The Pareto Principle – How It Can Help in Your Business
For businesses looking to grow, the general statement “We need to find more customers” can become a precarious sales directive. What businesses need to strive for are the right customers, ones that drive profitability upward. This brings us to the following question; who are these “right” customers? Applying the Pareto Principle, also known as the 80/20 Rule, you can easily define who the right customers are for your business.
The business-management consultant Joseph Juran made the assertion in 1941 that 80% of the effects come from 20% of the causes. Juran dubbed the principle “Pareto’s Principle” after the Italian economist Vilfredo Pareto whom in 1906 observed that 80% of the land in Italy was owned by 20% of the population.
While the Pareto Principle has seen a few decades pass since its inception, the theory behind the principle is timeless. Some business examples of the Pareto Principle are:
– 80% of your profits come from 20% of your key customers,
– 80% of your sales come from 20% of your key products or services,
– 80% of your defects come from 20% of your products.
A Pareto analysis will underscore the market’s perception of the business by identifying the key products or customer demographics. Through the actions of your customers, the Pareto Principle will help you to refine the business’ model to further satisfy the market. The influence of the Pareto Principle within the business will appear in the tactical planning for sales and marketing, departmental staffing, product or service design and inventory allocation.
How can this simple principle help my business? Focusing upon key customers provides reductions in transaction costs and operational complexity. Marketing programs can be cost effectively scaled to reach potential customers of similar makeup or demographics as your key customers. As the number of transactions and operational complexity decreases, an opportunity will present itself to reallocate staff to maximize their contributions. Determining the key products, excluding complimentary offerings, provides an opportunity to simplify services and reduce product varieties. Reduction in product or service variety will allow narrower inventories resulting in better cash flows.
What happens to the Customers we discourage over time? With any luck these ex-customers will gravitate toward the competition, increasing their lead time and costs.
Operational complexity is a businesses’ worst enemy. Not only is complexity challenging for the employees, complexity can quickly become frustrating for customers. The Pareto Principle will help identify opportunities to simplify and allow the business to truly focus upon the needs of the customer!