Business Development
Profitability
What does a 19th century Italian economist have to do with your business? 19th Century Italian Economist, Vilfredo Pareto, observed that 80% of Italy’s income went to 20% of the population.
Although this was over 100 years ago. The same principle can be applied to modern businesses today.Typically, 80% of a businesses’ revenue will come from only20% of its customers (or from 20% of the products or services offered). This is commonly known as The Pareto PrincipleSo if this 80/20 rule is applied, who are the customers that make up the top 20% of your customer base?
Here are 4 quick steps to get you started on your own 80/20 analysis:
1. Print out the sales ledger for the most recent financial year by customer/client account number.
2. Save as an Excel spreadsheet.
3. Aggregate the information by ‘Buying Unit.’
4. Do the same again by product type.Here’s what we’ve typically found:
| Customer size* | % of customer base | Number of customers | % of total sales | Total sales | Comments |
| Extra Large | 1 | 9 | 25 | 1,170 | 5% of the customer base is contributing more than 50% of the businesses sales |
| Large | 4 | 35 | 27 | 1,300 | |
| Medium | 16 | 139 | 30 | 1,450 | |
| Small | 79 | 687 | 18 | 835 | 79% of the customer base only contributes 18% of total sales |
| Total | 100 | 870 | 100 | 4,755 |
* Remember this is a rule of thumb, so don’t spend too much time defining your customer segments
So what does this 80/20 Analysis tell us?
This (example) business is heavily reliant on the top 5% of their customer base. If one or two of them defected, they would take a large proportion of the total sales with them. It is also evident that a lot of time is being spent serving smaller customers, when they only contribute 18% of sales.One of the key questions we should be asking is, “Could time spent serving 79% of the customer base be better spent on the larger customers?” If more time is spent on the larger customers, they are less likely to be dissatisfied with the product and service provided. The following discussion should focus on strategies to move customers in the large bracket to extra large, and then turning medium sized customers into large customers.The 80/20 Analysis gives a clear understanding of which customers can be considered the most important.When a company is armed with this information, the management decision making can improve dramatically!For help in working the 80/20 principle into your business thinking, call Gordon D’Silva on 020 8241 3000.
