The 80/20 Rule or the Pareto Principle is named after the economist Vilfredo Pareto who observed that 80% of the results are caused by 20% of the inputs. In business it means that 80% of your revenue comes from 20% of your clients. It serves as a general reminder that between inputs and outputs are, and always will be, imbalanced. For example, let's say you have 100 clients in your current business. It means that 80% of your revenue comes from 20 clients only. Logic says that you should focus on the top revenue generating clients more, but most of the time human nature takes over and we apply the same amount of work and attention towards all your clients, even though sometimes it would not be worth the time and effort to do so when compared to focusing on the top 20% clients. For example, sales agents who us feel that sometimes smaller clients actually take up more time to handle but provide smaller revenue or smaller margins.
So, taking this knowledge into account, how do we improve our bottomline?
Some businesses actually have rating systems for their customers. They keep track of how often they buy or use their services and also track how much margin they can get. The top customers usually get rewards for being loyal customers and get offered exclusive deals. The exclusivity and the rewards keep the client from shopping around for other service providers. Businesses like pay TV, although they would never admit it, have a system put in place in their massive call centers which, depending on the client's concerns, would get offered different deals depending on the customer rating. It would be taboo for businesses to openly admit they discriminate between their own clients, but look at it this way: which one would you consider doing business with, client A who pays on time all the time, you get high margins from you, almost never calls in about complaints and has been your customer for more than 10 years or client B who is always late on payment on a comparatively smaller bill, has a lot of qualms about your services and always threatens about shopping around for other companies while only been doing business with you for less than a year?
Some businesses actually focus on B2B (business to business) instead of B2C (business to consumer) because businesses are more likely to get more services or products from your company and are usually bigger clients. Let's say you run a computer repair shop and cater to 100 clients a month. They bring in their computers or you do house visits and you charge for those. Let's say you get a clean $100 off each customer. but your bottomline is around only half because of your operating costs. Your bottomline for doing daily work the whole month is at $5,000 a month. That amounts to $60,000 annually. Let's compare it to a business where you focus on offering you services to businesses that have servers and they call you in once or twice a year to do maintenance on all their office computers. You only take a day of work but charge $2000. Let's say you have around 20 clients and thus only work 20 days a year and get $40,000 for those 20 days of work that year. That means you can add more clients as you move along, and since you cater to businesses you can also hike up your asking price if they want more work or more complicated work completed. Which business model do you think is better and more scalable?
Good businesses focus on replicating their top 20% clients and focus on acquiring high-paying customers. Some businesses focus on getting more clients that have the same qualities as their top clients. Some businesses therefore cater to the high end only because of higher margins and have more capabilities of making big payments. It makes their workforce more efficient by focusing their efforts on those clients that provide the biggest revenue to them, instead of allotting them equally over all their clients. Though each client is important, it would definitely mean more to the company's bottomline if they failed to provide quality service to their top clients and lose them to the competition. It also applies to employees. 20% of your top employees provide 80% of your company's revenue. It doesnt mean that you should get rid of those 80%, but it would help for your business to take time and share their best practices with each other or undergo coaching or training so each of them brings more to the table and therefore improve your profitability.
The 80/20 Rule or the Pareto Principle is one important aspect of business that entrepreneurs should know since leveraging it to your advantage helps your business improve its efficiency and profitability.