Few rules are more widely quoted in marketing today than the 80/20 Rule (the Pareto's Principle), which states that 80% of your sales come from just 20% of your customer base.
In this age of relationship marketing, this rule has become an often-heard battle cry to focus our efforts on maintaining the loyalty of customers belonging to the golden 20% that drive most of our business, while spending less effort on the trivial other 80%.
Intuitively, it makes sense. But this marketing interpretation of the 80/20 rule is actually flawed.
The present understanding of the 80/20 derives in large part from Dr. Joseph Juran, who in the 1940s wrote a wonderful article describing the 80/20 rule's applicability to industrial quality control. He concluded that the greatest quality gains were to be found in focusing quality assurance efforts on the 20% of all defects that cause 80% of problems. He saw that not all defects were created equal, so it is inefficient to treat them as if they were.
Juran's work has subsequently been expanded to a wide range of other fields, including marketing, where it has found a home in customer loyalty theory and relationship marketing. While interesting, the direct application of Juran's work to marketing is not as straightforward as it first appears, and care should be taken when applying it to our marketing practices.
The 80/20 rule as conceived by Juran assumes an equal return on investment for each opportunity. This is not an assumption that typically works in marketing, where the margins on sales vary widely based upon the terms of those sales. Most importantly, the more a customer buys, the more bargaining power they tend to have to drive down the price they pay per item.
For instance, a bar of soap sold through Wal-Mart will tend to margin less for its manufacturer than the same bar of soap sold through a small grocery chain, since Wal-Mart's purchasing power enables it to drive a significantly better price per bar of soap than everyone else. This difference in margins means that the gains in volume catering to the golden 20% can come at the cost of a lower profit margin. When those differences are great, it is easy to have situations where the "trivial" 80% of customers are actually more profitable on only 20% of the volume.
This observation lies at the heart of a richer interpretation of the 80/20 rule, which can lead you in many circumstances to do the exact opposite of what a simple Juran-style interpretation of 80/20 would lead us to believe.
Matthew Syrett is a marketing consultant/analyst—a hybrid marketer, film producer, technologist, and statistician. He was vice-president of product development at the LinkShare Corporation and vice-president at Grey Interactive. Reach him via syrett (at) gmail (dot) com.