J. Miller and Company Blog

August 19, 2008

Company triage? Use the 80/20 rule!

Over the years of working with remodeling contractors, some simple patterns have become apparent. One remodeler’s strong interest in people leads to success in sales. Another’s love for design produces award-winning projects. Still another with a fondness for systems can produce a company which produces predictable and repeatable customer experiences, time after time.

Each company can enjoy a certain level of success and stability.

But to develop a larger company complete with beautiful office space, internal staff and consistent profitability sufficient to develop a nest egg for retirement demands an owner with another attribute – a love of numbers.

Only by digging through job cost reports, understanding financial statements and developing trend-lines for current concerns can an owner truly understand and protect and forecast company profitability. This is not a task for the faint-hearted; neither can it be delegated in the early stages of company development. The owner must understand certain vital components of the business and measure them continually.

To many whose interests lie elsewhere, the task seems overwhelming. But long-term success rests on determining not just what to measure, but when. Some indicators, such as cash flow, merit weekly tracking, others, such as gross profit margin, are job dependent. Monthly and quarterly tracking suffice for still others, such as accounts receivable and payable turnover ratios.

Use Pareto’s Principle, otherwise known as the 80/20 rule, to establish the current highest priority. The 80/20 rule predicts that 80% of the result is determined by 20% of the effort. Using this rule, 80% of company profits derives from 20% of the jobs, or 20% of the job types – such as kitchens and baths. Additionally it says that 20% of your employees cause 80% of company losses and problems. Conversely, 20% of that same pool of employees produces 80% of your profits. The key to using the 80/20 rule is to determine where to first apply it.

Certain problems are immediately apparent: if vendors and subs continue to hound you for payment, then cash flow should be your number one priority. If your produced gross profit margin is always more than 2 or 3 points different from what was bid (either way), then estimating jumps to the top. When sales are erratic and you complete one job only to wait for the next, marketing data, including lead and close numbers bear scrutiny.

Just as the emergency room crew determines which patient to handle first, you must use Pareto’s Principle to perform ‘triage’ on your company. Triage looks at the current situation, establishes relative importance and operates ‘first on the worst’, then moves on to the next. This process continues the life of your business – just as one variable is stabilized, another takes on greater importance.

As the company moves through various stages of growth (as discussed in my JLC article “Evolution & Revolution: 3 Stages of Growth for Construction Companies”, July 1996, page 45) some indicators will be more critical than others. Build a stable foundation at each stage using the 80/20 rule, then build on it to reach the peaks of business performance. The business model which best fits an individual personality will have in it the same critical indicators at each stage.

At stage 1 the owner does everything and cash flow and customer satisfaction are key. At stage 2 the owner begins to delegate, gross profit margin and overhead control become vital. Stage 3 the owner handles only sales and employee productivity and pipeline capacity develop greater importance. In stage 4 the owner manages the company and develops exit strategies, employee satisfaction and development together with metric predictability is paramount. Metrics for each stage build on previous: at stage 4 cash flow and customer satisfaction are as important as ever.

Extracting predictable and accurate metrics requires patience and clarity. First establish your current greatest need using the 80/20 rule. Then develop the tracking tools and procedures. Monitor your results closely for a quarter or 2, then move on to the next most pressing issue.

Remember, that although you might delegate the process of metric extraction to others, it is your responsibility as owner to understand and control the direction of the company over time.

Job cost accounting, Metrics ,