25 Mar 2020

What is the 80/20 Rule and Why is it so Important?

You may well have heard of the 80/20 principle.

It also goes by the name of the Pareto principle, named after the Italian economist Vilfredo Pareto. If the name rings a bell, it’s most likely because you’ve heard somebody use the term “pareto the data”.

Now you know where the term comes from!

The 80/20 rule was an observation made in the 19th century by Pareto when looking into how land ownership was distributed in his native Italy.

He observed that 80% of the land was owned by 20% of the landowners.

He then went on to observe that 20% of the pea plants in his garden produced 80% of the total yield.

The principle itself isn’t hard to understand. It’s simple evolutionary “survival of the fittest” rationale that ultimately holds sway when there are no intervening forces to skew natural law and market forces.

 

How Pareto’s 80/20 Rule can help you focus on more effective tasks

Now let’s look at this principle to observe opportunities and patterns when it comes to managing vendor spend.

This is actually one of the most powerful laws which can be applied. For me, the most interesting aspect is the insight and validation it gives you to stop spending too much of your time and resource on “busy work”, to the detriment of where your real value lies.

 

Let’s look at some examples 

These statements, along with the consequential action I’ve suggested after them, quickly gives clarity of how to free up white space and to unlock value. The resource and energy saved can give your organisation extra capacity to concentrate on what’s important, whilst eliminating or ignoring what’s not.

Because at the end of the day, administrative work and tactical day-to-day issue resolution is the task of admin assistants and junior staff, not highly paid senior managers.

20% of vendors are the key partners who account for 80% of your total spend. How much time are you spending developing and partnering with them vs. dealing with day-to-day communication with the long tail of irrelevant suppliers.

80% of your invoice volume is represented by the long tail of vendors who make up the last 20% of your spend. That’s 80% of the issues being caused by non-core vendors. How could this time be better put to use?

80% of the late deliveries or quality problems come from 20% of your vendors. If they’re key vendors, work with them. If they’re not, get rid of them.

20% of your stakeholders account for 80% of your time spent serving your internal business partners. Are they the ones who you need to be building alliances with, or just the ones who shout the loudest or who like working with you? Who should you really be in front of to drive the most value and achieve your objectives.

And so on. You get the picture.

80/20 Squared

The other twist on this is when you start to apply the power law and perform 80/20 squared.

Take the 20% and then apply the 80/20 rule to this also.

You come out with 64%/4%.

If we’re talking about vendor management, then what this speak to is if you’re strategically managing and building alliances with the top 4% of your vendors (by spend), that will help you drive 64% of your results.

Be that savings targets, DPO improvements, on-time deliveries and so on.

In short, 80/20, or even 64/4, is the ace card I always play when trying to convince sceptical stakeholders of the benefits of vendor consolidation.

That’s my speciality and it fits perfectly with this power rule. Cut out the noise, to free up the resources, to drive results from the vendors who matter.

Don’t get bogged down with operational issues being caused by a long tail of insignificant suppliers.

If you’re an SME and have 250 vendors, it’s impossible to manage all of them, especially if you don’t have an in-house buying team. Very best case you’re actively managing 50 vendors. Realistically, it’s probably closer to 25, which is 10%.

If we then take the power law squared and say that by managing just 4% of the vendors properly, they can deliver 64% of annual cost reduction target (or any metric for that example – we could just as easily be talking about improvements in on-time delivery), this is dynamite.

4% of 250 vendors is just 10 companies whom you should focus on to be your strategic partners, and they could deliver 64% of the total value.

The journey to working to the 80/20 rule

To get to this point, first of all you need to free up resource to manage this. You do this by eliminating the background noise.

First of all, you need to perform a basic spend analysis and get serious about cleaning your data.

Then you need to look at automating, simplifying or reduce the time it takes to perform tactical, day-to-day tasks.

Finally, you need a sustainable process and ongoing monitoring of the key performance indicators (KPIs) to make sure this is working.

Only by doing this will you be able to rationalise your supply base and automate inefficient processes which cause unnecessary day-to-day administrative tasks.

If this has tickled your interest and you’d like to know more about how using the 80/20 principle can help to drive the right decisions in managing your supply base and procurement processes, then I look forward to discussing this with you.