The 80/20 rule has been a part of the business world for many years but it actually goes back much further than that. It originated with an economist called Vilfredo Pareto in the late 19th Century, which is why it’s often labelled ass the Pareto Principle.
The idea behind this rule is fairly simple, stating that 80% of something good is generated by only 20% of something else. Back when Pareto came up with this theory, he was talking about land- more specifically that 80% of the land was owned by only 20% of the people. This idea was born from a socialist perspective and was objectively correct. In fact, it’s common knowledge in today’s society that the vast majority of wealth is owned by a small percentage of people.
Conversely, the 80/20 Principle jumped over to the business sphere- an irony that wouldn’t have been lost on Pareto. The idea has been applied to a variety of relationships but the one that gets talked about the most is the theory that 80% of sales comes from only 20% of customers.
It’s clear to see why this idea has become so popular amongst those within the business sector- it’s music to their ears. If the majority of a company’s sales is only coming from a relatively small section of customers then promotion becomes infinitely easier and cheaper. Aiming all of your resources at a select few is always going to be an attractive option- especially compared with the alternative which is casting a wide net, taking extra time, money and effort.
So, is the 80/20 rule valid or is it an urban myth that won’t go away? Short answer is- it’s a myth. Yes, there are examples in which companies receive the majority of their sales from a small number of customers but it’s rare. Not to mention that sales fluctuate constantly, with some customers leaving and new customers joining. Therefore, it would be next to impossible for this 80/20 ratio to be a hard and fast rule.
One of the ways in which this idea has been able to take hold is because companies refuse to actually sit down and work out their numbers. Having a real-time view of sales and customers can be invaluable as it gives businesses an advantage when it comes to marketing.
Another point to consider is Sharp’s “Law of Buyer Moderation” – which basically states that you can’t extrapolate buyer behaviour using limited date. For example, there is no guarantee that a customer who makes many purchases one year will repeat this in the next. The marketplace can be volatile and customers are often unpredictable, especially when you’re trying to fit them in to a strict ratio.
Furthermore, whilst the 80/40 Principle is attractive in some respects, it may not be something to aim for. If a business is relying on a small number of customers for the majority of their revenue, that’s a very precarious place to be in. The company would only have to lose a small percentage of customers in order to notice a dramatic dip in sales. When the customer base is larger, the risk is spread out further and the likelihood of crashes is reduced.
Whilst it’s clear that the Pareto Principle was never a great fit with business- there are circumstances in which companies rely on smaller pools of customers for the majority of their revenue. For example, high end fashion and other luxury items. In situations such as these, it would make sense to target these particular customers. However, even in these rare cases, businesses would be foolish to ignore the vast majority of customers who make smaller purchases.
To summarise, whilst it may be an interesting concept, the 80/20 law is far too rigid to apply to the diverse and ever-changing world of business. It may be costly and time consuming but reaching out to a wide range of customers and potential customers, regardless of how much they buy is still a tried and tested roadmap to success.