Pareto Power and Leveraged Growth

The Pareto 80/20 rule can be used to drive significant cost restructuring, but it can also generate powerful leverage, enabling companies to deliver far more value to the market with far fewer resources.  In a time of increasing economic pressure, more companies are likely to discover the power of Pareto.

Cost restructuring

My previous blog posting focused on the application of the Pareto 80/20 rule to cost restructuring. It is a powerful tool to achieve significant cost reduction in a short period of time, far more effective than the usual cost-cutting techniques used during downturns. 

Yet, most companies have not yet learned that cost reduction buys temporary relief at best.  As competition intensifies in global markets, cost savings get competed away and captured by the customers.  Cost reduction is a necessity, but it is far from sufficient. If a company focuses only on this, the executive team will find itself managing a steadily shrinking business. To avoid value destruction in the process, executives have to find powerful new platforms for growth.

The challenge of growth

This posting shifts to the leverage side of the Pareto 80/20 rule, offering the potential to drive revenue and, more important, profit growth. How does the 80/20 rule apply here?

The Pareto 80/20 rule can be used to get more value into the market more quickly with lower investment.  Significant growth initiatives have a challenging economic profile – they typically require significant upfront investment, long lead-times before a return can be earned on the investment and considerable uncertainty about results.  This profile applies to both organic growth and acquisitions where effective post-merger integration often takes far longer than executives ever anticipate.Companies need to pursue leveraged growth.

How to change this profile?  Networks and power laws hold the key. It turns out that networks often generate power law relationships – that is, a very few nodes in the network account for a vast share of the connections. It is the Pareto 80/20 rule once again in action – 20% of the nodes often account for 80% or more of the connections. 

If one can identify and target effectively those few “Pareto nodes”, there is a potential for enormous leverage.  Limited effort, appropriately directed, can mobilize a vast network of participants to add value to your business initiatives. 

The role of networks in supporting growth

So, let’s start with the various roles that networks can play in amplifying growth:

Generating new product ideas – Not much need be said here. We are all familiar with the role of networks in scanning the environment for promising technologies and product ideas as well as evaluating product ideas.  Companies are rapidly overcoming “not invented here” cultures to leverage creativity wherever it resides. James Surowiecki addressed some of this opportunity in his best-seller, The Wisdom of Crowds.

Accelerating product development and delivery to market – Many companies are also beginning to understand the power of open innovation networks to significantly compress product development lead-times, tap into deep and diverse expertise, resolve challenging development problems and push performance envelopes much more rapidly than any individual company could. JSB and I have written about the extraordinary management innovations emerging in China to create highly scalable networks in areas as diverse as apparel, motorcycles and consumer electronics.

Accelerating new product adoption – This is the territory marked out by many, including Malcolm Gladwell in The Tipping Point where he highlighted the role of “mavens” – a much sexier term than “Pareto nodes” – in influencing broader consumer adoption of new products.

Enhancing the value of products in the market – Fewer people have focused on this, but it involves mobilizing large networks of highly specialized participants to add value in tailored ways around core product or service offerings.  Salesforce.com does this with their platform, aggregating an increasing number of software developers that offer more specialized functionality tailored to specific customer needs.  To fully realize this opportunity, companies would be well advised to re-configure their products as platforms.

Increasing customer satisfaction – Companies are beginning to understand the power of mobilizing passionate customers to provide advice and help others get more value out of using their products. JSB and I have recently written about the impressive initiatives by SAP in mobilizing an ecosystem of over 1 million participants to more effectively address customer needs. Scott Cook’s recent article in Harvard Business Review on “The Contribution Revolution” also highlighted this opportunity.

So, networks can provide increasing leverage in driving all phases of growth initiatives.  As I indicated, many companies are beginning to understand and address this leverage potential.  In another context, JSB and I have called this capability leverage, and it is extremely helpful in driving economic performance, especially in hard times. Rather than using other people’s money, as in financial leverage, companies can be much more successful using other people’s resources to add value to their business initiatives.

Achieving even more leverage with Pareto nodes

Fewer executives understand that even greater leverage can be achieved by identifying and targeting Pareto nodes within these networks. Rather than engaging with all participants in these networks on an undifferentiated basis, more targeted approaches can achieve much greater impact with less investment. By building deep, trust-based relationships with the participants that represent the Pareto nodes, a company can more cost-effectively access and mobilize the resources of the entire network. These Pareto nodes can help a company identify, understand needs and connect with all of the participants that they deal with.

The first challenge of course is to identify the Pareto nodes.  Fortunately, a variety of powerful network mapping tools are now becoming available to help executives accomplish this.  In the past, network structures have evolved below the surface, not easily detected by the casual observor. Whether it is mapping patent activity to surface networks of expertise or looking at the pattern of website network ecosystems through linking structures as my collaborator Christian Sarkar does so well, new analytic tools can help to make connections visible much more cost effectively. They quickly identify the nodes that represent concentration points for connections within the network.

The second challenge is to effectively engage with these Pareto nodes.  Unfortunately, even the companies that understand the power of Pareto nodes fall far short in terms of building sustainable and effective relationships with these nodes.  Here’s the problem. Executives revert back to conventional mindsets when they reach out to these nodes.  All they can think about is “what’s in it for me?”  They are extremely clear about what they want out of the connection.  But they generally don’t have a clue of what would motivate or be valued by the other party. They also tend to view the interaction as a short-term transaction or, at best, a series of standalone events, rather than the opportunity to build a longer-term trust-based relationship. It is no surprise, therefore, that they often come away from these meetings disappointed with the meager results.

Engaging with Pareto nodes effectively

Effectively engaging with Pareto nodes requires a form of collaboration marketing. Collaboration marketing emphasizes the need to attract others, creating a motivation for them to seek you out wherever you are, rather than trying to reach out, intercept them and get their attention. Of course, in order to do that you need to develop a deep understanding and appreciation for what motivates the other party.  It forces you to get out of the “what’s in it for me?” mindset. 

The best way to attract others is by offering assistance to them, by being more helpful to them than anyone else.  Once again, this requires a deep understanding of the unmet needs of the other party.  Finally, the most cost-effective way to assist them is to affiliate with others.  The trick here is to understand what relationships you already have that can be enormously helpful to the Pareto node participants and how these relationships can be mobilized to attract the participants you want to engage with.

If companies approach this challenge from the perspective of developing a long-term relationship with Pareto node participants, they can begin with small initiatives to attract and add value to these participants. Most tend to approach this with a “big bang” mindset where everything needs to be accomplished in a single interaction and disappointment is a more likely outcome.  By structuring an escalating series of value exchanges with these participants, a company can rapidly build deep trust.

Here’s the interesting thing.  If done right, this effort to engage and build long-term relationships with Pareto nodes fundamentally changes the shape of the network.  Over time, the companies systematically connecting with Pareto nodes have an opportunity to become a Pareto node themselves.  But that is the focus of yet another blog post.

The bottom line

The bottom line here is that Pareto analysis is not just useful for deeply and strategically cutting cost.  It can be equally effective in driving leveraged growth, which in a time of economic stress, is even more valuable than in more prosperous times. The two applications of Pareto analysis go hand in hand. Together, they ensure that a company creates significant economic value rather than destroying value, even in the most challenging times.

Comments

[Edward]

Very Enjoyable post.
I looked at doing something similar with objective finding MIT style knowledge "gatekeepers" (those that bring new knowledge into an organisation).

Having identified individuals that had a lot of external and internal knowledge connections, we made some subtle organisational changes to our department to allow these human nodes to have more interaction and influence on some key projects and the results were outstanding.

[Todd Sampson]

Great post John. I am a huge fan of both your work and Pareto's. As such, I am thoroughly enjoying watching you weave Pareto's ideas into your own on Edge Perspectives.

The following line really stood out to me: "Rather than using other people’s money, as in financial leverage, companies can be much more successful using other people’s resources to add value to their business initiatives."

This makes a lot of sense. But to me it seems that utilizing the non-financial resources of other businesses (such as external APIs) are potentially even more valuable in creating business leverage.

What's your take?

[Michael P. Gusek]

Very interesting. I really enjoy your "baby step" approach.

However:

Do you think larger businesses are going to catch on fast enough? Not only that, but how do you diffuse this idea in the organization? Would you agree that any tactical approach to executing a strategy like this might take much too long for even a medium-sized organization to plan?