Understanding The Pareto Principle in Business
What is the Pareto Principle?
The Pareto Principle, also known as the 80/20 rule, is a theory that states that roughly 80% of the effects come from 20% of the causes. The theory was first developed by the sociologist and economist, Vilfredo Pareto, who discovered that 80% of Italy's lands were owned by 20% of the population.
Let's look at an example.
Imagine you took a test and got 100% on the exam. After taking a closer look, you may find that 80% of the questions on the exam account for 20% of the entire course material that's being tested. It's something to think about if you're wondering about how to best utilize your time and resources.
Interesting isn't it? But how is this relevant?
It's relevant because the principle can be applied to a number of different situations — business, economics, personal productivity — but for this particular article, we’ll be looking at how the Pareto Principle applies specifically to business.
Pareto Principle in Business
In business, the Pareto Principle suggests that 80% of a company's revenue comes from 20% of its customers. This means that a small number of key customers are responsible for the majority of the company's income.
But why is this useful?
The answer is quite simple — less wasted resources.
Understanding this principle can help you focus your resources in the right places. In business, you could consider your regular customers as your top 20% where you should be focusing your efforts on.
Tip: Channel.io's business communication platform offers features that can help you specifically target your customer service, sales, and marketing toward your top 20%.
Based on this theory, it would make sense then, for companies to focus their efforts on retaining and growing these regular customers.
But this doesn't mean that customer acquisition — and the other 80% of your customers — should be completely neglected. The 80% are still important to a business, and a business needs new customers before they can be converted into regular customers. The Pareto Principle just shows where we should be focusing our efforts, rather than telling us who we should ignore. You can also apply the Pareto Principle towards customer acquisition.
Focusing your marketing efforts towards the top 20% can also produce better returns as opposed to spreading your target across your entire customer base. These regular customers are also more likely to introduce your brand to others.
Tip: If you'd like to learn more about how to focus your marketing efforts on your regular customers click here.
Examples of the Pareto Principle in Action
If we wanted to see examples of the Pareto Principle at work, local brick and mortar stores, or local bars and restaurants would be a good place to start. There are cases where these types of small local stores survive for generations. When you ask these businesses how they manage to stay alive for so long they’ll more than likely answer the same way — “regulars.”
These businesses maintain operations thanks to these regulars, and most of the acquisition of new customers comes from the regular customers introducing friends and family to the establishment.
It's something to think about for your own business.
The great thing about this business model, is that little money needs to be placed into maintaining traffic to the store, and whatever efforts they make to acquire more first-time visitors, becomes extra potential income for them.
They also have a bottom-line that’ll maintain itself thanks to the regular traffic.
The Impact of the Pareto Principle on Your Business
No matter what type of business you have, it’s important to identify who your top 20% are. If you can figure out who they are, your sales, marketing and customer service efforts should be focused on increasing this number.
Tip: Getting a CRM for your online store can help identify your customers and figure out who your top 20% are.
There’s a reason why large retail businesses differentiate their customers, and label some of them as VIPs. The businesses that understand the importance of the top 20%, do everything they can to treat this group differently. They personalize the buying experience for these customers and show them that their loyalty is appreciated.
Customers that feel like they’re receiving special treatment, or feel like they’re invested in a brand or store, tend to return and spend more because of this personalized experience.
Some common ways to increase the size of your top 20%:
- Improving the overall start to end customer journey
- Direct and customized interactions — personalized greetings, on-the-house services, etc.
- Increase business efficiency and speed of service
- Maintain consistency with service/product quality
- Keeping them engaged with your brand and your staff
- Letting them know they matter — special VIP promotions, loyalty programs, etc.
Does the Pareto Principle Apply Online?
Differentiating customers in an in-store setting is pretty straight forward. You can remember their faces, their names, and approach those customers with a friendly smile and a set of gestures that indicate that they’re important to your business.
But when you're dealing with customers online — this becomes a challenge.
Because we're stuck behind a screen, greeting customers, showing your appreciation, or providing care and attention to these customers isn't so easy.
But thanks to the development of live chats, chatbots and other customer service software — like Channel.io — it’s now possible for online businesses to provide the same level of personalized customer experience as you would in-store.
These types of software allow you to connect with your top 20%, and target specific messages, greetings and promotions to these groups, to help you personalize the online shopping experience. By doing so you'll be able increasing the number of regular customers to your store for long-term and sustainable growth.
The Pareto Principle is not a hard and fast rule and the ratios may not always be exactly 80/20, but the principle still holds true that a small portion of causes creates the majority of effects.
This being said, business owners should avoid the pitfall of ignoring the remaining 80% of their customers, because they've figured out who their top 20% are. The principle is simply showing the importance of identifying key priorities.
With increasing inflation and rising acquisition costs, managing resources and time is becoming key to surviving the economic downturn, and many businesses are beginning to notice the importance of their regular customers.
No matter the type of business you have — online or offline — being aware of this theory and allocating resources accordingly, helps in giving your business a way to survive.
By focusing on the most important tasks, activities, or customers, we can maximize our results and achieve greater success, while minimizing the amount of wasted resources.