The Pareto principle (also known as the 80-20 rule, the law of the vital few and the principle of factor sparsity) states that for many phenomena, 80% of the consequences stem from 20% of the causes. Source: Wikipedia
The Pareto principle was named after the Italian economist Vilfredo Pareto, who observed that 80% of income in Italy was received by 20% of the Italian population, but the same principle can be found in many other situations.
In most businesses, 20% of the customers account for 80% of the sales. And technical departments know that 80% of the problems are caused by only 20% of the clients. This is very interesting information for managers, who can use these numbers to steer their sales and support departments.
But how can we correlate the Pareto numbers for these two departments? Are the 20% that purchase the most the same customers that use most of your organization’s resources? Well, experience tells us that this is not the case: there usually are customers buying for huge amounts without ever needing the support department. The two Pareto principle are not correlated, so if we only look at the small group of customers responsible for 80% of the sales, you will find once again that 20% of that group is using 80% of the resources.
As there is no correlation, I can easily divide my customers into four distinct groups:
- Clients generating 80% of the sales, but using only 20% of the resources;
- Clients generating 80% of the sales and using 80% of the resources;
- Clients generating 20% of the sales, but using only 20% of the resources;
- Clients generating 20% of the sales and using 80% of the resources.
I put those four groups in a specific order. The first group is worth the most, as they bring in a lot of money at low costs and the fourth group is the most difficult group.
So should you just drop the customers in the fourth group? Of course not, as we are talking about a principle and not a fixed categorization. If you drop group four, and look again at the numbers, you will see that once again 20% of the customers account for 80% of the sales and 80% of the resources are used by only 20% of the clients. Customers who were in to top 20% before, not rank lower simple because you have less customers. If I have 100 clients, there are 20 clients in the top 20%, but if I drop 50 of them, the top 20% will be formed by only 10 customers. Of course, if you have to drop customers, because you haven’t got enough resources, make sure you drop clients from the fourth group, as the clients in the other three groups are worth more.