I Say Pareto, You Say Pareto …
Fine in principle. What about practice?
Have you heard of the Pareto Principle (also called the 80-20 rule)?
It says that for many things, 80% of the results come from 20% of the causes.
In business, this means 80% of your revenue comes from 20% of your clients.
I’ve found this principle extremely useful.
But does it work for you?
Numbers Game
I run a spreadsheet that tracks all my business metrics.
So far this year, 80% of my revenue has come from 29% of my clients.
The last two years it was 36% and 30%.
I’m a bit off the pace, but this is because I’ve vigorously reduced risk by increasing and diversifying my client portfolio.
You may recall I lost one client worth 82% of my business and took two years to recover.
Talk about all your eggs in one basket!
I won’t do that again.
Tardy Performer
For years I encountered the Pareto Principle in almost every business book I read. But because it sounded technical, I resisted analysing my customers.
This was so dumb. Once I bit the bullet, it took all of ten minutes to collate the figures.
And jolly useful figures they’ve been, too.
Anger Management
When my top client annoys me, I check my spreadsheet.
If a retort imperils 28% of my income, I bite my tongue (and do something really nice for the client).
If, on the other hand, a 0.1% client is demanding freebies, refusing to do proper briefs and complaining about my work, I know I can ‘retire’ them with relative impunity. (And live a longer, happier life.)
Cents of Perspective
This year, my biggest client has spent almost 200 times more than my smallest.
I prize all client relationships. But next time I have conflicting deadlines, who do you think I’m going to squeeze in first?
Insights like this make the Pareto Principle a wonderful commercial ‘compass’.
The fact I was slow to embrace it makes me wonder if you’re tracking this vital stat.
If you are, I’d love to know how you use it and what you reckon.
If not, here’s a quick recipe for success:
Pareto Pronto
- List your clients vertically.
- Add up what they’ve paid this year and put each client’s total next to it.
- Sort clients in descending order of value.
- Calculate total revenue for all clients.
- Express each client’s contribution as a percentage of this total.
- Working down, see how many clients it takes to account for 80% of your revenue. (A cumulative column makes this a snap, if you know how to spreadsheet.)
- Divide this figure by your number of clients.
- Bingo! You now know what percentage of your clients generates 80% of your loot.
How did you go?
Is it close to 20%?
Do please let us know.
That way, we can all see if we’re rank amateurs
or principled performers.
Paul Hassing, Founder & Senior Writer, The Feisty Empire
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G’Day Paul
I’ve been a fan of the Pareto Principle for ages. It’s a hell of a good ‘rule of thumb.’ But you raise the bigger issue of counting in business.
I wrote a blog post about this earlier this year. You can check it out there. Count everything you can. If you don’t, a lot of your business decisions will be based on myth and legend, not fact: great for movie blockbusters; bad for business.
And remember what Mark Twain said, “It aint what you don’t know that gets you into trouble. It’s what you know for sure that just aint so.”
Regards
Leon
Thanks very much for kicking us off, Leon. I’m glad you’re a fan.
Could you please give us the link to your post again? I’ll embed it in your comment. Best regards, P.
Actually, Leon, I think I found it:
http://managingemployeeperformance.com/2011/03/counting/
Is this the one?
Hi Paul,
It is an oldie but a goodie and does help you see where your business is coming from. I also calculate the average transaction value, which just means dividing the transaction value say for a year by the number of transaction over that year.
It can show that although some company spent the most in total value another may have a higher value per transaction and therefore may become an opportunity.
Good on you, Susan. Yet another new idea for me.
Would triple bonus points tempt you to reveal your Pareto percentage to us?
While I think of it, I wonder if our resident $80 million CEO has his company’s Pareto figure at his fingertips …
But Paul there’s more… two other things in the business that Senor Pareto’s fabulous Principle applies to…
What Pareto highlights is really the power of leveraging. That means identifying the smallest amount of effort that’s needed to produce the biggest result. His fabulous principle can be applied to the three balls you need to juggle in your business, no matter what sort of business you are in, to get the best possible results.
The first ball relates, as you have said, to your customers. Simply, it’s that 80 percent of your business (and profit) that is generated from around 20 percent of them. But here’s the 64-dollar question. Do you know who those profitable 20 percent are precisely? If you do, are they getting the time investment commensurate with their value to you and what are you doing to make them feel special over and above the normal good service that you give the rest of your customers? More importantly, when you have identified them and find some common characteristics what are you going to do to find more prospects like them?
The second ball is the products and services you sell. Guess what? Amazingly again, 80 percent of your profits come from around 20 percent of the products and services you sell. Now you know the drill, list out your sales by product or service in descending order of the revenue generated. Then add down from the top and when you get to 80 percent of the revenue, there’s that magic 20 percent of your products or services that is so important. Now ask yourself the critical question. How do we sell more of these top revenue generators? See the results improve!
The third and final ball is time and that’s really quite a sobering one. For you it’s how you use your time. You see it’s another Pareto stunner. Put simply, 80 percent of your results are produced by 20 percent of the time you put in. To work out where your payout is here, start keeping a time diary in which you record your activities and the results they generate. Pretty soon it will help you sort out your gold activities from your garbage activities.
Juggling these three balls well is what business is all about. You can hack away at the edges of your business by doing other things that seem worthwhile. But if you want to do things that are worthwhile invest some time in looking for leverage the Pareto way. It’s the way to turbo charge your business and your results.
Cor struth, Winston! It’s always a bonus when you rock up, especially with wisdom like this. Many thanks indeed!
Paul, You’ve got it. Just subscribe and you can have all Winno’s words of wisdom plus mine. That’s the genuine “Wow Factor.” Beats the pants of old Senor Pareto.
Keep moving, Regards
Leon
Done!
I was going to do a trade fair again this year – everyone in wholesaling does it, so why should I be different?
Because, my top 20% of customers aren’t there –
Having done the sorts of number crunching you outline above I pinpointed ‘who’ our top customers are and ‘where’ they are and we’re now spending the $7,000 it would have cost to do a fair (to gather up a sprinkling of one-order wonders) to target ‘our’ kinda retailers directly, who once on board are long-term, repeat customers
Fabulous snapshot, Linda. It’s so valuable to get these reports from the real world.
I abhor trade fairs. Sounds like your $7K was very well saved and spent. With gratitude for your contribution. P.
Hi Paul,
We do this by customer, customer segment, state, brand and product. We then look at the numbers both by sales value (volume) and profitability.
Then we know what to promote at what price to whom and have the greatest opportunity for success. We have our ‘A’ products (high volume, high margin) and use this information to direct our purchasing.
We invest more in the ‘A’ products and less in the B and C. As a result our inventory levels are down, stock turns up, we always have the key selling and highest profit lines ready to go so every one is happy. Easy.
Fabbo, Malcolm; thanks heaps! And may I ask what system/s you use to keep track of all this data? I’m guessing it’s not cuneiform tablets!
Most people have heard if not read about this principle. What I find useful is your simple process to produce it. Not many people go that far and as you say it only takes a few moments.
One of the challenges with the principle however is which customers are lying in the middle somewhere that with a little more looking after could become regular.
As a small business you are probably one in the 80% for most of your suppliers. What do you do to get more attention and support?
In many of the companies I have worked for, “Key” accounts are identified this way and services created around them accordingly.
It does work and at a minimum ensures that resources are invested with the right clients.
Thank you, MCB. As usual, you shine an interesting light on our discussion. High beam, in fact!
I love starting really small with clients, then ending up doing enormous things with them.
Accounts that begin with a tiny email sign-off optimisation can lead to massive government tenders.
I strive to get attention by helping my clients succeed. The more they trust me, the richer they get. One tends to notice that sort of thing.
The trick is getting them to go with my flow from the outset. It doesn’t happen often. But the switched-on ones who ‘get it’ are soon rewarded. And I get a huge kick witnessing their new-found prosperity. Best regards, P.
We use a smokin’ etchasketch!
We have a person that does it full time, it’s that important to us.
Fair dinkum?! Geez, exploded pie charts must be a bugger to do on that!
Hello Paul and all,
Here’s a variation:
20% of your staff cause 80% of your grief as an employer.
Cheers,
Jas.
Hi, Jas; great to see you again.
Sounds like you may have learned that one the hard way!
Best regards, P.
For the record, I got the idea of running a business metrics spreadsheet from Jason. You should see HIS!
Ah yes, Paul! I do recall proudly showing you my spreadheets, replete with bar and pies charts tracking goodness knows what. That was quite a few years ago now.
This is a getting a little off topic (or perhaps the seed of a new topic?), but…
Since then I have come to learn that the best reason to report on the past is to use that informaiton to plan for the future. Businesses often operate in cycles. The financial year being an obvious example, but there are many others.
One of the greatest challenges for a small business owner can be to maintain consistent positive cash flow. A good cashflow projection report is invaluable in ensuring you don’t get caught short. It’s a horrible feeling when you have to juggle paying your creditors, sub-contractors, staff and tax bills, not to mention putting food on your own table.
In addition to quantifying upcoming work and outstanding invoice payments in a cash flow projection, a great way to make sure you stay in the black is to look at the patterns from your reporting of the past and use that information as assumptions in your cash flow planning. As an example, we all know things go quiet for many businesses in December and January, but just how quiet? Use trading information from past Dec/Jan periods to make decisions about what you do today and in the future may mean you don’t have to worry about how you are going to cover that December quarter BAS and still be able to that holiday you deserve. Suddnely that office Espresso machine that is on sale in November doesn’t seem like quite the bargain it intially appears!
They certainly made an impression, Jas. I was most taken when you could tell me the hourly cost of your nightlight!
We love off topic, and yours is a ripper. I’ve had some truly horrible ‘off’ seasons. The pain has seared a trendline into my brain, so I’m a lot more circumspect these days. Yet I could’ve saved a lot of tears by following the simple yet eminently wise strategy you outline.
I’d love to get you to expand on this (or any other topic) in a guest post one day. Your mind is fine and your clarity of expression rare. I hope you’ll consider joining our Hall of Fame at some stage.
With best regards and many thanks for your ace contribution.
Oh, I’m flattered that you suggest I might join your Hall of Fame.
Is a guest post one where someone other than yourself kicks off a topic? If so I’ll need to curb my run-on sentences and improve my proof reading!
Thank you, kind Sir.
You got it, Jas. Simply email me a few one-line ideas for articles interesting and relevant to our readers.
I’ll run them past our Naomi, who’ll pick one. You then write 350-450 words and suggest a royalty-free pic (or leave that to us).
Editing is very light to non-existent. We agree on a run date, when you can field comments a few times during the day.
You also give us a bio and headshot so we can immortalise you.
With your years of experience on both sides of the business fence, I’m sure you have a bevy of tales to tell and tips to impart.
I’ll therefore be delighted if you decide to go ahead.
@KenBurgin says via Twitter:
‘80% of what you wear comes from 20% of your wardrobe – the comfortable stuff.’
I agree! Funny how this rule applies to so many disparate things.
Many thanks, Ken!
over the last 10 years nearly every wardrobe has 80% that sits there feeling lonely. we wear 20% of our wardrobes and this consist of what suits our style expression and comfort. Makes sense huh?
As an expert closet dweller, you’d know all about this, Helen!
I was wondering if you agreed with Ken.
I wear 4%, but I’m an anomaly. Much to my poor wife’s distress …
I don’t have the luxury of any high percentage customers. Our largest customer is still below 1% of our sales. This is an interesting idea however.
Thanks
Thank you, Rick. I appreciate your comment. Hopefully this means you have many hundreds of customers – a good thing in uncertain times. Best regards, P.