The 80-20 rule (often referred to as Pareto's Law) asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards. Taken literally this means that, for example, 80% of what you achieve in your business comes from 20% of the time spent. Therefore for all practical purposes, four fifths of the effort (a dominant part of it) is largely irrelevant. This is contrary to what people expect.
So the 80-20 rule states that there is an imbalance between causes and results, inputs and outputs, and effort and reward. A good benchmark for this imbalance is provided by the 80/20 relationship, a typical pattern will show that 80% of outputs result from 20% of the inputs, that 80% of the consequences flow from 20% of the causes, or that 80% of results come from 20% of the effort.
The 80-20 Rule in Business
In business, many examples of the 80-20 rule have been validated. 20% of the products/services usually account for about 80% of the sales value, 20% of the customers usually account for 80% of the sales, and these same customers account for 80% of the profits.
Let's imagine your business has 100 products, and you have established that the most profitable 20 products account for 80% of the profits, (see figure below).
We can see in this example that these 20 products (20% of the number of products) comprise 80% of the total profits (in the shaded area).
Conversely in the white area, we can see the flip side of this relationship, 80% of the products only make, in total, 20% of the profits.
The 80 20 rule is only a benchmark, and the real relationship may be more or less unbalanced than 80/20. The 80 20 rule asserts, however that in most cases the relationship is much more likely to be closer to 80/20 than 50/50. Sometimes 80% of the profits come from 30% of the products/services, sometimes 80% of the profits come from 15% or even 10% of the products/services.
The 80/20 principle can be best analysed with cumulative data so over time you can see the normality of the data emerging. The 80/20 principle is also best analysed with charts and graphs, so much so that it has its own name called the "Pareto Chart".
80% of the sales in a given sales territory will come from 20% of the customers. From this the term the "important few, the unimportant many" is derived, meaning that from a sales territory perspective you should concentrate your activities on those customers that make up the 20% to grow this business.
The 80%'ers should not be neglected, but these customers would be seen less often than the 20%'ers. It should be looked at a little differently with the promotion of your products, we are assuming that the 20%'ers would buy your products/services regardless of whether they are promoted to or not, so it is reasonable to assume if we promote (advertise etc), to the 80%'ers, then there is a chance that one day they will become a 20%'er.
This principle is similar to the approach of the Sales Growth Matrix or Boston Consulting Group Matrix (BCG Matrix), where each product in our portfolio is labelled a Star, Cash Cow, Dog or Question Mark. Each product in each category is behaving differently over time, and therefore demands a certain level of care and attention in order to move around the matrix, or in some cases even be removed from the portfolio.
Some 80/20 Rules in Business to Consider