The Pareto Principle is a way for businesses to optimize business performance and maximize growth. Here’s how you can apply it to your operations
The Pareto Principle, also known as the 80/20 Rule, helps entrepreneurs have a better grasp of how to grow their business. The 80/20 Rule is commonly applied across industries, including sports, risk determination in healthcare, personal finance, engineering, computer science, and many more.
While the modern principle was first developed by an economist and related to the distribution of land and wealth, entrepreneurs who can understand how it shapes performance will see major improvements in areas like valuable customer acquisition, time management, and cost-efficiency.
Pareto Principle explained
The Pareto Principle generally has to do with cause and effect and follows that 80 percent of outcomes originate from just 20 percent of causes. The concept is named after the Italian economist Vilfredo Pareto, who first applied the principle to land ownership at the end of the 19th Century. He found that 80 percent of land in Italy was actually owned by just 20 percent of the population, and his theory proved to be accurate in other regions as well.
But Pareto also applied his theory to other areas, including gardening. He noticed that 80 percent of his peas came from just 20 percent of the pea pods.
Another theorist, Dr. Joseph Juran, started to apply the theory to business productivity in the 1940s. He posited that 20 percent of production problems caused 80 percent of product defects.
In other industries, the 80/20 theory works similarly. For example, in sports and fitness, the application of the principle has theorized that 20 percent of exercises or training efforts produce 80 percent of the results and impacts.
So how does the principle apply to modern businesses?
The Pareto Principle and sales
It’s commonly thought that in business, 20 percent of your customers represent 80 percent of your sales. This means that certain customers are far more valuable than others. Once small business owners understand this, they can make improvements to their business plan by:
- Focusing more time on the most valuable customers
- Identifying traits of the 20 percent
- Recognizing specific behaviors from the 20 percent that indicate an intent to buy
- Bringing in new clients with those identified traits
It’s important to note that this principle does not mean that your other customers aren’t as important as the 20 percent. It just helps you know where to focus your attention to help you increase revenue and sustain business growth.
Another way to improve your business with the 80/20 Rule is by using it to improve time management. Think about all of the small tasks you do throughout the day that keep your business functioning, but that don’t directly contribute to increasing revenue. You have to do paperwork or run errands or enter data. These tasks are necessary, but they are not part of the 20 percent of what you do with your time that brings in 80 percent of your revenue.
It’s easy for entrepreneurs to want to do everything themselves instead of delegating. But focusing your energy on things like sales, business growth, marketing, and obtaining new valuable clients is a much more valuable use of your time.
Try hiring an assistant or contractor for everyday activities like administrative tasks, writing marketing copy, or even home maintenance chores like laundry that take away from your focus on your business. Remember that just 20 percent of the things you do with your time contribute to 80 percent of revenue.
Business cost management
The Pareto Principle can also be applied to cost management for your business. It would follow that 20 percent of costs are responsible for 80 percent of revenue. This can help you avoid counterproductive spending and help you improve your budget and cash flow. But it can also help you understand how big of an impact it would have to cut costs that contribute to a large portion of sales.
This is a similar idea to the concepts that 20 percent of customers and 20 percent of time spent are directly contributing to 80 percent of sales. The principle can be applied to other areas of the business as well, like marketing efforts or the value of individual sales team members.
The 80/20 Rule is still implemented by business owners across industries to help them plan for where to invest money, energy, and focus for optimal growth.
When you need assistance creating a sustainable business plan, the team at Provident CPA & Business Advisors can help. We provide growth and profit improvement services for businesses and incorporate the tools of the Entrepreneurial Operating System® (EOS) to help align teams and increase productivity. Contact us today to learn more about our services.