The Secret of achieving more with less, explained in this book. If you are starting a business than read the principles before.
SIMPLE IS BEAUTIFUL
My effort is in the direction of simplicity. People in general have so little and it costs so much to buy even the barest necessities (let alone the luxuries to which I think everyone is entitled) because nearly everything we make is much more complex than it needs to be. Our clothing, our food, our household furnishings —all could be much simpler than they now are and at the same time be better-looking.
HENRY FORD
We saw in the previous chapter that nearly all businesses have within
them chunks of business with widely varying profitability. The 80/20
Principle suggests something quite outrageous as a working hypothesis: that one-fifth of a typical company’s revenues account for four-fifths of its profits and cash. Conversely, four-fifths of the average company’s revenues account for only one-fifth of profits and cash. This is a bizarre hypothesis. If we assume that one such business has sales of $100 million and total profits of $5 million, for the 80/20 Principle to be correct $20 million of sales has to produce $4 million of profits—a return on sales of 20 percent; while $80 million of sales has to produce just $2 million of profits, a return on sales of just 1.25 percent. This means that the top fifth of business is sixteen times more profitable than the rest of the business.
What is extraordinary is that when it is tested, the hypothesis generally turns out to be correct, or not very far wide of the mark.
How can this be true? It is intuitively obvious that some business chunks may be considerably more profitable than others. But 16 times better? It almost beggars belief. And, routinely, executives who commission product-line profitability exercises often do refuse to believe the results when first presented with them. Even when they have checked the assumptions and verified them, they still end up baffled.
The next stage is often for managers to refuse to get rid of the 80 percent of business that is unprofitable, on the apparently reasonable grounds that the 80 percent makes a very large contribution to overheads. Removing the 80 percent, they say, would clearly decrease profits, because you simply couldn’t remove 80 percent of your overhead in any sensible time frame.
When faced with these objections, corporate analysts or consultants
generally give way to the managers. Only the most horribly unprofitable business is removed. And only minor efforts are made to increase the extremely profitable business.
Yet all this is a dreadful compromise, based on a misunderstanding.
Few people stop to ask why the unprofitable business is so bad. Even
fewer stop to think whether you could in practice, as well as in theory, have a business solely composed of the most profitable chunks and get rid of 80 percent of the overhead.
The truth is that the unprofitable business is so unprofitable because it requires the overheads and because having so many different chunks of business makes the organization horrendously complicated. It is equally true that the very profitable business does not require the overheads, or only a very small portion of them. You could have a business solely composed of the profitable business and it could make the same absolute returns, provided that you organized things differently.
