Why Your Strategy May Be Wrong
Unless you have used the 80/20 Principle to redirect your
strategy, you can be pretty sure that the strategy is badly
flawed. Almost certainly, you don’t have an accurate picture
of where you make, and lose, the most money. It is almost inevitable
that you are doing too many things for too many people. Business
strategy should not be a grand and sweeping overview. It should
be more like an underview, a peek beneath the covers to look
in great detail at what is going on. To arrive at a useful business
strategy, you need to look carefully at the different chunks
of your business, particularly at their profitability and cash
generation. Unless your firm is very small and simple, it is
almost certainly true that you make at least 80 per cent of
your profits and cash in 20 per cent of your activity, and in
20 per cent of your revenues. The trick is to work out which
20 per cent. Where are you making the most money? Identify which
parts of the business are making very high returns, which are
just about washing their faces and which are disasters. To do
this we will conduct an 80/20 Analysis of profits by different
categories of business:
- by product or product group
- by customer or customer group
- by any other split which appears to be relevant for
your business for which you have data; for example by geographical
area or distribution channel
- by competitive segment.
Start with products. Your business will almost certainly
have information by product or product group. For each, look
at the sales over the last period, month, quarter or year (decide
which is most reliable) and work out the profitability after
allocating all costs. How easy or difficult this will be depends
on the state of your management information. What you need may
all be readily available, but if not you will have to build
it up yourself. You are bound to have sales by product or product
line and almost certainly the gross margin (sales less cost
of sales).You will also know the total costs for the whole business
(all the overhead costs).What you then have to do is to allocate
all the overhead costs to each product group on some reasonable
basis. The crudest way is to allocate costs on a percentage
of turnovers. A moment’s thought, however, should convince you
that this will not be very accurate. Some products take a great
deal of salespeople’s time relative to their value, for example,
and others take very little. Some are heavily advertised and
others not at all. Some require a lot of fussing around in manufacturing
whereas others are straightforward. Take each category of overhead
cost and allocate it to each product group. Do this for all
the costs, and then look at the results. Typically some products,
representing a minority of turnover, are very profitable; most
products are modestly or marginally profitable; and some are
really making large losses once you allocate all the costs.
