No More Trivial Pursuits
If irrelevant data is consuming too much of your typical day, it may be time to change your reporting systems
Do you find yourself so bogged down that you don't have the time you need to focus on what's really important to your company? Are you facing so many reports, meetings, and discussions that your dilemma is how to sort out what you should be worried about from what's irrelevant? Or do you find yourself hashing out dozens of problems that have a trivial effect on the bottom line? These are perennial problems for many managers -- and particularly for owners of fast-growing companies. But two techniques that companies have been developing over the years can help you out. While neither approach is perfect, both can simplify your life.
Exception reporting is the better known of the two ("Hitting Your Numbers," April 1987). Rather than reporting everything that's happened in a particular area -- in sales, say -- an exception report tells you only those cases in which actual performance differs from standard performance by more than a predetermined amount. For example, one of your exception reports from the sales department might show the performance of salespeople who've sold less than 90% of their sales quota. You might have another that shows those people who've sold more than 110% of quota.
The advantage of this technique is that reporting the exceptions allows managers to cut to the heart of problems and opportunities, skipping the many instances in which performance is as you expect it to be. The primary disadvantage of this technique is that you must set a standard. For some business activities, of course, standards should be set -- a sales quota, for example, or a budget, or a production plan. But standards don't fit other areas of company performance, such as customer complaints, returned goods, paperwork, or price variances. An additional problem is that frequently more goes wrong than right, and exception reports can run on for pages.
The other technique is called the Pareto analysis, named for Vilfredo Pareto, a professor of political economics in Switzerland at the turn of the century. In economics, Pareto's law concerns the observation that a minority of a nation's working population earns the majority of its personal income. But in business, his law has come to refer generally to the inequality of cause and effect.
Pareto's law is also called the 80-20 rule, because about 80% of the result tends to be generated by about 20% of the cause. For example, about 80% of your sales and profits probably come from about 20% of your customers, most of your personnel problems come from a handful of employees, most of the value of your inventory comes from a small number of stockkeeping units or part numbers, a few of your vendors are probably associated with most of your paperwork problems, and so on.
Over the years, I've found the 80-20 rule to be an extremely useful technique for financial analysis and reporting. As an analytical tool, it can help you distill the interesting details from data. As a reporting tool, it can speed up your ability to identify both problems and opportunities. If you haven't looked at various aspects of your business through the 80-20 prism, I think you'll find it effective. Here are some examples of the ways it has helped me.
Just after I got my M.B.A., I worked as an accounting manager for a division of a large computer manufacturer. My predecessor had designed a monthly exception report for the purchasing department, which showed the variance between actual and standard costs by part number for all shipments during the month. The buyers hated the report because it usually contained about 20 pages of exceptions that they were supposed to research and explain.
Because the buyers usually ignored the hefty report, I asked our programmers to create two 80-20 reports. One of these was a monthly report that never ran more than a page and that listed in descending order all price-variance percentages that were at least 50% above or 50% below standard. Usually these turned out to be data-entry errors, which we could correct quickly.
The other report calculated the total price variance in dollars for each part and then sorted these data from the largest price variance to the smallest. Because I found that the first 2 pages of this report always accounted for more than 80% of the total dollar variance, I gave only these first 2 pages to the buyers. The two reports reduced the buyers' paperwork from about 20 pages of questions that they seldom answered to 3 pages that they always did.
Other ways that I often use 80-20 reports are for both sales reporting and analysis. For example, a $50-million company that I worked with was forecasting negative cash flows for the coming year. To see where some of the problems might lie, we did a quick sales analysis. In a computer spreadsheet we listed the yearly forecast for sales, cost of sales, and gross profits for each product, and then sorted these products according to the gross profit, going from the largest to the smallest.
It turned out that roughly 25% of the company's products contributed 80% of its gross profit and that about 75% of these products contributed more than 95% of the profits. A quick analysis of the sales information made it seem that the company could slash both inventory and administrative expenses, and generate a positive cash flow, merely by dropping the least profitable 25% of its products.
Of course, this wasn't the end of the analysis. Many of the overhead costs allocated to the products at the bottom of the list would not have gone away if the company had dropped the poorly performing products. Some of the poor performers were new products and needed time to develop. Others were loss leaders, making the sale of more profitable products possible. Even so, the 80-20 analysis suggested two sets of actions. First, it highlighted several products the company needed to discontinue, which would save administrative expenses, inventory costs, and factory space. Second, it pointed out many products that needed a price increase, a cost reduction, or both.
Several years ago I went to work for a company that had fallen on hard times. Soon after I started, the president and I analyzed every expense account in the general ledger, searching for ways to cut costs. But after hours of work and discussion, we'd saved hardly a dime. We had found so few ways to save because there were so many pages of expenses from which to choose. Rather than make the hard decisions about a single expense, we kept hoping to find easy answers in other expenses.
The next day, I loaded all of our expenses into a spreadsheet and sorted them from the largest to the smallest. When I did so, I learned that about 15% of all expense categories accounted for about 80% of all expenses. I printed these major expenses on one sheet of paper and met with the president again. This time there was no way to escape. We had to cut the costs from that short list.
In Managing for Results Peter Drucker points out that many costs are affected by the number of transactions in a business and not by the dollars associated with each transaction. For example, administrative expenses to process a small order are about equal to those for a large one. For many years, I've combined this idea with the 80-20 analysis to find ways to control expenses.
In one company, for example, 10% of the vendors generated 90% of the billing and shipping errors processed by its accounting department, and most of the rejection slips issued by its quality-control department. Replacing these vendors improved quality and cut the administrative work load.
In another company, products generating about 20% of its sales created about 80% of its paperwork, as measured by the number of customer and vendor purchase orders, credit memos, quality-rejection slips, returned material authorization numbers, co-op advertising credits, and so on. Because low-volume products require about the same paperwork as high-volume products, much of this imbalance will never disappear. But highlighting the imbalance can help keep it under control. The company dropped products it should have dropped years earlier, raised prices on others, set a minimum dollar amount for customer orders, improved quality, and took other measures to reduce the administrative burdens the 80-20 analysis had revealed.
When you apply Pareto techniques to your own reports and analyses, you'll probably start to look differently at the problems and successes in your company. You'll look for ways to distill problems into a few causes, such as certain expenses, products, or vendors that you should improve on or eliminate. And you'll look for ways to distill successes into their major causes, such as customers, employees, or products that you must protect and build on.
Charles W. Kyd, a writer and consultant in Seattle, spent 10 years as the chief financial officer of fast-growing manufacturers, start-ups, and turnarounds. His most recent book is The Microsoft Excel Business Sourcebook (Microsoft Press).
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