The Pareto Principle 80/20

Last month we covered cash flow. This month it is workflow and how it connects to cashflow and all other key business ratios.

If you are a small, medium or large business, currently setting targets or looking to achieve and maybe exceed those already set for 2019, the Pareto Principle which states 80% of results will come from 20% of all actions should not escape your attention.

 

In 1896, an Italian economist named Vilfredo Pareto published a paper showing 80% of land in Italy was owned by 20% of the people. His research demonstrated similar findings relating to crops, for example, 20% of tomato plants delivered 80% of all tomatoes while income statistics demonstrated that 20% of workers earned 80%of all income.

In 1941, Joseph Juran, a management consultant studied Pareto’s research and found the 80/20 rule applied to key business issues and opportunities. He used it extensively while helping companies focus on building a sustainable future without a major waste of time and effort.

Pareto Principle 80/20 Examples

Listed below are some examples of 80/20 logic. Many of the business examples are used by companies to focus their efforts and improve results.

Business Examples	Life Examples
20% of products equals 80% of sales. 20% of customers equal 80% of the revenue. 80% of complaints come from 20% of customers. 80% of work is completed by 20% of the staff. 80% of referrals come from 20% of customers. 20% of queries escalate past 1st point of contact.	80% of tips come from 20% of customers. 80% of beer in the world is drunk by 20% of beer drinkers. 80% of the pollution originates from 20% of all factories 20% of criminals commit 80% of all crimes. 20% of all students achieve 80% + marks in examinations. 20% of clothes are worn 80% of the time.

Operational 80/20.

Sometimes key operational activities such as credit control, service, administration and sales get only 20% of the total business effort. A business cannot address every single issue or capture every opportunity. It therefore must decide on the small number of activities that matter most and then ensure 80% of the total available effort is dedicated to the timely completion of these key tasks.

Sales 80/20.

Pareto’s Principle of 80/20 is extremelyeffective when applied to selling. It motivates and encourages activity which in turn generates higher energy levels and improves results.

It can be applied to all steps in the sales cycle, for example, who is the target market, what existing customers have potential for more business, what product/s should be getting more or less attention and is pricing, either higher or lower, an issue with any of the big drivers of profit.

Selling 80/20.

Sales people usually approach customers with different offerings and quite rightly believe any sale is a great sale. Which is always okay provided 80% of sales are not to the 80% of customers who deliver the least amount of revenue.

Connected to this individual result is a likely company scenario: 80% of all new customers result from sales of 20% of the available products. (It may not be exactly 80-20; it might be 70-30, or 90-10 but the principle is usually true for most companies.)

Therefore, both company and seller improve their results when they identify what product/s attracts most new customers with the highest revenue potential. A key 20% activity must be more and more opportunities to sell to customers the product/s which are high revenue and strong profit drivers.

Risk Management 80/20.

Many businesses have big customers who represent a disproportionately large percentage of total sales. Business owners usually see this as being a double edged sword; valuable right now and as long as possible and a significant risk to their business today or sometime in the future.  

Likelihood: 80% of the most valuable sales revenues probably come from 20% of customers. (This is sometimes an even more extreme ratio, like 90-10 or 95-5.)

Managing the Risk.

• The more extreme the ratio, the higher the risk.
• Being aware and avoiding complacency is a critical first step.
• Delivering superior service to existing customers in the 20% category is a must-do every day.
• Reducing the dependency with similar rich in revenue customers must be a target.
• What internal behaviour needs to change in order to overcome the risk.
• How can target customer behaviour be influenced.
• Is there an operational 80/20 analysis and a plan available to align available resources and skills with the need to mitigate this high risk?

Advantages 80/20.

The Pareto Principle of 80/20 applies logic to business situations, brings clarity and points the way forward. It increases effectiveness, helps people become more efficient and shines a spotlight on too much of anything or whether if too little is focused on what’s important now.

Using 80/20 to move your business forward is motivational. It asks people to identify what are the most important tasks they complete for themselves or others, calculates time spent on delivering to these key tasks and identifies agreed adjustments to daily weekly workflow schedules.

Summary 80/20.

Please note the 80/20% ratio figure is a guide. The actual ratio which would deliver optimal effectiveness to a business depends on the situation and any other considerations. But important to note; there are ratios in all businesses. It may be more extreme than 80/20 or less. Either way, it is important to know the ratios and see if anything needs to change.

Starting Point.

• Communicate and explain 80/20 clearly.
• Identify the 20% of actions vital to your business (based on the fact they probably deliver 80% of productivity, performance, effectiveness, etc).
• Retain this 20%, and nothing else, unless it serves a crucial purpose.
• Depending on the size of your business, think about 80/20 as a small project.

Next month we will be writing about customer segmentation and how it fits to the 80/20 rule.