Just over a century ago, Italian economist Vilfredo Pareto observed that 80 per cent of Italy’s land was owned by 20 per cent of the people.
He also noticed that this applied in other countries. Since then, the 80/20 rule, or Pareto Principle, has rapidly evolved and can readily and successfully be applied to every area in life, including business.
In fact, I would venture to say that no matter what your business model is, the 80/20 rule can be applied to it on some level. That’s because roughly 80 per cent of our effects come from 20 per cent of the causes. Similarly, 80 per cent of the causes are created by 20 per cent of the effects.
When it comes to business, the idea is to focus on the 20 per cent that really matters and subsequently work on those things. That means fine-tuning and simplifying your actions and intentions so that you only expend energy on the 20 per cent of business activities that will be more productive for your business. It also helps reduce stress levels and anxieties because you’re not focused on the bigger picture of your business. Instead, you’re really drilling down on the finer detail and breaking it into the 80/20 concept, which helps separate the wheat from the chaff, so to speak.
While fairly simplistic, consider this: 80 per cent of your gross profit comes from 20 per cent of your goods, and 20 per cent of your customers usually make up a large share of 80 per cent of your revenue.
With regards to what I focus on in my retail businesses, the 80 per cent is basically wall hangings, which tend to move at a slow rate. But if you focus on your biggest sellers, that is, those products that are moving out the door, and apply the 20 per cent part of the rule to them, then you can create more margin on those products. Let’s face it, this is the key to getting more profit in your business. The problem is a lot of business owners look too broadly at all of their products or services. In other words, they’ve got a vast brush on their whole business model.
These are the nuts and bolts of effectively using the 80/20 rule in business:
Focus on customers who matter
As mentioned before, 20 per cent of your customers or clients contribute to a sizeable chunk of your sales (about 80 per cent), so if you place some emphasis on those 20 per cent who regularly purchase from you, the greater the rapport and customer relations you create. What’s more, you will gain more referrals. However, that’s not to say that you shouldn’t treat every client the same. But you do want to pay extra special attention to those who have provided you with 80 per cent of your revenue. For instance, out of every hundred customers who, say, deal with a travel agency, it’s likely that 20 of them actually decide to book a holiday on that particular day and not just make an enquiry. And whether a travel agency is operating from home, online, remotely, or has an office, you really want to be focusing on keeping those clients who are consistently coming back to travel. This means you are really looking after them and getting them the best deal possible.
Creating better and bigger profit margins
When you break your business model down, the 80/20 rule really helps to simplify things even further. It also helps you hone in on creating better and bigger margins. Like I said before, it’s something that I’ve done quite successfully, especially in my retail businesses. But it wasn’t until I realised that I was being too broad with my business approach that I started to apply this principle. I started working out ways to create that extra margin in those 20 per cent of products that were selling well. Then, as challenging as it was, I started importing from overseas by cutting out the middleman (and the related costs) and dealing directly with the supplier. By going to the source of supply, I saw huge gains in my business profit. In saying that, you really want to be aiming for more than a 200 per cent margin. Personally, I don’t believe that 100 or 200 per cent is sufficient because there are a lot of costs that are incidental or unforeseen, especially in the initial stages of business.
At the end of the day, the 80/20 rule helps simplify your thinking and your business model. It enables you to put a microscope on the products or services that provide 80 per cent of your revenue. It’s a fascinating concept that reinforces the idea of working smarter, not harder.
This article was contributed by Johnny Carter, a “Law of Attraction’ mentor and serial entrepreneur, specialising in Speaker Sessions and Topic Seminars for groups and events.