The 80-20 theory is based on 20% of markets generating 80% of the Earnings Before Tax, Interest, Depreciation, and Amortization (EBITDA). The main objective of applying the 80-20 rule is to identify the most productive or profitable segments, and prioritize them. By extending the 80-20 rule to the valve market, companies can use niche analysis to expand on which markets are generating the most EBITDA.
By Robert McIlvaine, President & Founder – The McIlvaine Company
The Internet of Wisdom
The 80-20 rule is widely applied in business and finance. However, at its core, the principle is to identify an entity’s best assets, and then use them efficiently to create maximum value.
Artificial Intelligence (AI) is based on the belief that the vast amount of digital information can be best harnessed by computer programs with algorithms substituting for wisdom. The McIlvaine Company created the term ‘Industrial Internet of Wisdom’ (IIOW) and has been applying the concept to small niches.1
The Internet of Wisdom is based on niches small enough that human wisdom can grasp the information available. In other words, summarizing and segmenting information so it can be readily understood by the user. The important takeaway of this is that by using a rule such as 80-20, extensive niche internets of wisdom are justified.
Applying the 80-20 Rule to Valves
For example, there are many types of valves and many applications of those valves. Massachusetts, U.S, represents a small fraction of a USD $100 billion world valve market. Additionally, single-use valves are a tiny but fast-growing technology. An IIOW around the potential for single-use diaphragm valves, in cell and gene therapy, in Massachusetts, could therefore be created.
The annual valve market is more than USD $1 million per year, which is a sub-niche threshold. It can be combined with complementary sub-niches to reach the USD $10 million niche level.
Many companies are profiting from the 80-20 rule by identifying the 20% that are the most profitable macro niches. Companies will find that EBITDA continues to increase as this concept is expanded to each niche, and then to every USD $1 million sub niche. The goal should be 30% EBITDA and more than 40% market share.
Further Segmentation of Market Niches
How could a company identify its best assets without analyzing each niche? For example, specialty chemicals provide a much higher return than the rest of the chemical industry. However, if one digs a little deeper, one would find that surfactants have a higher return than other specialty chemicals. Further analysis reveals that BASF, Stepan Chemical, and a few other producers, account for most of the valve sales to this market.
To reiterate, the following is another example of applying the 80-20 rule: 10 out of 50 major segments generate USD $80 million in valve revenue. Therefore, 100 out of 500 sub-segments could generate USD $100 million in valve revenue due to higher EBITDA and market share.
The 80-20 rule continues to be relevant as more subdivisions are created, such as individual customers and even distributors. An oil & gas oriented distributor can be outstanding in one market, however the same cannot be expected in the process market.
Another segmentation is OEM versus end user. The 80-20 rule is no better than its implementation. The greater the segmentation, the easier it is to provide niche forecasts for each territory, and then assign specific targets for each distributor and product manager.
California and Texas are bigger valve markets than all but a few countries. Segmenting the U.S. and China into individual states and provinces is there- fore warranted, rather than comparing each country as a whole.
New market opportunities should also be approached based on niche analyses. A big market for valves will be in automobiles fueled by hydrogen. This will not be a high EBITDA market for industrial valve manufacturers. However, by using segmented analysis, several of the following factors can be observed. Green hydrogen will be a high EBITDA market for valve manufacturers already serving the ultrapure water market. Blue hydrogen presents a major opportunity for valve manufacturers with refinery expertise. Since ammonia may be the preferred compound to ship hydrogen, it will be a natural extension for the present suppliers of ammonia valves.
All of this brings up the issue of timing, which is yet another niche. Another fac- tor to consider is that a niche in a volatile market may offer high EBITDA for only a limited period. For example, grey hydrogen is big now, but will eventually recede, and blue hydrogen will dominate for the next decade. However, in the long term, the future of the industry is in green hydrogen.
There should be an investment in niche analysis. Similar to how there is no benefit to switching to single-entry bookkeeping, the cost is justified for accurate cost accounting. The return on investment (ROI) on niche analysis is as high as accurate cost accounting, and therefore crucial for companies to invest in.
Reference:
- Most Profitable Market Program published by the McIlvaine Company
