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Power of the Pareto Principle

Power of the Pareto Principle

In 1906, an Italian economist made what seems like a simple observation, but it was one that immediately resonated with his fellow economists and has been codified into a principle named after the man who first stated it. Vilfredo Pareto observed that 80 percent of the land in Italy was owned by 20 percent of the population, and furthermore, he observed that the same ratio was applicable to other areas of economics.

The Pareto Principle—also known as the 80-20 rule—doesn’t just describe the way things are; it can also be used as a powerful tool to help you focus and redirect your energies, becoming more efficient and more profitable in the long-term.

The reason Pareto’s observation is so powerful is because it applies far more widely than he originally imagined. The 80-20 rule holds true for things like wealth distribution in many countries, but he also observed that 80 percent of the produce he grew came from 20 percent of the plants in his garden. If you were to look at what you’re wearing today, you’d probably discover that you wear 20 percent of your clothes 80 percent of the time.

Your Moneymaking 20 Percent

So what does Pareto’s Principle have to do with your long-term business strategy? We’ve been taught to treat everyone equally—that every customer is valuable. We’re encouraged to devote equal amounts of time to every client, simply because we don’t want to appear elitist, giving preference to some customers over others. We want to spread our time and attention around.

But we’re doing it wrong! If we heed Pareto, we learn that 20 percent of our customers make up 80 percent of our business. Wow. The vast majority of our revenue comes from a small minority of the clients who walk through our doors. If you spread your time and attention out evenly among all your clients, you’re missing out on the enormous opportunity you have to maximize the business you do with the customers who matter most.

And that’s a fact—some customers do matter more than others. The customers who generate 80 percent of your revenue—the ones who spend the most with your company and who purchase your highest dollar, highest profit offerings—those are the ones who deserve the lion’s share of your time and attention. Those clients are the ones who would seriously damage your profitability if they left to patronize another company. Those are the ones who keep the lights on. Your best long-term interests are tied to those customers, and you must focus additional resources on ensuring they get the very best service you can provide. You want to keep these clients.

Additionally, you want to find more of these clients. One strategy I’ve found useful is to sit down with my heavy hitters and interview them. I ask questions to find out who they are and learn where I can find more clients like them. How did they hear about my company? What clubs or organizations do they belong to? Can they refer me to friends or associates who might benefit from the services I provide? If you’re looking to lengthen your list of powerful, profitable clients, it’s worth your time to ask for referrals from the folks who already spend the most with you.

Cut Back Resources Where Necessary

Another way you can incorporate the Pareto Principle into your long-term strategy is by looking at the clients who consume the most time and attention. You’ll nearly always find that 20 percent of your clients take up 80 percent of your resources. Make a list of the squeakiest wheels on your client list and compare that list to the list of the clients who generate the most revenue. If you discover you have exceedingly demanding customers who don’t contribute much in the way of income, you might want to look at ways you can decrease the resources you spend on keeping these costly customers around. Conversely, if you discover you’re spending most of your time tending to clients who generate the most profit, then you’re spending the resources of time and attention wisely.

Your long-term strategy should be to maximize your profitability, and Pareto’s Principle can help you selectively cultivate the clients who will help you achieve that goal.


Article was written by Mike Michalowicz who is the author of Profit FirstThe Pumpkin Plan and The Toilet Paper Entrepreneur and is a nationally recognized speaker on entrepreneurial topics.

 

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