Friday, April 27, 2007

99/1 Rule vs 80/20 Rule

Question: You mention in your speech that TOC (Goldratt's Theory of Constraints) is about the 99/1 Rule, not the 80/20 Rule. Can you explain that?

Answer: Let’s start by talking about the 80/20 Rule. The 80/20 Rule, also called the Pareto Principle was made universal by Juran and refers to the “vital few and trivial many”. According to Juran:

“It is a shorthand name for the phenomenon that in any population which contributes to a common effect, a relative few of the contributors account for the bulk of the effect.”

This principal is universal. It applies to your customer base – 20% of your customers account for 80% of your revenue. Your customers are independent or unrelated contributors to your revenue.

When we are talking about maximizing profitability, and the contributors of profitability (various elements in your system) are related, then the 80/20 Rule still applies, but it is too broad. Because the contributors of profitability are related, the largest contributor will have a much greater impact than all the remaining contributors. This is due to the statistical fact that dependent contributors add up as the sum of their squares. By squaring each contributor, the largest one ends up being closer to 99% of the sum of the squares. This largest contributor is your constraint – it’s the thing that limits your profitability most.

Most companies have one or few constraints. The number depends on the number of independent processes. If all your processes are in some way dependent on each other, then you will have one and only one constraint. If you have 2 completely independent processes for 2 different products or services, then you will have 2 constraints in your system. Since your system is limited by the amount of work that the constraint can process, your constraint is the BIGGEST contributor to your profitability. Hence, focusing on your constraint(s) is where you will have the greatest leverage on your profitability – the 99/1 Rule.

In summary, when you are trying to identify where to focus your efforts (quality or otherwise) and the contributors are related or dependent, then determine your constraint (your 99/1) first. Then, use the 80/20 Rule to determine the main contributors of an effect or problem within the constraint or constraint process.

Here's to maximizing YOUR profits!
"Dr Lisa" Lang

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