The Pareto Principle is a great tool that small business owners can use right across their businesses to ensure they are getting the best from their resources – people, equipment and IT. It helps you to focus on what’s important and on the issues that will have the greatest impact on your business.
For those new to this Blog, the Pareto Principle states that around 80% of the effects are produced by 20% of the causes.
It is a great tool to focus your mind on improving overall effectiveness within your business. Let’s start with a look at your clients.
Based on the Pareto Principle, 80% of your profits will be produced by 20% of your clients. In some small business I have looked at, the ratio is nearer to 90:10. Sometimes there is just a single major client underpinning the whole company.
Of course, this means the remaining 80% of your clients will produce only 20% of your profits.
What can you conclude from this simple analysis?
Firstly, you must pull out all the stops to give the top 20% of your clients the best possible after-sales service. Nothing should be too much trouble. These clients are the ones who allow you to carry on in business. Help them, advise them, be available whenever they want you and do a good job for them.
Secondly, by studying them closely, you should be able to identify what makes this group of clients different to your remaining clients. There must be something that separates them from your other clients, factors which mean they produce healthy profits for you.
Lastly, your profitability will grow fast if you can secure more clients that are similar to your top 20% most profitable clients. When you know what criteria determines your top 20%, tweak your marketing to focus on finding more of them.
Now, let’s turn out attention to the remaining 80% of your clients. Remember these produce 20% of your profits. The Pareto Principle will apply to these as well. So 20% of this group of clients will produce 80% of the profits this group produces. It might be possible to increase the profitability of this 20% with some attentive account management activity.
By combining these two applications of the Pareto Principle, you will see that 36% of your clients will generate 96% of your profits (see below for the calculations). The remaining 64% of your clients produce only 4% of your profits. This is very enlightening.
How much time and effort do you put into looking after this 64%?
Could it be directed more effectively? Perhaps by looking after your 36% most profitable clients or finding more new clients with the same characteristics as this 36%.
Many of your clients in the 64% band will be loss making. It makes no business sense to retain them as clients. Encourage them to go to one of your competitors.
Make every effort to ensure each client in your 36% band of clients is happy with your product/service and keep them away from your competition. The defection of one of these prime clients will have a relatively large impact on your overall company profits
- Analyse your existing clients to identify your top 20% (or top 36%) and invest as much time as possible to keep them happy.
- Look for more prospects that have the same characteristics as your best clients.
- Decide what to do with your loss-making clients
Note: Assume you have 100 clients. 20 of these will produce 80% of your company profits. The remaining 80 clients produce 20% of your profits. Of these, 16 (20%) will produce 80% of the profits produced by these 80 clients (16% of your company profits).
By combining these analyses, 36% of your clients (20 + 16) will produce 96% (80% + 16%) of your company profits. The remaining 64% produce just 4% of your profits.