The Pareto Principle and the 80/20 Rule

The Pareto Principle and the 80/20 Rule

By John Schnitzler

Origin

At the turn of the 20th century, economist Vilfredo Pareto determined that 80% of the land in Italy was owned by 20% of the population. In addition to being an economist, Pareto was also an avid gardener; it was there that he observed that 20% of his plantings yielded 80% of his harvest. The Pareto Principle, or the 80/20 Rule, was born as a result of these studies and has endured the test of time for more than 100 years.

Application

Pareto suggested that individuals and organizations would be better served by focusing on the 20% of assets or activities that provide 80% of the yield. For example, Pareto would say that individuals who focus on the top 20% of their “to do” list will achieve 80% of the desired results. Translated to a corporate setting, 80% of revenues are derived from 20% of customers, which is where field sales resources should focus.

Challenge

Pareto was right to conclude that there is an uneven distribution of output (80%) from a corresponding level of input (20%). There have been some very good applications of his principle. However, a challenge arises for companies with an 80/20 distribution of their business. Few would disagree that highly-skilled and trained sales personnel should focus on these top-producing accounts. The challenge centers on what to do with the remaining 80% of accounts. Individually, these accounts appear incidental to a company's top line revenue performance and margin contribution. Collectively, however, the performance of this low-end group of customers can be the difference between a good and bad year.

Frustration

Realizing that this 80% customer group can’t be ignored, companies have been continually frustrated with what to do with them. Sales and marketing executives frequently restructure their organizations and processes to find cost-effective ways of managing and growing this set of accounts. Failed attempts to properly address this challenge include an entry-level sales force, inside sales programs and direct marketing initiatives. Many times, the outcome is the same: poor revenue performance and/or prohibitively high cost-of-sales.

Alternative

A proven solution for this problem is the utilization of a channel dedicated to managing and growing low-value accounts. Crucial to the success of this approach is the integration of an endto- end database marketing engine to drive demand and deliver cost-appropriate communications.

Approach

They say the first step in fixing a problem is admitting you have one. The first step in addressing an 80/20 situation is understanding the degree to which you have a client concentration issue. To that end, the best way to start is to examine three years’ worth of sales transaction data to determine what percentage of the customer base is responsible for 80% the of business. Then, it is helpful to look deeper at the data to analyze the performance of high-value (20%) and low-value (80%) customer sets. Insights gained from this critical analysis inform future strategies and recommendations.

Both of these analyses should take place as part of initial conversations with those responsible for the outsourced channel. This often serves as a meaningful framework for aligning business challenges with the capabilities of the channel.

Preparation

When all parties have agreed to the scope of an outsourced engagement, the low-value customer set is segmented and ranked based upon:

  • Current value based on customers
  • Recent and historical actual spending levels
  • Potential value based on customers
  • Pending capacity for your products and services
  • Behavior is defined by changes in spending patterns over time and may warrant specific attention:
  • Loyal customers maintain or increase spend
  • Leaving customer have a decreasing spending rate
  • Lost customers stop spending altogether
  • New customers have just recently started purchasing

Propensity is the likelihood to exhibit a certain behavior and/or to respond to a particular marketing offer.

Value is determined by comparing current spend to spending capacity. Behavior is a description of their current activity in general terms: loyal customer, leaving customer, or former customer. The last dimension measured is propensity, the likelihood to exhibit a certain behavior and/or to respond to a particular marketing offer.

Marketing investment and sales focus is then determined based upon the above-mentioned segmentation and scoring process. Customers with high-value and high propensity receive a higher proportion of investment. Lower-value and lower-propensity accounts are given attention, as well, but in ways that are less costly (less frequent communications and/or emphasis on lower-cost media such as direct mail).

Implementation

A vital component of effective communication is an understanding of the audience. For this reason, it is standard practice to begin implementing new programs by profiling (sometimes called mapping) each account to identify and capture contact information for decision-makers and influencers. Combining this profiled data with information gathered through third party data sources helps to paint a clear picture of contacts and potential targets. A detailed description of their decision-making process and competitive information is also documented. All of this information, as well as data related to the sales process, is gathered and stored in a central database.

Campaigns designed as a result of the front-end analytical work can then be executed via telephone, direct mail, email, digital advertising and fulfillment. Personalized messaging is leveraged to increase responses and drive results; things learned during the analysis of customer behavior are factored into call guides and mail templates.

All communications merge information from the database with branded and approved materials in an on-demand workflow, delivering timely, one-to-one messages. Three dimensional marketing pieces and/or samples are also pulled and can be sent with a personalized letter. In addition, emerging technologies like digital engagement centers and video-on-demand are utilized to provide a unique and impactful alternative that gets noticed and remembered.

In a fully-functioning operation as described above, these low-value accounts (the previously unmanaged 80%) are not only covered, they are communicated to in a personalized and costappropriate way. Brand and product awareness increase, resulting in increased sales, while customer defection significantly decreases. A favorable bi-product of this approach is a central data asset, rich with accurate and updated customer information.

Results

A major HVAC manufacturer had declined over 20% in 7 years, and were looking for a way to optimize their sales and begin to grow again. Through the use of multichannel marketing to the bottom 80% of customers, the company experienced 21% growth over $275MM in sales. This drastic shift in both revenue but also growth direction can be seen across many firms utilizing this methodology.

Conclusion

Vilfredo Pareto was right about the 80-20 principle. In fact, most organizations have an uneven distribution of revenue contribution in their customer base. The answer is not to focus all of your time, energy and resources on growing high-end accounts at the expense of the lowervalue accounts. Instead, organizations should utilize a supplemental channel to apply appropriate coverage models for these distinctly different types (and sizes) of customers. This is a proven and cost-effective sales coverage model for those accounts.



About MMC

MMC is a sales optimization company, expert in working with manufacturing and distribution clients in the building products market to deliver profitable growth through programs that increase sales reach while lowering the overall cost of sales.

When deployed in concert with, or in place of a traditional field sales model, our methodology will increase the efficiency of acquisition, improve existing account performance, and reduce customer attrition.

About the Author

John Schnitzler
Product Director, Channel 80/20

John joined Modern Marketing Concepts in 2006 and has since specialized in developing and executing database marketing and sales programs to drive sales growth for his clients in building materials markets.

He currently oversees operations for various clients in building products distribution, working with his clients to build and launch programs to ensure growth in some of their most underserved customer segments.

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