What does a 19th century Italian economist have to do with your business?

Without going into an in-depth history of Vilfred Pareto, he observed that 80% of Italy’s income went to 20% of the population. Interestingly, this observation translates to business extremely well. And as a general rule, 80% of your revenue will come from 20% of your customers (or from 20% of your product offering).

So, knowing the basics of the 80/20 Rule, who are the customers that occupy the top 20% of your customer base?

Here are 4 quick steps to get you started on your own 80/20 Analysis:

1. Print out the sales ledger for the most recent financial year by customer/client account number.
2. Save as an Excel spreadsheet.
3. Aggregate the information by “Buying Unit.”
4. Do the same again by product type.

Here’s what we’ve typically found:

Customer size* % of
customer base Number of customers % of total sales Total sales Comments
Extra Large 1 9 25 1,170 5% of the customer base is contributing more than 50% of the businesses sales
Large 4 35 27 1,300
Medium 16 139 30 1,450
Small 79 687 18 835 79% of the customer base only contributes 18% of total sales
Total 100 870 100 4,755
* Remember this is a rule of thumb, so don’t spend too much time defining your customer segments

So what does this 80/20 Analysis tell us?

This business is heavily reliant on the top 5% of their customer base. If one or two of them defected, they would take with them, a large proportion of total sales. It is also evident that a lot of time is being spent serving smaller customers, when they only contribute 18% of sales.

One of the key questions we should be asking is, “Could time spent serving 79% of the customer base be better spent on the larger customers? The ensuing discussion should focus on strategies to move customers in the large bracket to extra large, and then turning medium sized customers into large customers.

Please let me know if you are interested in discussing this further. The 80/20 Analysis is a real eye opener. We know that what you can measure you can manage, and armed with this information your management decision making will improve dramatically.


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Filed under Accountancy & Tax Stuff, Business advice

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