I hope you have your seat belt on (even if you’re sitting in your office chair). At the very least you’re about to experience a jolt, and at the very best you are about to master the greatest tool for colossal business growth. This best kept secret is not so secret after all. It is something you likely have already heard about – it’s called Pareto’s rule, or the 80/20 principle. The secret is not in knowing it, it’s in using it.
In case you’re not familiar with the 80/20 rule here is a quick primer: In 1906 an Italian economist named Vilfredo Pareto noticed that 80% of the land in Italy was owned by 20% of the population. He started looking around and noticed that 20% of the pea pods in his garden contained 80% of the peas, and so and on and so on. He determined that much of life, and muh of business, can be categorized with this 80/20 principle. In fact, you may have heard that 80% of your sales come from 20% of your clients. Yep. That’s from Pareto’s law.
I recently saw a presentation by Peter Philippi, the President of Strategex, a business growth consultancy that focuses on the 80/20 rule. In his presentation he displayed a chart that blew my mind away. His company had studied the P&L of nearly 1,000 companies and divisions. They broke down the P&L by customer, sorted by revenue per customer from most to least, and segmented the clients into four quartiles. Pareto would have been proud because this is what they found:
|Customer Quartile||Total Revenue||Effort||Net Profit|
|Top Middle 25%||7%||25%||breakeven|
|Bottom Middle 25%||3%||25%||breakeven to loss|
|Bottom 25%||1%||25%||major loss|
Shocking, right? 89% of the revenue is generated through the top 25% of clients. And look where all the Net Profit is! Right at the top. Pareto was obviously onto something huge, and if you want to benefit from what he discovered you’ll put this principle into action. Use the same table to figure out who your twenty to twenty five percenters are and start focusing on them:
- Customer Quartile – Use this to group your revenue per client over the last 12 months, from most to least revenue. Based up the number of clients you have, break into quartiles. For example if you have 160 clients over the last 12 months, the top 40 revenue producers would be in the top quartile, the next 40 in the top middle quartile, and so on.
- Total Revenue – This is the percentage of revenue that each quartile makes for your business as a percentage of all revenue. For each quartile add up the client revenue, and divide it by total revenue for all four quartiles.
- Effort – This a simple cost analysis. How much money (this includes time spent by your people) do you use for each quartile? Sum up each quartile and divide it by your total cost.
- Net Profit – Is the profit you made from each quartile. If you have good accounting, you should be able to determine profitability per customer. If you don’t take your total revenue by each quartile and subtract the effort. The determine the percentages of total net profit.
This process alone should be a big eye opener for you and get you motivated to do what’s next.
When I did this exercise for my business, I found it to be very similar to the share above. My top clients and, you will find, your top clients represent most of the revenue and all the income for our respective business. Now that you have this clarity, you’re ready to take action to benefit from it.
Just knowing this information isn’t enough. I mean it’s fun to know, but it’s way more fun to take action on it. So, here is what you want to do next… Pumpkin Plan your business. If you don’t know what that means, then allow me to shamelessly plug my book by the same name. Until you have time to check it out, here’s the applicable part of the plan in a three-step nutshell:
- Play Favorites – Concentrate on wowing your Top Clients. I am not suggesting dumping the entire lower 75%, but I am suggesting that you hyper-serve the top clients you have, the ones that make you the most money and bring you the most business. You probably already know who they are without checking the chart, but appreciate that they’re the ones you need to focus on.
- Clone The Best – Study your top 25% quartile and learn what makes them unique – industry? demographic? psychographic? Concentrate all your marketing efforts on getting more clients like your top quartile. This may take some digging, but keep asking your top client what it is that they do, or that you do for them, that makes them repeat customers. Find out where your top clients congregate and start going there – birds of a feather do flock together.
- Dump The Rest (Selectively) – Don’t randomly fire your lower clients, but do look for traits in them to see why they aren’t producing. At the same time look for the traits in new prospects, or existing lower ranked clients that you see in your current topcClients. Treat these new or existing clients with priority, since if anyone is to rise up to become part of that 20 percent Pareto recognized, it is these clients.
I can hear you baulking already. I did too. In fact, I even asked Peter a question specifically about this. I said, “Peter, this is great, but I think I need to keep all of my clients. What if one of them turns into a top 25% client?” I mean, you never know, right? And even the major leagues keep a farm league around to move up their talent. But I was thinking about this all wrong.
Peter told me a sobering fact. His firm researched this question, and found that only 1% of lower tier clients ever jump to the top. This means it costs far more to wait and see which weak client becomes strong, then to set up a marketing plan that just goes after top clients.
The 80/20 rule makes it clear that different clients have a dramatically different impact on our business. We need to focus our energies on serving and duplicating our best clients. The weak ones, shouldn’t be mistreated, but they should never been served to the level as our best.
Mom told us to treat all clients equally. She lied. Or at least she didn’t know the Pareto principle.