The 80/20 Rule

The Pareto Principle, more commonly known as the 80/20 Rule, makes the claim that 80% of outcomes are the result of 20% of the causes. This is probably most apparent in terms of distribution of wealth. For example, 80% of the income in a typical society is earned by 20% of the population.

When used in the context of a business, a common philosophy is that 80% of a company’s profit or turnover is generated by 20% of the customers. This is the case for the majority of medium-sized businesses, and there are several instances where a company is founded purely to fulfil one contract.

Leveraging the Pareto Principle

There are two schools of thought in terms of how you should respond to such a scenario and make the Pareto Principle work better for you..

Firstly, you could try to further increase the effectiveness of the small number of key clients. The idea here is to milk a cash cow and get more yield for your efforts. After all, if you increased the amount of trade by 10%, the economies of scale mean that the larger client works with bigger numbers than a smaller client.

The second idea would be to try to develop the less fruitful clients. This tries to nurture more cash cows. You can study the behaviours and factors that characterise the cash cow(s), and try to replicate that with others. The main benefit to this is that you are spreading risk. If your number one customer were to go bust or decide to trade elsewhere, this would have a huge detrimental impact on the business. Developing a few significant accounts means a more diverse revenue stream. This represents excellent forward planning and a risk-averse production strategy.

Top Selling Products

As well as looking on a customer level, you can apply the Pareto Principle to the products and services you sell. For example, an electronics company might get most of its sales from of two models of digital camera. They could effectively run a profitable operation by putting all of their resources into these products and save the money and energy they spend on the less profitable products.

However, the risk factor in this scenario is much more apparent. In two years’ time, the market for digital cameras may have reduced due to the proliferation of smartphones. That time could be spent on new product development rather than on just one product line.

The perfect response to the 80/20 rule would be to change the ratio to something like 70/30. This would mean you have a better spread of profitable products or customers. The more even the spread of productivity, the less risk is involved, and the more efficient the business operation will be for the future.