The 80/20 Rule
and how it fits into every business
All businesses, whether they like it or not, have to live with the phenomenon called The 80/20 Rule. It is not a “rule” in the sense that someone decreed it. Its formal name is Pareto Principle, after its discoverer, Italian economist Vilfredo Pareto.
The basic rule as applied to business activity is: 80% of the results come from 20% of one’s activities. In business, the 80/20 Rule can be applied in many different ways:
There is more to these ratios than meets the eye. Having the knowledge of how these ratios affect business can be put to good use. Let’s examine how the above variations of the 80/20 Rule can be used to further the business.
INVENTORY – 80% of the business will be done on 20% of the selection of products or services.
The logical thing to say is that if this is so, then why carry or offer things that don’t sell often or don’t sell at all? The 80/20 Rule is a ratio, so if the total selection is less, the total sales will be less.
For a new business selling products, this means that until one gets a track record it will be necessary to have depth in each item, line, etc. This calls for a very large beginning inventory until the “rate of sale” (or usage) can be established.
Rate of sale is something that has to be tracked very carefully, because one has to keep good selling items in stock at all times and have enough coming in, so that as the popular items sell out, more are coming in to replace them. Replacement time becomes very critical because the depth of inventory needs to cover current sales as well as sales while replacements are on the way.
Not everything sells all the time at the same rate. Each item or style of item will have a high selling period, a slow selling period, and times when it sells somewhere in between. As the saying goes, everything has its “Christmas” selling season, but it may not be in December.
Warning – “logic” would say to get rid of the some or all of the 80% that doesn’t sell or sell well. This is “fuzzy logic,” because if the overall selection decreases, the ratio still holds true and it will have a negative effect on the 20% that does sell well.
Better, “unfuzzy logic” says to look for ways to increase the sales of things that sell slower or don’t sell. If successful, it will help increase overall sales and, since the 80/20 Rule is a ratio, the sales of the better selling products or services will also increase.
SALES – 80% of the business will be done in 20% of the time (year, month, week, or day) the business is open to its public.
Some firms decrease the number of employees on hand during the slow times. This is possible, if looked upon as a yearly or weekly thing (as some days in many businesses are traditionally slow) as long as one has a trained staff or someone that can be called in when needed.
However, there are many tasks in business that get put off when things are busy that need to be accomplished and this is where the “surplus” staff may be put to work doing these activities different from what they usually do.
Trying to boost sales for slow and non-selling products or services and looking for ways to increase profitable sales during slow times will increase gross sales and will cause the busy times to be busier.
SALES PRODUCTIVITY – 80% of the sales come in from 20% of the sales staff. So, fire the ones that are not producing? It may not be the fault of the salesperson. It may be the fault of how the territories are set up, a difference in industries, materials not suited for the potential client base, difficulty in delivery, etc. The question to ask, possibly, is what the sales per customer or order are.
MAJOR CUSTOMERS – 80% of sales will be done with 20% of one’s customers.
It is widely practiced that businesses divide their customers into A, B, and C categories by the amount of business these customers generate. Often, it is the A customers that do the most and are highly targeted by the sales & marketing departments, while B customers are treated half-heartedly and C customers are almost entirely ignored. What is also well known is that in a 10 year period A customers become C customers or go out of business and C customers grow to be A customers.