Many people believe that 20% of
their customers account for the success of their business and the other 80% of
customers are unprofitable and need to be ditched. Speakers on business topics
and authors of business books promulgate this little gem.
If you sack 80% of your customers
then they will feel insulted and aggrieved. Assuming that you are dealing with
a particular market segment, it is likely that many of the segment members will
know each other. You could well be on the receiving end of a negative word-of-mouth
campaign, not confined to the market segment.
The facts are that this piece of
nonsense is based on research by Vilfredo Pareto, an Italian living in the late
19th century. He concluded, correctly, that 80% of the land in Italy
was owned by 20% of the population. That is why it is called Pareto’s Law or,
sometimes, the 80/20 rule.
It is not a law! It is not even a
reliable rule. 80/20% only applies to land in Italy, over 100 years ago. In
your business the distribution could be 99/1% or 50/50% or any other divisions
of 100.
A company that I worked with manufactured
in India and distributed through UK retailers applied the 80/20 rule to their
customers. They graded their customers by sales revenue and got rid of the
smallest customers – 80% of all their customers!
Unfortunately, grading by sales
revenue is totally wrong. They should have graded by profitability. A better
solution would have been to raise the prices to those customers contributing
the lowest profit. The price-sensitive retailers would fade away and those who
accepted the price increase would raise the profits of the producing company.
The
Black Swan put in an appearance – they lost their largest customer about six
months later, who had decided to design and source their own stuff. A little later, they lost another large
customer. Needless to say, the company went bust 18 months later.
