David Brown: Narrow Focus, Big Returns
Use the 80-20 rule to control your overhead.
BY DAVID BROWN
Published in the May 2012 issue
One of my favorite rules of thumb is the Pareto Principle — the relationship between cause and effect that has such a profound effect on how a business operates.
The Pareto Principle, or its better known name, the 80-20 rule, was based on the studies of an Italian, Vilfredo Pareto, during the 19th century. Pareto discovered that 80 percent of the wealth in his study group was concentrated in the hands of only 20 percent of the members. He then noticed that the principle applied to other areas of society — 80 percent of the crime was committed by 20 percent of the population, 80 percent of the population lived in 20 percent of the country, and so on ...
So what does this have to do with retailing?
Very simple. By applying the 80-20 principle to your business you can concentrate more effort on the 20 percent of activities and time that give you the majority of your results. For example:
- 20 percent of staff will give you 80 percent of your sales
- 20 percent of inventory will give you 80 percent of the units sold
- 20 percent of vendors will provide 80 percent of your inventory
- 20 percent of your expenses will incur 80 percent of your costs As our focus is on financial data, let’s talk about expenses.
If you’re looking to control overhead it would seem easy to look at all expenses equally, but that is time consuming. You can effectively review 80 percent of your costs by concentrating on the main areas that consume overhead:
Given that rent is largely a set cost, you can review a large percentage of your expenses by going through only two departments.
Alternatively, depending on your expense system you can focus solely on those transactions that are over a certain value, or are expenses that repeat on a regular basis. Again you’ll probably find that a small number of line items will account for the large majority of your costs during a year. You won’t make a significant difference itemizing the photocopy paper purchased during the year, but the travel expenses, or a newspaper advertising bill may be easier to identify and have a much greater effect on your overhead.
Let’s look back at what you spent last year and ask, “Did this expense provide me with the return I needed?” This simple exercise takes little time and could save you thousands of dollars.