Back in 1906, Vilfredo Pareto looked at who was wealthy and who wasn’t in Italy. He discovered that 20% of the population had 80% of the wealth.
It wasn’t until the 1940s when Joseph M Juran took this a step further. He started to see the same 80:20 ratio in different areas. He named it the Pareto principle.
How the Pareto principle applies to your business
Take a look at your business. You’ll see that:
- 80% of your income comes from 20% of your customers.
- 20% of your products/services generates 80% of your sales.
- 80% of the complaints come from 20% of your customers.
- You use 80% of your time to achieve 20% of your results and,
- 20% of your time generates 80% of your results
- 20% of your advertising generates 80% of your sales
- 20% of your customers generate 80% of your referrals
I could go on, but you get the picture. Now, it may not be exactly 80:20 ratio. In some cases it may be nearer to 70:30, but the fact is, a significant volume is being created by something small.
How this improves your business
Take some time to look at your customers. Work out which are the 20% that are generating the 80% of your income. Then, using the customer profiling tools, create a customer persona.
Now look at your advertising ratio. Where did 80% of your customers come from? And which advertising created 80% of your income? This is important as, what you want to attract is high profit customers, rather than lots of low profit ones.
Double check to make sure the customers you want to attract came from that advertising. Then, invest more money into that advertising.
You can take this one step further and investigate your customer:income ratio. Create a table putting the customers into fifths (so every 20%) based on their value. Create personas for each, look at where the customers are coming from (on an advertising basis). Stop the advertising to the lower end customer and invest more in the upper end.
Use it to analyse your products/services. Which ones are making you the most money? Once you know this, is it worth investing more into this and dropping those that aren’t?
To show the value of this, I’ll share an insight from when Graham, my partner, had his shop.
When Graham bought the Grinning Demon, he bought a comic shop. Over the 13 years that he ran the shop, things changed.
Comics sales started to drop. There were changes in the big name comics that loyal readers didn’t like. Graphic novels (buying a series of weekly comics in a hard back book) became more popular.
Whereas before he could count on the weekly comic sales to pay the overheads, he was soon falling short.
When I met him, he was diversifying into Board Games and Graphic Novels. This is where the sales were being made. Unfortunately, it was too late and he closed the shop a year ago.
Had he applied the 80:20 rule, he would have seen the shift in spending and revenue. He could have adjusted what he was selling to reflect the changes.
Graham reflected “I knew comic sales were down. I just thought it was a ‘blip’ and they’d pick up. I realised, too late, that it was a permanent thing. By this time I had run out of working capital to invest in the things that were selling’.
Using the 80:20 rule across your business gives you a snapshot of what is working, where to focus your time. It also creates red flags, warning signs that you may miss in the day to day running of your business.
How the 80:20 rule can reduce customer complaints
80% of your complaints come from 20% of your customers. There are two questions to ask here.
- What are the complaints about?
- Who are the customers complaining?
What are the complaints about?
Look at what the customers are complaining about. Is it the customer experience or is it about the product.
Is it a misunderstanding about the product – how to use it, what happens etc?
If so, then use this to create a fact sheet for customers addressing these issues. This is a way to add value AND reduce complaints.
Are their complaints valid? If so, look at the product and ask if it’s worth selling or look for an alternative supplier.
If their complaints aren’t valid then look at the customer themselves. Where do the fit in the customer value table? If it’s down the bottom, then ask yourself, is it time to say goodbye to that customer?
Using the Pareto Principle with referrals
Referrals are a business owner’s best friend. They cost nothing in advertising and they already trust you.
So, who is sending you referrals? Look again at your customers and see who these are. Find a way to thank them and encourage more referrals.
Applying the Pareto Principle to your time
Using the 80:20 rule, you spend 80% of your time on trivial tasks and only 20% of your time on tasks that are vital.
It will be different for every business, but find a way that you can shift this. Use priority lists, rather than to-do lists. Identify the key tasks that will make a difference and do these first.
For me, the 20% rule means I need to find time in my day to work on attract new customers. So, I schedule an hour a day to work on this (such as writing articles, organising advertising etc). This is the first thing I do everyday. Once that’s done, I can then do the things I am paid to do, knowing that there is a steady stream of new customers.
Using the 80:20 rule to make key business decisions
The 80:20 rule applies across our lives and can be addictive. Once you see the truth in it and the power it gives you, it will form part of your business decision process.
You no longer have to guess at where to advertise – the 80:20 rule will give you the facts.
You will know which products/services to stock as you know the ones that bring the most profit to your business.
You will know which customers to avoid and which to nurture.
While this tool has been around for nearly 70 years now, it still holds true. And, when used, it can create the difference between a thriving business and a failing one.