The 80/20 or Pareto principle is a long-standing business strategy that a lot of companies are applying right now to increase profit margin. Classic examples of the 80/20 rule include the burgeoning growth of American manufacturers such as Illinois Tool Works, which grew from $300M to $18B by applying the 80/20 business model. Books like The 80/20 Principle by Richard Koch made the best seller list, focusing the common Pareto Principle on highest margin work to create competitive advantage.
Especially in periods of high growth, it's easy to lose track of where your margin comes from. Sometimes complexity is just noise that distracts from what’s most important. By focusing on the 20% of inputs that create the majority (80%) of their outputs, businesses can reduce complexity and prioritize their efforts for greatest impact. Across industries, companies have used the 80/20 strategy to better their businesses, for example:
- VW went from 128 build combinations to 15 for their Passat line, improving margin and delivery and growing–not diminishing–customer satisfaction.
- Microsoft found that 20% of its bugs caused 80% of its errors; in fact, just 1% of bugs caused half of all errors. Applying the 80/20 principle helped them to prioritize tasks and improve their product and reputation.
To help ensure attention to your 20%, one 80/20 consulting firm, Strategex, suggests segmenting customers and products by revenue:
- Identify "A" customers (those that represent 80% of revenue) and "B" customers.
- Identify "A" products (those that represent 80% of revenue) and "B" products.
- Target the A’s and eliminate or at least treat separately the B’s.
Many companies base these segments on more than just revenue, however. For example, you might consider:
- Profit margin
- Referral / influence
- Fit with core capabilities
Yes, you will have to say no. You may “fire" customers, increase prices on B products, cut product lines. Saying no is difficult, but employees will appreciate your focus, commitment to key customers, and reduced busy work. Just as important, customers will appreciate your honesty and help if you say no and refer them to a better fit company. Saying no in this way can add value and build credibility.
Many of our customers have made pursuing an 80/20 strategy a priority. The ramifications will be different for each. For one company, it means separating manufacturing lines and equipment for OEM and standard optics. For another, it means splitting industries by channel, not just geography; while they'll focus their direct sales on academic, they'll use their distributors and e-commerce for industrial sales, which require less expertise and post-sale service and offer less account potential.
For you, it may mean:
- Standardizing technology platforms
- Rethinking product families
- Retiring or sunsetting products
- Packaging service offerings
- Narrowing your target audience
- Crystallizing your brand
- Changing your thinking of competitors to partners
- Tracking new metrics or KPIs
We have worked with these and other companies to identify, profile, and understand their sweet spot – A customers buying A products. The positioning process and marketing assessment help them attract more A’s and eliminate activities that blur the lines of the brand.
In order to reach your ideal B2B buyers, you need to understand their roles, habits and values. Use our Persona Development Worksheet to get to know your A customers.
Editor’s note: This blog post was originally published in June 2015 and has been updated for comprehensiveness and to reflect current best practices.