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September 22 2019.
Quality tool to improve sales.

The '80/20 rule.

You must have come across the Pareto principle on which this rule is based. It says that 80% of the outcomes will come from about 20% of your effort. It can be applied to many aspects of your sales & marketing activities.
For example:

  • 80% of your profits may come from just 20% of your customers.
  • 80% of your sales may come from just 20% of your products and services.

This simple rule has a scientific basis, & help you to understand how effective your sales/marketing efforts are. It gives you interesting & useful insights. It shows how you operate & where you should be focusing your resources.The '80/20 rule' is a simple way of looking at your sales and profit figures and identifying the largest sources of contribution. Let us see how to use this technique to find profitable customers,products & services, which channels to market you use are most profitable.

Why it is important for sales / marketing planning?
We have wide variety of customers to cater to. Some are more important than others and some cost you more than others. Knowing which customers are the most profitable helps in a number of ways:

  • You can make sure you are really looking after those customers.
  • You will understand what makes them profitable.
  • You can use the finding to find other customers who are can be profitable.
  • Increase number of profitable customers & reduce unprofitable ones.

The ratio of 80% and 20% is not sacrosant which work out exactly in all situations, nor do they need to add up to 100%. Ratios such as 80/35, 80/25 or even 80/10 may equally apply. The principle is that, in each case, we are seeking to find the source of the majority of whatever activity is being measured. We will observe following conclusions from this analysis;

  • A small proportion of your efforts provide most of the result.
  • A large proportion of your efforts provide a relatively small result.

There is a limitaion to this rule: If you use historical data, it may not provide an accurate or realistic indication of the future sales or profit potential from customers, products and services or distribution channels. You need to take a view on how representative the data used is. Using data from more than one period will be more representative.

How to use thus tool?
So how do you apply this to your business to achieve a better understanding of your marketing activities? There are several key areas of your sales/marketing activities that you should consider analysing. These include:

  • Sales per customer.
  • Profitability per order.
  • Sales of products &/or services.
  • Contribution of products and services.
  • Sales and margins per channel to market (direct sales force, distributor sales, web sales, etc).

Here are the steps to follow to analyse any of these activities:

  1. Calculate the values (sales or profit) contributed by each of these activities (customers, products/services or channels) over a given period and add to give a total. The period of analysis may be a year, but could equally be a quarter or even a month. The customer activity in this period should not be biased by any seasonal fluctuations in ordering patterns.
  2. Arrange the values for each activity in descending order & calculate the value of each activity as a percentage of the total for the period.
  3. Calculate the cumulative percentage in descending order.
  4. Find the row in your data where the cumulative percentage is approximately 80%. Then look across to see what proportion of the activities account for the 80%. For example, if 5 out of 24 customers account for 80% of sales, 5/24 = 21%. The ratio in this case is 80/21: 80% of sales come from 21% of customers.
  5. If possible, compare this information with results from other periods (say a previous year) or with an average for the industry.
  6. Analyse, interpret & apply your results to the weak & strong areas as shown by the facts.

What are you waiting for?
Try applying the 80/20 rule in your business, and see what new insights you can find.

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