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Why you need to use the 80-20 rule in your business

When making business decisions they should be based on hard facts, as much as possible. But how you look at the facts determines for a great deal how you are going to react to them. That’s why I want to spend some time here to talk about a very powerful, and perhaps for you a new, method to look at the facts. It is called the 80/20 rule, or the Pareto principle.
In short, the rule states that 80% of consequences stem from 20% of the causes.


It was discovered by Vilfredo Pareto, but has been popularized by Richard Koch I believe, in his books “The 80 20 Principle” and “The 80 20 manager”. I recommend reading both books. But let us first have a look at how this principle can be applied to your business.

Concerns

The 80/20 principle is a powerful principle that you can apply to your business and get very focused on the matters that are most important, the ones that have most effect. When I had to grow the branch office I was managing a couple years back I couldn’t have done that without the help of this rule.

At the time there were two main concerns I had.

The first concern was, I needed to delegate sales for a large part, but which part? If I wouldn’t delegate, it would have taken me far too much time. But if I promote a few people to account manager, till what kind of order size would they be allowed to decide themselves? If I still had to look at all the offers and all the orders, then there wouldn’t be much time saving, just an extra management layer. I needed a figure above which the new Account Manager would need to consult me and for all the rest they had the authority to completely handle the orders themselves. If I would set the figure too low, however, there would be no point, as I still would have to do most of the work.

The second concern I had was making sure that I still retained control over the majority of the business. If I set the figure too high, I would lose partial control over too big a portion of the turnover.

The analysis

I looked at all the orders we had in the previous year and applied the 80/20 rule. In the below graph you see all 164 orders we had on the x-axis, with the order value on the y-axis. I ordered them by order size, so you get this nice curve.

Our biggest order, number 1, was more than € 600,000.- while the smallest order, number 164, was just € 71.-

From this spread in order size it became absolutely clear that all orders weren’t created equal, so I shouldn’t treat them with equal amounts of my attention and time. And neither should you in your business.

After applying the 80/20 rule I found it was a perfect match for this data set. The biggest 33 orders, or 20% of the 164, had a combined value of 80% of all sales. At what amount did you think the split was? What do you think was the order size of number 34? It was just above € 20.000,-

Conclusion

With that figure I would only need to focus on 33 orders out of the whole total of 164. But not only the orders. Also, all the offers, purchasing, invoicing, order follow up of all those orders. It was a huge time saver. And as an extra bonus my new Account Managers felt a great deal of responsibility, because they actually had quite a responsibility. It is not often that an employee gets to decide on € 20.000,- matters, especially in India, where the office was based.

But alas, the Corporate management didn’t want me to give them too much freedom. They felt the € 20.000,- value was too high, it made them uncomfortable. After going back and forth we agreed that I would institute a € 10.000,- limit and even that was a hard sell. This would require me to spend time on 51, or 31%, of the orders which accounted for 88% of the sales. But I digress.

The important part here is that you need to apply this line of thinking to your business and not only in sales. You can apply it to where you spend your time on, which are your best clients, what are your biggest expenses and so on. Whenever you feel uncomfortable with the initial figure from the analysis, take a smaller one that still has a big impact, but stretch yourself a bit here. Get out of your comfort zone and try to get the actual 80/20 figure as soon as you can.

Make the analysis for your sales today and share the results with us. What is your 80/20 value? How exactly does it match the 80/20 rule? Let us know in the below comments section.

See you around,
Timon Vinke

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