A recent article in My Business “Shedding clients grew a business sevenfold in 5 years” discussed how a business sacrificed short term revenue and shed less profitable customers to focus on more high-value ones – and grew by “six to seven” times in just five years.
It is an excellent example of the application to a business of what is known as Pareto’s Law.
Back in 1906 an Italian economist, Pareto, observed that 80% of the land in Italy was owned by 20% of the population. He later investigated other countries and found, to his surprise, that the same principle applied.
Many years later an American consultant, Joseph Juran, named the principle Pareto’s Law. He also referred to it as "the vital few and the useful many". Juran used it as a tool for continuous improvement in businesses, initially in quality management for manufacturing, but then on systems and processes throughout businesses. It became a great tool for reducing costs.
If there were production, quality or service problems, he wouldn’t try and fix all the problems, but rather identify the “vital few” that caused most of the problems, and fix those.
You may know it as the “80-20 Rule”. And very useful it is too!
In later years, Juran emphasised the remaining 80% should not be totally ignored. And I agree with that.
I’m sure many of you have used this Rule in your business, even if you didn’t know where it came from.
The first thing to understand is that of course the ratio is not going to be exactly 80-20. What you are looking for is the ‘vital few’. The vital few could be 33/67 or whatever.
You probably know of the 80-20 Rule in relation to sales; 80% of your sales come from 20% of your products or services.
But what about profitability? 80-20 can gives us a different picture. Which of your products or services produce the majority of your profits?
Might it be useful to apply the 80-20 tool to our customers? After all, we sell products and services, but customers buy them. Their decision, not ours. It is also suggested that 80% of sales come from 20% of your customers.
In my experience, it does. And equally importantly, which customers provide the majority of your profits? More customers doesn’t always mean higher profits.
So what does the 80-20 Rule mean for your marketing, future cash flow and profitability?
The whole point of this Rule is that you will get most of your sales and profits from a small proportion of your products, and customers.
And once you know that, your marketing can be targeted, and not sprayed. You can more tightly define your ideal customer, and refine your marketing, so you are more directly talking to them, and not to “everybody”.
As I said in “Does your Marketing Tail Stretch to the Sea?”, if you spend $500 on a promotion from the mountain to the sea, i.e. to everyone, your promotional message will be about everyone, and no-one. The first thing any potential buyer looks for in any promotion is WIIFM (what’s in it for me). Because your ‘landscape’ message will of necessity be general, no-one will be able to say “that’s me”, and be enticed into your message.
Good businesses work on the important tasks, not just the urgent ones; improving sales, improving margins, and reducing costs. And the 80-20 Rule is a good tool to do just that.
Remember you don’t have to fix everything to close a performance gap. You just have to fix the few things that are causing most of the problem.
I’m know many excellent businesses who use the 80-20 Rule to improve not just the profitability of their sales, but to improve the business behind them.
Good businesses keep getting better. They keep getting better because they continually work on all their key processes, only one or two at a time if necessary, to build a better business.
I have written further about this in:
When clients find it difficult to achieve their goals, it often comes down to a lack of clarity of what is happening in their business, and not being able to identify Vital Few. If they could, they would have used them, and achieved their goals.
You need to know what is happening in your business, and that means more than acting on PHOGY thinking. The road to success is paved with good information, so you can see where you have been, and where you are going, and not be fog-bound.
For more than 30 years I’ve been helping small business owners use the right tactics to plug the profit leaks in their business and restoring their cash flows by assisting them determine their Vital Few and free them up so their goals are achieved.
If you would like to discuss with me how you might do that, book a Strategy Consult here. There is no cost.
To your profitability and enhanced cash flow.
© Copyright 2019 Adam Gordon
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?