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9/1/2003

# Profit Center: The 80/20 Rule

I know I’ve mentioned the 80/20 Rule to you before, but I don’t think I have ever explained it. Often, I make reference to it so I thought that this month I would try to explain this principle in more detail.

An Italian economist named Vilfredo Federico Damaso Pareto observed back in 1906 that 80 percent of the land in Italy was owned by 20 percent of the population. Later, he observed this noteworthy ratio seemed to apply to other parts of life such as gardening: 80 percent of his peas were produced by 20 percent of the peapods. He later discovered that virtually all economic activity was subject to his principle.

Over time and through application in a variety of environments, this analytic has come to be called Pareto’s Principle, the 80/20 Rule, and the "Vital Few and Trivial Many Rule." I like to call it the 80/20 Rule. However, called by whatever name, this mix of 80 percent – 20 percent reminds us that the relationship between input and output is not balanced. In a management context, this rule of thumb is a useful tool that applies when there is a question of effectiveness versus diminishing returns on effort, expense or time.

The 80/20 Rule states that a small number of causes are responsible for a large percentage of the effect, in a ratio of about 20:80. Expressed in a management context, 20 percent of a person’s effort generates 80 percent of the person’s results. The corollary to this is that 20 percent of one’s results absorb 80 percent of one’s resources or efforts. For the effective use of resources, the manager’s challenge is to distinguish the right 20 percent from the trivial many.

The 80/20 Rule works in many aspects of one’s life. The examples are endless yet true. Try taking some of these examples and validate them in your business. I think you will find the results amazing.

Practical 80/20 applications:

• 80 percent of your sales come from 20 percent of your products or services;
• 80 percent of your profits come from 20 percent of your products or services;
• 80 percent of your sales come from 20 percent of your customers;
• 80 percent of your profits come from 20 percent of your customers.
• (However, please note on the previous four applications about profit and sales that these two groups are not necessarily the same 20 percent)
• 80 percent of your sales and profits come from 20 percent of your sales force;
• 80 percent of your sales time is spent with 20 percent of the customers, who may not be the profitable 20 percent;
• 80 percent of your growth comes from 20 percent of your products or services;
• 80 percent of your innovation comes from 20 percent of your employees or customers;
• 80 percent of your comebacks come from 20 percent of your products, services, customers and employees;
• 80 percent of the productivity in your shop comes from 20 percent of your employees;
• 80 percent of what we produce is generated during 20 percent of our working hours;
• 80 percent of a manager’s interruptions come from the same 20 percent of the people;
• 80 percent of the traffic in any town travels over 20 percent of the roads;
• 80 percent of your success comes from 20 percent of your efforts.

Think about this for a moment… if you’re really getting 80 percent of your profit from 20 percent of your customers, then you’re getting the remaining 20 percent of your profit from 80 percent of your customers. Why waste so much time, effort and energy trying to serve the 80 percent of your customers that are generating only 20 percent of your profit?

With this in mind, let me ask you three questions:

1. How much time is being spent servicing people that don’t buy the profitable items or services from you?
2. How much time is spent answering questions from people who bought from you last year and aren’t a current customer?
3. How many people call you, ask lots of questions, take up your time, and then buy the profitable products or services someplace else?

When you’re spending your time and resources dealing with these people, you aren’t giving yourself the opportunity to find new prospects that could become valued customers. Spend your time serving the 20 percent of your customers that generate 80 percent of your profits and let someone else look after everybody else. Now, you’ve more time to find customers that have the qualities of your best customers.

We tend to ignore these realities in practice. We often give the best salespeople the most difficult accounts instead of focusing their talent in areas where they could generate extraordinary volumes.

Hopefully, I have given you enough information to ponder for awhile. Try looking at only a few ways that the 80/20 Rule can help you in business or life and act on them. I think you will find the results to your satisfaction.

Jim Rickoff is AERA’s marketing consultant. For information contact AERA toll-free at 888-326-2372. jrickoff@engine-builder.com

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