Apr 2019 How to use the 80/20 rule to run a more efficient profitable business
The 80: 20 rule is a guiding principle in business that states that 80% of the results come from 20% of the causes. In other words 80%, of your sales comes from 20% of your clients or 80% of your complaints come from 20% of your customers and so on.
3 jobs produced nearly three quarters of his overall profit
Years ago I was analysing a client’s business income over a year. They operated a landscape construction business and had completed many projects throughout the year. So we wanted to know which jobs produced the highest profit and which jobs were best aligned to their business vision. After doing a full analysis of all income, it was easy to see that just 3 jobs produced nearly 71% of the company’s income and the other 12 smaller jobs accounted for 29% of the remainder profit. It was a worthwhile exercise because although the business owner knew he wanted to win more projects like those 3 jobs, seeing the actual profit breakdown shocked him as he didn’t realise that those 3 jobs produced nearly three quarters of his overall profit.
As you can see by my analysis that the 80:20 rule is not an absolute truth, it is a guiding principle that when applied to our business makes us aware where we should be putting our focus and doing things more efficiently and effectively.
80:20 was discovered
The 80:20 rule is also known as Pareto Principle, named after the economist Vilfredo Pareto. Back in 1906, Vilfredo Pareto noticed that 80% of Italy’s land was owned by 20% of the population. He also noted that 80% of the peas in his garden came from 20% of his pea pods. Later, the economist Joseph M. Juran took Pareto’s work and applied his logic to management theories realising that the principle could be applied to many of the results and causes we get in business.
So where else in your business could this principle help you?
What about 80% of your customer complaints come from 20% of your customers?
I have tested this with some of my clients and found this to be the case. Again, it isn’t smack on 80%, but it has worked out to be very close to that number. When you know this to be the case, you could deal with this by categorising your customers into 3 different groups (A, B, and C’s going from best customers to least).
You can categorise your customers based on total sales per customer per year or project, average spend, referrals, ease of relationship etc). If many complaints are coming from the customers in category C, you can decide whether category C customers are worth retaining and that winning more clients in category A and B would be worth focusing your efforts.
Recently, I also found that 80% of the strongest sales leads came from 20% of the alliances a client had. He had several alliances (5 to be exact) that were sending him leads (potential work), but the leads that were the strongest (winning the jobs and they were the highest in contract sum and profit) came from just 1 alliance. Numbers don’t lie, and when my client saw that result from this little analysis, he realised he needed to start focusing on finding another alliance like the one that was providing the great leads.
What about 20% of our marketing dollars could produce 80% of our leads or sales, or 80% of the time you spend fixing problems are caused by only 20% of the problems, or 80% of our problems come from 20% of our employees? I think most business owners could immediately relate to the employee statistic and say that seems about right.
The 80:20 rule is a great principle that every business can use to target a couple of areas like sales and profits and once it helps you identify where you can be making more money use it to apply to some other areas.
It is definitely a powerful guiding principle to start using in your business to increase profits, sales and overall efficiency.