Pareto principle – case study

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How the 80/20 rule saved one department millions each year

 

Can you imagine if you saved your company millions of dollars per year? It would make you look like a rock star, the top of the list for new opportunities or initiatives. Here is a story where that happened in a major global company.

 

This is a fictionalized and simplified case study based on a real business problem.

 

The story

 

Sandra was a finance specialist who tracked projects at Ultimate Industrial Company (UIC). UIC manufactures, delivers, and installs large custom concrete and metal solutions for large infrastructure projects. Have you ever seen a highway overpass get delivered by a truck? They probably built and delivered it. In addition to highways, they also do business for oil and gas wells and commercial shipping docks.

 

UIC has a sales staff that works with customers at the beginning of a project. They agree to the price and timing with the customers. Once the project begins he interaction with the sales team is complete. Project managers guide the project through completion and they sell follow on work.  When UIC is unable to meet the terms of the contract they pay back a part of the agreed to price.

 

One of Sandra’s responsibilities was negotiating the terms of how much UIC paid back to customers. When she started thinking about how much UIC was returning to customers she wondered if the reasons for needing to pay back were random. Were they due to factors beyond their control, or were there systematic issues that lead to projects having issues?

 

Sandra couldnt believe that the total amount of pay backs, and who they were paid to, was not tracked in a single location. If she wanted to analyze the pay backs they would first have to find all the data and then make sure it is in a common format. Sadly, this is not uncommon, even at blue chip companies like UIC.

 

What she found

 

When Sandra actually did get the pay back data together she noticed that it was a lot of money, $38m per year or ~5% of the division’s revenue. If she could make a dent in that figure, it would be a great result. Best of all, if she could reduce pay backs, it would flow 100% to the bottom line.

 

Note: The data was manually captured so it needed extensive time to format and clean it to be useable

 

Sandra understood the pareto principle and sought to prove that there was an 80/20 opportunity to reduce paybacks. She worked with the individual project managers to identify the root causes. If she was correct there would be a small number of fixable root causes that lead to most of the problems.

 

There were three reasons why UIC might pay back money to the customer; the product was late, the product did not meet the required specifications, or the construction needs were simpler than projected. In all, 90% of the paybacks were due to late product, 2% were due to product not meeting specifications, and the remaining 8% were for when the needs were simpler than projected.

 

Note: Sandra got a little too excited about this data and shared it with her organization without giving them the proper background. This will come back to bite her when the department leadership start working on improving the problem before they have determined the root cause.

 

Sandra noted that this information was a start, but these were not fixable, or even root causes. She would need to take the next step to understand why the product was late. What situations and decisions lead to the product being late, and what can we do about them?

 

Sandra needed to investigate the root cause of the late products. Her research showed that there were 7 reasons for product being late.

 

The fact that impossible to keep promises are the single largest root cause jumps off the page. That should be easy to fix.  However, that is also dangerous territory; Sandra would need to tread carefully. She would need to learn why the sales team was making promises that manufacturing could not keep.

 

The second largest “bucket” was a shortage of manufacturing labor.  That is also interesting. Getting to the bottom of that issue could also be a sensitive subject.

 

Sandra decided to focus on those two buckets and developed her game plan.

 

Understanding the root causes

 

Sandra uncovered two large, tricky, and sensitive root causes: the sales team was making promises that manufacturing could not keep, and manufacturing was missing deadlines due to insufficient labor. She would need to understand those situations in much greater detail before moving forward.

 

There are several potential reasons why the sales team would make promises manufacturing could not keep. Their incentive structure could be set up in a way that encourages short timelines, their customers could demand it even knowing it is impossible, they might not know their promises are impossible, etc.

 

Sandra got lucky and it turned out to be an easy fix.  The sales staff had outdated training material which showed shorter manufacturing times. They had no idea the manufacturing process was now longer and more complicated. Customers were often flexible with timelines in the bid process. It was only after work had started that delays became a problem for them.

 

Manufacturing labor shortages can also have many causes. The company may have cut back on labor to save costs, they may have their process issues which make it hard to add labor, they may be having union trouble, etc.

 

Sandra found that UIC was having trouble attracting welders. The oil and gas boom needed so many welders that it drove up the salaries past what UIC was willing to pay. UIC might change its mind when it saw that the shortage of welders was contributing to $38m in pay backs to customers?

 

Stakeholder issues

 

Sandra’s findings excited her. She thought it would be easy to make big improvements, but unfortunately her enthusiasm did not last long.

 

When she shared that product arriving late accounted for $34m of the $38m in pay backs that set off a chain reaction. Management writers often call this “bright, shiny object syndrome,” something that consistently leads to over-reactions. Management had already begun discussing plans to have a third party logistics (3PL) firm take over their shipping.

 

This was terrible for her change efforts. Transportation speed was a minor problem, it would do little to reduce pay backs. It would also steal any momentum she thought she had towards making large changes.

 

Sandra should have considered the situation from their point of view before she shared what she found. From middle management’s POV they were presented with a large and fixable problem. What would they look like to senior management if it comes out that they knew about the issue but took no action?

 

Sandra learned an important lesson in change management, and that is the need to manage stakeholder expectations. She presented a seemingly large problem with a hint at the root cause but no proposed solution. This led to a chain of events designed to solve the problem she found. Instead of working on solutions, she would spend the next several weeks meeting with stakeholders to discuss what the real problem was.

 

When Sandra met with middle and senior management she  realized there was more than meets the eye to their 3PL push. They did not want to be in the shipping business. They did not want trucks and drivers on their balance sheet or payroll. It did not matter that moving to 3PL did not solve the pay back problem. The pay back problem gave them an excuse to do what they already wanted to.

 

Sandra would have benefited from knowing about the 3PL push in advance. That information would have helped her create a more convincing plan to senior management. Even if she did not know about it, if she had prepared an overview of what the solution looks like it would help her show how fixing the sales process and manufacturing labor model would provide larger benefits.

 

Developing solutions

 

Sandra tasked one of her project managers with finding and making all needed updates to sales literature. She also tweaked the update checklist to make sure future changes did not fall through the cracks.

 

The HR team supporting manufacturing operations was in a tough spot. They did not want to increase welder salaries to compete with the oil and gas boom, but they did not want to leave the business understaffed. They had trouble putting together a business case showing why higher pay was necessary.  The information about delay costs from Sandra gave them what they needed to justify signing bonuses for welders.

 

The 80/20 rule in action!

 

Sandra’s changes are an excellent example of the power of the pareto principle. At first glance it seems completely reasonable that delays would happen. UIC is dealing with huge custom structures, lots of specialized labor, and shipping all over the country.

 

However, the difficult situation is not the primary reason for the costly late deliveries. Simple literature updates could make a huge impact on the problem. Labor costs are often the third rail of organizational politics. In this situation they drove a shortage which caused delays.  Sandra came up with concrete data on how much their labor shortage was costing them. The HR team can use that data to justify increased salaries or one time bonuses to stop the welder shortfall.

 

If it was this simple, why didn’t someone already solve this?

 

Sandra’s success is a good example of the difference between simple and easy. What she did was rather simple, but it was not at all easy. She spent hours of extra time hunting down and distilling the root causes.

 

How many people do you think she needed to talk to before she realized that what the sales literature’s timelines were impossible?

 

How many manufacturing leaders did she need to interview before she realized that a lack of welders was the real issue causing delays?

 

Do you think that people were defensive and blamed others for the issues?

 

Do you think people complained about issues they were facing and asked her to help them get more resources?

 

Do you think some people were “too busy working on the problem” to talk to her about it?

 

I ask these questions to highlight some of the obstacles she came across. There were many more obstacles, but that gives an idea of these issues continue.

 

Do you have a story about when you did something like this? Did this give you an idea for something you can look into at your company?

 

It is worth it to put in the effort as Sandra did. She is well positioned at UIC for promotions and raises.  Senior management knows her name and that she has drive and talent. If she does not want to stay at UIC, she has a killer resume bullet and “dragon slaying story” than any employer would value. She leveraged the 80/20 rule to supercharge her own career in addition to the business.

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