If I told you that the majority of your efforts that you put into your work do not result in any considerable output you would probably look at me and say ‘That’s rubbish’! Nobody wants to admit that a lot of what they do, sell or purchase doesn’t actually contribute to anything substantial. Read on and find out why this is most likely true! Read on and find out why Pareto’s 80 20 Rule plays into your life more than you’ll probably wish to realise!
First off though….who is Pareto and why is his 80 20 Rule so important?
Vilfredo Pareto was an Italian economist who in 1896 published his paper “Cours d’économie politique” which focused on the un-balanced distribution of land ownership in Italy. He stated that 80% of the land in Italy was owned by 20% of the population. He supposedly came up with this principle of distribution by noticing that 80% of the peas in his garden came from 20% of the pods. This un-balanced distribution has gone on to be recognised in an abundance of different areas and has become known amongst other names as The 80 20 Rule.
Where do we see the 80 20 Rule?
Not every example of the 80 20 Rule has to be exactly 80% outputs and 20% inputs. This is just a rule of thumb remember. The results of a distribution could easily be 78/19 or 83/22…It’s really just a way of showing an un-balanced distribution…the fact that 80 & 20 add up to 100 is actually a confusing aspect of the 80 20 Rule…it really has nothing to do with these two figures needing to add up to 100.
The reason for this is because this is a distribution relationship between two different sources. If for example we were talking about complaints recieved in our business the 80 20 Rule could show that 80% of the complaints recieved come from 20% of the causes. We could also come to see that 80% of the sales generated in our bar come from 20% of the staff serving our products.
Most people when asked would believe that the distribution of the inputs and outputs of their businesses would be a 50 50 rule, i.e. 50% of their inputs account for 50% of the outputs…but this just isn’t the case and is rarely found in any analysis done.
If you’re starting to think that this just couldn’t be the case I suggest you indulge me and read on. I too once thought that the 80 20 Rule couldn’t be true but on investigation into different areas of the businesses I work with I couldn’t believe how much Pareto’s principle was actually evident.
Just as Vilfredo Pareto noticed, the 80 20 Rule is evident all around us!
- 80% of problems can be attributed to 20% of causes.
- 80% of a company’s profits come from 20% of its customers
- 80% of a company’s complaints come from 20% of its customers
- 80% of a company’s profits come from 20% of the time its staff spent
- 80% of a company’s revenue comes from 20% of its products
- 80% of a company’s sales are made by 20% of its sales staff
It’s how we recognise this distribution and use it to our advantage that we can start to use the 80 20 Rule to make improvements in our businesses. It’s also important to remember that the 80 20 Rule applies to a snap shot of time only. Any one of the 6 examples above would need to be attributed to a time period, i.e. “80% of a company’s monthly revenue comes from 20% of its products”. Knowing the time period that the distribution is referring to is extremely important for comparisons.
Let’s say for example that on analysis you notice that 80% of your sales are coming from 20% of your customers! Wow! I’m pretty sure that without applying Pareto’s Principle you wouldn’t have noticed that. But what does this mean? Do we try to increase the sales from the 80% of our customers that produce 20% of our sales in order to try and balance out this relationship? Probably not. As stated early, the 50 50 Rule doesn’t really exist that much in business.
What we could take from this 80 20 relationship between our customers and sales is that the 20% of our customers that we have identified as our high purchasers are really our ideal customers. We could realise that by increasing the number of customers of this type by X% would increase our revenue by a further X%.
What if you delved deeper and discovered that the complaints and problems generated from a certain customer played into this relationship also. You may find that of the 80% of customers that create only 20% of your sales actually form 80% of the complaints and problems that you deal with (this is all hypothetical by the way). If you were particularity ruthless you could eliminate the 80% of low revenue generating customers and still retain the 80% of sales coming from the 20% of high spending customers. By doing this you would also be eliminating 80% of the complaints and problems which you then have to allocate resource to to resolve!
This is just an example of how the 80 20 rule can be applied to provide Pareto Analysis to our business. In the example above we potentially could be freeing up our resources to find more of our ideal customers. With this free resource we could also be looking at ways to up-sell to our ideal customers to increase our revenue.
Seriously. Once you’ve started to get the hang of the 80 20 Rule and how it can play into your business the possibilities are endless.
Let’s look at an example of the 80 20 Rule for products and revenue
Say we have 20 products numbered from 1 to 20. In this distribution the input would be the products and the output would be the revenue generated from the sales over a given time period.
By using an 80 20 Rule Analysis tool (you can get one here if you’re interested in increasing your business efficiency) we can find how our 80 20 Rule applies to this data set.
Looking at the analysis tool above we can see that from the 20 inputs we generated a total sales of £13,634. Looking at this distribution in terms of the 80 20 Rule we can see that actually, we have a 79.21/25.00 rule here meaning that 79.21% of our output comes from 25.00% of our input. So, £10,800 of the total £13,634 come from only 5 of the 20 products!!
How can we take this further? Well, what if we applied Pareto Analysis to the results we calculated above?
From the 5 products that generated our 79.21% of revenue (£10,800) we can see that 3 of those products actually generated £9,100 giving us a 84.26/60.00 relationship. 3 products out of our initial 20 products generated £9,100 of our total sales. This is what we call an un-balanced relationship. and it’s how we use this knowledge to our advantage that the 80 20 Rule becomes extremely powerful!
The 80 20 Rule really is one of the most underutilised businesses analysis tools there is. Understanding Pareto’s principle and how to utilise it can be extremely powerful for both your business and its use in your life.
There’s are some fantastic books on that focus on the 80 20 Rule, most famously Tim Ferriss’s book “The Four Hour Work Week“, Richard Koch’s “The 80/20 Principle: The Secret of Achieving More with Less” and Perry Marshall’s “80/20 Sales & Marketing: The Definitive Guide to Working Less & Making More“. These are three books that I swear by!
Having a good 80 20 Rule Analysis Tool makes all of this so much easier. I have one that you can download here. You will be so happy that you chose to apply 80 20 Rule Analysis to your work and business. Getting more out of what you are putting in is what we all want isn’t it?
Once you start applying 80 20 to everything you do you will start to wonder how you ever lived without this new found knowledge!
Let me know in the comments below how effective you have found Pareto’s Anaylsis of the 80 20 Rule in your own work and business!
Links to books in this articale are affiliate links with Amazon