- October 12, 2021
- Posted by: Paul Foster
- Categories: Increase Profits in Business, Profit Improvement Strategies for Small Businesses
The Pareto Principle (also called to 80/20 rule) states that for many outcomes, roughly 80% of consequences come from 20% of the causes.
In your business, it suggests that 80% of the revenues come from the top 20% of your customers.
It also implies that 80% of your revenues come from the top 20% of your products and services.
I recently read a good story where the purchaser of a business used this principle on the first day of owning it! He was scheduled to meet the management team for the first time in the board room. In preparation for the meeting, he asked them to assemble all the company’s products on the board room table. He asked that the highest revenue product be placed at one end, with the second-highest beside it all the way down to the lowest revenue producer at the other end. When he walked in, he identified the bottom 20% of the products and proceeded to clear them right off the table. He asked they be discontinued immediately. That was quite the first impression!
What this business owner also knew was that the worst 20% of your products consume 80% of the company’s resources! Late payments, customer service calls, product training resources are all disproportionally depleting resources. More products tend to mean more complexity. Fewer products are just simpler. Simplifying your product lines is profitable.
With respect to customers, the Pareto Principle implies eliminating the worst 20% of your customers. I know from experience this works. (I went from 150 customers down to 8!).
But if these drastic changes make so much business sense, why doesn’t it happen more often? It’s because change is hard for humans! There is an inertia to the current daily operation of your business model that keeps rolling along every day, and it is difficult to make a change. It comes down to the existence of the natural human emotional resistance to change. The change in ownership for the business owner in the story provided a unique opportunity to make a product change along with the ownership change. Another scenario is to wait until the emotional pain of dealing with selling and servicing the worst 20% of your customers on the lowest 20% of your product line is more than the pain of making a change. This seems pretty painful to me!
There is another option. Instead of actually firing customers and cutting products, just prioritize your team’s focus on the top 80% of revenue customers and the top 80% of revenue products they purchase. The reality is that everyone on the team is already busy 120% of the time. With giving priority to your best customers, you end up ignoring them in order to deal with the urgent fires created by the more challenging 20% group.
The decision to focus on your best customers and best products is still a change in focus, but since it is a less radical change, it has a higher probability of success. It gives your team permission to prioritize their focus on the good customers, which means permission to give less attention to the worst customers and/or the low volume products.
Why not give it a try? If you are not sure, collect some data. For example, identify which customers or products consume the most resources every day. What would everybody’s day look like if they didn’t have to deal with those issues any longer?
Let me know how it goes!