I don’t remember exactly when I first read about the Pareto principle, but I’m certain I did not understand it early in my career. It wasn’t until I was running a multimillion-dollar company in which I had secured a profit share… and there’s a good reason for that.
There’s something about aligning one’s interests with those of the business that makes such insights invaluable. It is immensely helpful in analyzing problems, understanding challenges and making important decisions.
Since then, I’ve written about the 80/20 rule many times. And now that I think about it, I can say that the Pareto perspective was responsible for all of my bestselling business books, including Automatic Wealth and Ready, Fire, Aim.
There are so many examples of how the Pareto principle applies to business:
- 20% of a company’s salespeople produce about 80% of its sales.
- 20% of a company’s customers/clients account for 80% of the purchases made.
- 80% of all customer complaints come from 20% of the customer base.
- 80% of customer complaints are related to 20% of the company’s products.
I could list hundreds.
But there are three categories that stand out.
1. The 80/20 Rule in Product Development
If you look at almost any business, you will find that about 80% of its revenues come from only 20% of the products sold.
This seems obvious to me now. It’s almost a bromide. But it was a revelation when I first figured it out.
At the time, we had about 20 product lines and were doing about $20 million in revenues, with average revenues of $1 million per product. I was well aware that some products performed much better than others. But until I looked at our sales from the Pareto perspective, I didn’t realize how lopsided the distribution was.
Sixteen of our products generated sales of $5 million. They averaged just $312,500 each. The rest of our sales – $15 million worth – came from just four products, an average of just under $4 million each.
The imbalance was much more extreme than I would have guessed. But it allowed me to understand, instantly, that my habit of giving equal attention to all of our products was a big mistake.
The cost of producing and marketing each product was about the same, but the revenues were so terribly uneven. It was easy to see that we were basically losing money on 80% of our products and making huge profits on just 20% of them.
If profits were the lifeblood of a business (and they are), why was I not giving 80% of my time and attention to the 20% that would yield 80% of our profits?
We had been dividing our marketing resources equally among the products we were selling. After understanding the Pareto principle, we directed 80% of those resources to the top three or four. That resulted in a much faster-growing customer base and, subsequently, higher revenues and profits.
2. The 80/20 Rule in Customer Spending
After learning that lesson, I began to apply it to every other aspect of our business. One challenge had been the issue of customer retention.
In our industry (information publishing), we measured our long-term success by renewals. The average first-year renewal rate was about 20%. It was generally accepted that if you could raise it by increments – to about 50% in the second year and 60% thereafter – you could grow the business.
Then one day I met a man named Jay Abraham who had a crazy idea he was peddling – what he called “the back-end.” The idea was that instead of trying to boost our renewal rate by increments, we could do much better by giving customers more of what they wanted. If, for example, they had spent $39 for a newsletter on executive productivity, we could sell them a special report “on the back-end” written by an expert on the same topic for, say, $79.
I got it instantly because I was thinking in terms of 80/20. I was pretty sure that 80% of our existing subscribers would never buy a more expensive product, but that 20% of them would. And the first test we did – selling an information product for hundreds of dollars – more than verified that. It blew us away!
3. The 80/20 Rule and the People You Depend on to Make Your Business Grow
Those two applications of the Pareto principle made me better at developing products and marketing them. But I’m most excited about a realization that came late in my career.
I was thinking about the writers, editors, publishers, copywriters and marketers I had worked with, and it occurred to me that Pareto’s principle applied to them as well: A relatively small percentage – maybe 20% – had been responsible for the great majority of the business success I had witnessed.
I should qualify that. Building a business is a collaborative effort. Dozens or hundreds of people are involved in getting the work done.
But it would be naïve to pretend that everyone is equally responsible for its success. There is always a small number that stands out clearly. They work harder. They think harder. They never run away from a problem. They never hide a mistake. They treat your business as if they owned it. In the skyscape of any company’s employees, they shine where the best of the others only glow.
Although money matters to them, these superstars are not motivated by it. Nor are they motivated by the desire for approval. They are unique. They are rare. And they are worth their weight in gold.
Based on my observations, if you are very lucky, 20% of your employees will be superstars.
Something to seriously consider.
I’ve heard it said that the Pareto principle is the best-kept secret in business. That’s difficult to believe if you are familiar with business literature. There are literally thousands of articles, essays and manuals written about it every year.
So, no, it’s not the best-kept secret in business. But it is routinely ignored. I’m not sure why that is, but I do know this: If you pay attention to the Pareto principle in your business, you will be glad you did.
How have you witnessed the 80/20 rule in action? Tell us about it at email@example.com.