In their book, Larry Selden & Geoffrey Colvin uncover the trillion Dollar opportunity corporations are missing by not being able to clearly identify unprofitable customers.
Even in the most successful companies, while some customers can be very profitable others have a profound negative impact on the bottom line.
In a business that has more than twenty customers, the Pareto Principle will be evident.
Over a century ago, while studying the wealth distribution in European societies, Vilfredo Pareto discovered the 80/20 Rule by which 20% of the population accounted for 80% of Income.
The 80/20 Principle still has wide application in economics, market analysis and business strategy, where 20% of the effort delivers 80% of the results.
If a business is large enough to be significant, its sales, cost and profit data usually respond to a non-linear statistical distribution that contains the 80/20 Rule.
This means that the top 20% of customers generates close to 80% of profit while the bottom 80% of customers generates only 20% of the profit.
Looking inside the famous 80/20 principle one usually finds that the top five percent of the customers generates close to 50% of the profits while the bottom 50% of the customers generates only 5% of the total profit.
Note that the top 5% of customers are 100 times more profitable than the bottom 50% as (50/5)/(5/50) = 100.
The story gets worse as the bottom 40% usually generates no profit at all. Within this group some customers are slightly profitable, some are profit neutral and some are true cash drainers.
This analysis is fundamental to understand who the strategic customers are, how they are different from key customers and standard accounts; and finally identify those in the cash drainer group to either make them profitable or yield them to the competition. This exercise usually frees valuable resources to be re-deployed to support strategic customers and develop additional profitable accounts.
The 80/20 Strategy goes beyond customer analysis and is based on two steps:
1) Segmentation of clients, products and markets to differentiate the vital few (stars) from the trivial many (dogs), in order to plan the re-deployment of resources given to each segment strategically, with the objective to reducing cost and freeing time for new business generation.
2) Identification of those areas that fit the profile of the stars (top 20% customers, products or segments that generate 80% of profits). The objective is to understand the causes in order to replicate their profitability.
I've successfully used the 80/20 Analysis and Strategy for many years to increase profitability, by increasing revenue and reducing cost, in the following areas:
a) Product portfolio
b) Customer portfolio,
c) Market segment strategy,
d) Sales force, and distribution channel productivity
e) New product innovation metrics.
While the Pareto Rule is widely know, many companies do not fully exploit its potential to increase profitability. They have a hard time identifying which customers belong to each group.
Ideally, companies need to know at any time of the month, quarter or year exactly which customers, products or segments fall in each category, and understand the reasons why, in order to drive the profitability distribution towards a higher, more balanced and stable bottom line.
Knowing which 80% of the company's activities yield only 20% of the profits brings the opportunity to optimize by reducing resources given to low profit activities and deploying them to replicate the success of the top performing ones.
The 80/20 Principle is a powerful strategic tool to differentiate the vital few (stars) from the trivial many (dogs), in order to plan the allocation of resources given to each segment strategically, in order to achieve profitable growth.
A Strategic deployment of Business Analytics provides the right answers instantly by allowing to visualize the 80/20 map for each customer, product, sales rep, business unit or market segment in any combination.
by Bill Cabiro and Strat-Wise LLC
„Please visit their web site at www.strat-wise.com for additional articles and resources on the strategic use of Business Intelligence and Analytics”