but 80% of total margins. You must interfere with this natural allocation of resources unless you wish to see these imbalances to grow even further. Acknowledge the reality that the majority of what your firm does is worth much less than the minority of high margin activities and reallocate resources to take your firm to a new higher level. Don't stop there do that again.