Sep 242011
 
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The Pareto Principle For Entrepreneurs

The Pareto Principle For Entrepreneurs

Most people in the business world have heard of the Pareto Principle, also known as the “80/20 Rule”.  For those who haven’t and for those who may have forgotten, first a little refresher, then we’re going to talk about how to use it to your advantage as an entrepreneur.

The Pareto Principle, suggested by management consultant Joseph Juran and named after Italian economist Vilfredo Pareto, refers to the concept that in many “systems,” roughly eighty percent of the output comes from roughly twenty percent of the inputs. Or, as it’s described in Wikipedia, “for many events, roughly 80% of the effects come from 20% of the causes”.  In other words, there’s the twenty percent that really matters, then there’s the rest.

Back in the first decade of the 1900’s, Pareto observed that eighty percent of the land in Italy was owned by twenty percent of the population.  If you take a look around in your world, you’re likely to find many “80/20” realities.  I know I do in mine.  For example, in many groups to which I belong, twenty percent of the members are very active and generate roughly eighty percent of the activity of the group, and the other eighty percent, well, they don’t do much.  It’s not necessarily a negative, but once you’ve seen this phenomenon enough times, it does help you to set your expectations better and look for more “20-percenters”.

You may also note the presence of Pareto in your own efforts in your business and personal life.  Do you ever get the sense that a minority of the actions you take, say roughly twenty percent, have the biggest impact in moving you in the direction of your goals?  Chances are that you are not imagining it; once again you’re seeing the Pareto Principle at work.

Also, note that it’s the Pareto Principle, not the Pareto “Rule”.  It is not “written in stone” and it’s not exact; it’s an approximation or “rule of thumb” that can be quite useful in understanding what you’re observing and determining where to focus your efforts.  It’s worth noting too that you will see much more extreme examples in certain situations, where rather than being 80/20, it will be 90/10, or even more lopsided.  Again, it’s a principle, not a rule.

I think the greatest use of the Pareto Principle for an entrepreneur is in helping to determine where to focus your efforts and expend your resources.  You can try to convert the “80 percenters,” or you can work more closely with the “20 percenters” and make them even more productive, profitable, etc.  Let me explain.

In business, applying Pareto, you may find that, for example:

  • 80% of your revenues come from 20% of your products
  • 80% of product returns come from 20% of customers
  • 80% of profits come from 20% of customers
  • 80% of machine breakdowns come from 20% of processes
  • 80% of your revenues come from 20% of your salespeople
  • 80% of your revenues can be traced to 20% of your “ad spend”
  • 80% of your sick days come from 20% of your employees
  • 80% of your worker’s compensation claims come from 20% of your employees
  • 80% of your return comes from 20% of your investments
  • 80% of your computer’s memory is used by 20% of its processes
  • 80% of your new business leads come from 20% of your referral sources
  • 80% of your viable new product ideas come from 20% of your R&D team
  • Etc.

This list could go on and on, but you get the idea.  Sure, you may find none of these 80/20 phenomena, or you may find all of them.  In any case, the point is, be on the lookout for Pareto in your business and personal life.  In some cases, when you find it, there may not be much more use for it than, “oh, that’s interesting”.  In other cases, it may be very useful, as it may be instructive in helping you determine where to allocate more or less resources, such as time, human capital, and financial capital.  “Pareto” is out there; the question is: can you find ways to use the Principle to your advantage?

I look forward to your thoughts and questions.  Please leave a comment (“response”) below or in the upper right corner of this post.

Paul Morin

paul@companyfounder.com

www.companyfounder.com

 

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  • Great post Paul! It really encouraged me to re-evaluate all aspects of my life, not just business. A hip hip hurray to the 20%, that great stuff that creates action and result!

  • Knikkolette

    Paul I loved this post and have lived by the Pareto Principle for a long time in many areas of my life (although I just called it the 80/20 rule)! I find it works well for diet and exercise. Thanks so much for providing all the stats. It was really interesting to learn about all those tidbits of information! 🙂

  • Grady Pruitt

    I was looking at my traffic, recently, and about 80% of the traffic came from about 20% of the sources. I’m seeing this in other areas also.

    Great reminder! Thanks for sharing!

  • Margaret (Peggy) Herrman

    Paul, brilliant! thank you. this is going into my sale booklet for my Orchid Ladies team! thanks and hugs, peggy

  • Thanks, Karla. I agree, when you think in terms of the Pareto Principle, it can cause you to go back and re-assess the way you have allocated time and resources in the past. It can be quite helpful! Paul

  • Happy you found it useful and interesting, Knikkolette. I had not really thought about the Pareto Principle in terms of diet and exercise, but I guess it does make a lot of sense. You can look at it either from the positive or negative side, but 20% of what you do (or don’t do) can certainly have 80% of the impact on your health! Thanks, Paul

  • Hi, Grady. Yes, the Pareto Principle can apply to a lot of web and technology metrics. As mentioned in the article, it’s not so much a “rule” as a “rule of thumb”. In the case of traffic though, once you realize which 20% of the sources are are providing 80% of the results, it make some sense to try doing more of those 20%. You’ll have to keep an eye on it though; as you know, at some point with most everything, you’ll start to experience diminishing returns per unit of input. Paul

  • Hi Peggy, yes, it’s a tremendous mindset and principle for salespeople. It can help greatly with learning to focus on those activities and prospects that yield the greatest results. Paul

  • Vilfredo Pareto gave us some things to think about.

    For example, a Pareto efficiency, refers to a social state in which some people can enjoy exclusive privileges without any others being disadvantaged. A Pareto efficiency represents an interesting mathematical value when it’s used to gauge social justice and disparity.

    The Pareto principle, 80-20, is a descriptive metaphor for abstract distributions. As you point out, Paul, it helps us reframe our view of things. We have to be careful, however, not to jump to conclusions, decisions, and actions.

    For example, a friend of mine was thinking that his field teams were the 20 percent that directly correlates to revenue. Of course, he handsomely rewarded his field teams. He raised their salaries by 25 percent. But he only raised the salaries of his field teams.

    But without the sales and contracts teams, there wouldn’t be a deal that puts his field teams on a job. Without research and drafting, there would be no proposals to offer and close. Without administration, management, accounting, and the company doesn’t operate.

    His other employees felt unappreciated. They became resentful. Then, they threatened to walk out and go to the competition. He fixed his mistake at the cost of going deep into the red. 10% raises for all the other employees.

    Profits aren’t expected to resume for the next 12 months – if the company can survive those 12 months.

  • Agreed, Stan. As with most “principles,” the Pareto Principle provides guidance, not answers. Any CEO, manager, leader, etc., must take the information provided by the Pareto “lens,” combine it with all other data available, then think through the consequences of any contemplated decision before pulling the trigger. Given all the permutations, it’s not possible to think through all consequences ahead of time. However, in an example such as the one you provided above, given human nature, the outcome was not entirely unpredictable. Thanks, as always, for stopping by and providing thought-provoking comments. Paul

  • Keri

    Paul,

    I think we’re so over-stimulated with our world that most processes might not get the concentrated efforts they deserve, thus resulting in the 80/20.

    Your post does prompt readers to step back and evaluate. Thanks for making us think! 🙂

    ~Keri

  • Emily Stoik

    This is such an important principle to be aware of in business! I remember learning about it years ago so it was really cool to hear about it again with a fresh perspective–thanks Paul! 🙂

  • Thanks, Emily. Yes, the Pareto Principle can be quite useful, as long as it’s used carefully.

  • Thanks, Keri. I think Pareto can be a positive, if handled correctly. I agree with you that we are over-stimulated, which gives us more incentive to figure out what the 20% is that we should be focusing on. Paul

  • Gosh, you can’t have a discussion about start-ups, entrepreneurship, or small business without discussing the Pareto Principle. It particularly applies to us online business folks and social media strategists/enthusiasts. I think about the 80/20 rule when considering, “Am I spending my time wisely?”

    I encourage you to check out my pal Mitch York’s take on the Pareto Principle:

    http://entrepreneurs.about.com/b/2011/05/19/a-new-spin-on-the-8020-rule.htm

    Here, Mitch says what I’ve always thought about. How many times do we spend too much time with a client that is not paying us what we’re worth? Now, what is the real value there? Are those our strongest advocates? Are they generating referrals and supporting us in other ways?

    All too often, we marketers go wide, focusing on our immediate natural market, rather than “going deep”. When I say “go deep” with marketing, I am suggesting you look at your core audience or, better yet, your true influencers, supporters, and avid fans. Leverage their networks by giving them something to be excited about and allowing them easy opportunities to spread the word (because you need to value their time too, yanno).

    The Pareto Principle often leads to some unethical business practice and snobbery. There are folks that say so boldly and rudely, “If you are not making me money, I do not have time for you.” This is unacceptable for any business but, if you’re a small business owner, this is particularly shameful.

    Mitch also speaks to this on About.com’s Entrepreneurs sub-site. He reminds us that our “middle tier” is often disregarded and we need to remember that we are in a “thank you economy” now more than ever. Show more gratitude and reward your biggest supporters. Be sincere in doing so because people love to be acknowledged but they do not wish to be patronized, either.

    What do you all think? Some powerful thoughts here… 8)

  • Good stuff, Yomar. I will check out Mitch’s post. The Pareto Principle can be quite useful, but it is just a principle, not a law or a rule. It’s a useful “rule of thumb”. I agree that it can be especially useful when we’re thinking about whether we’re using our time, or other resources, wisely. To your point about “some unethical business practice and snobbery,” I’d simply say “what goes around comes around”. I always like to say that we live in a “quid pro quo world”. There’s always give and take in systems and relationships that work and are sustainable. Where there’s only take and no giving by one party, usually the relationships don’t last. It’s for this same reason that I like your concept of going “deep” rather than “wide. In wide, superficial relationships and interactions, nothing truly useful ever happens. In deeper relationships, most everything that happens is useful, or at least instructive, at some level. I appreciate your thought-provoking comments, as always, Yomar.

  • Interesting. I myself had never encountered that. Thanks for teaching it. I’m honored to learn it. There’s 24hrs in a day, and as an entrepreneur I get on average 5hrs of sleep, which if I’m calculating in my head on the fly correctly is about 20% of 24. Hmmm’. That speaks volumes about productivity. As an artist, you forced me to examine something that a lot of independent artist are still chasing: A Contract. Every contract that I’ve ever encountered has been set up to bear truth to the principle which has moved it into the realm of a Theory vs. a principle. ( In relations to contracts.) I love mathematics. The numbers reveal to us so many truths.

  • Hi Quintius, I’m happy you found the Pareto Principle useful. It really can help with prioritization and with keeping perspective when there are a lot of moving pieces. Contracts can be particularly rough. It’s almost always worth it to have a good attorney on your side. If you’re dealing with a big company, you can bet they’ll have a good attorney, so if you don’t, you’re at an immediate disadvantage. I’d say having a good attorney falls into the “20%” when it comes to dealing with important contracts. Paul

  • Arthur Piccio

    The thing about the Pareto Principle is it has to be applied in context. You can’t just focus on making good on 80 percent of your customer interactions for instance, or you’ll lose customers. Same with security and other vital areas.

    Personally I’ve found it useful when I was learning guitar so I could play in a metal band. There’re thousands of scales and modes and playing styles, but I found by just focusing on pentatonics, barre chords, and chromatics, (sorry, nerd talk) I could already manage just fine.

    That said, we also found it useful for our business’s marketing strategies.

    http://smallbusiness.uprinting.com/knowing-your-20-percent-part-two-why-your-brand-persona-matters/

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