No more trivial pursuits
Two techniques to help you focus on what's really important
By Charles W. Kyd
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? Do you find yourself hashing out dozens of problems that have a trivial effect on the bottom line?
These are perennial problems for many business owners and managers - especially those in 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 and the Pareto analysis
Exception reporting is the better known of the two. 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 percent of their sales quota. You might have another that shows those salespeople who've sold more than 110 percent of quota. Reporting the exceptions allows you to cut to the heart of problems and opportunities, skipping the many instances in which performance is as you expect it to be.
The other technique is called the Pareto analysis - or, more commonly, the 80-20 rule. Its premise is that about 80 percent of the result tend to be generated by about 20 percent of the cause. For example, about 80 percent of your sales and profits probably come from a handful of employees, most of the value of your inventory comes from a small number of stock-keeping 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. 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 listed in descending order all price-variance percentages that were at least 50 percent above or 50 percent 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 two pages of this report always accounted for more than 80 percent of the total dollar variance, I gave only these first two pages to the buyers. The two reports reduced the buyers' paperwork from about 20 pages of questions that they seldom answered to three pages that they always did.
Sales and reporting analysis
Another 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 percent of the company's products contributed 80 percent of its gross profit, and about 75 percent of these products contributed more than 95 percent 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 percent 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.
In Managing for Results, Peter Drucker points out that many costs are affected by the number of transactions in a business, 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 percent of the vendors generated 90 percent 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 percent of its sales created about 80 percent 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 analysis, 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 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.
Charley Kyd is president of IncSight Corp, which specializes in helping owners turn business data into management insight.