Pareto Principle

The goal of any organization or business is to find the most optimal solution for a certain problem. Efficiency is key as it increases the wealth generated for a society. However, business is a people environment, where a lot of trial and error occurs before finding an optimal structure. There are little to no circumstances in which something “great” has happened without any tweaking.

Now the tweaking part is what is important here. During the process of moving a business forward, there will be little time spent on investigating what has not worked for the sake of moving forward. That momentum is important, particularly if you are using lean methodology.

Continuing with things that do work, will often leave a trail of things that have not worked out so well for an organization. This can be services you offer clients that are not generating enough sales to support a unit. Maybe a dish on your food menu that does not get ordered but you must keep in stock because it is on the menu. Or, if you are a webmaster, you may have too many dead pages that are detrimental to your overall SEO.

The Pareto Principle really starts with a frame of mind which leads to an analysis. You will want to know what twenty percent of the time and energy is responsible for eighty percent of the results. Now a frame of mind is nothing more than that, it does not really help with anything other than looking for that twenty percent. However, there is where it starts. You need to investigate what part of the business is a cornerstone and afterwards dissect the things that are not working out so well.

Continuity is very important for any business. Being able to generate enough revenue to secure that continuity will be for most organizations a primordial goal. What I am getting at here, is that when you are looking to optimize an organization you will more than likely understand that the things that are working out are great. You could further develop growth, but you can only do so when you look at the other part of the equation. What about the other eighty percent of the time and energy spent? If you continue to optimize your business through business development or growth hacking, it will become even more difficult to detach it from the core business. Let me explain why.

Imagine you are a chef and you are about to open a restaurant in downtown Amsterdam. You love both Italian and Korean cuisine and decide to call your restaurant Kimchi Pasta. You have made a menu with fifty different items, all distributed semi equally to the different courses you offer. You know it is a menu that is not too large, stock can be managed easily, you can teach the recipes to professional cooks and you are aware it is going to be a tad difficult to market your concept in the modern internet era. You open up shop and it is a hit. A few months pass by and you start to notice that the Korean dishes are ordered more plentiful than the Italian dishes. You understand that it probably has to do with the competition you are enduring from other Italian restaurants. You decide to not do anything about it because things are going great. After all, people are still ordering the Italian dishes and you do not want to alienate clients that want something of both worlds. A year pass by and you decide to open many more restaurants. You start to notice the same pattern across the other different restaurants, Italian dishes are just not as popular as the Korean dishes. You decide to do nothing, after all your concept revolves around Kimchi Pasta. Things are still going great and you move forward. You are attached.

Business are humans and humans are creature of habits. Something that may sound as simple as removing a single dish is not as simple as it sounds. There is good reason for that, removing something that may risk the things that have worked so far is a risk that nobody wants to take unless there are external factors forcing you to. In the example above that could very well be that the restaurants are not attracting as many customers. When that happens, reorganizations are inevitable. Reorganization is something that can be avoided by looking at the other eighty percent of the time and energy spent on something that did not lead to the results expected.

By flipping the model 80/20 (or 20/80) around it allows you to make difficult decisions on earlier stages. By making tough decisions in earlier stages the repercussions will never be as bad as the later stages of development.

In summary, how to use the Pareto Principle in Business Development: look at the things that are not working out before focusing on the things that are. Remember that the job is not easy, changing what is not working will be more difficult than the things that are working. If you question that, have you ever tried changing four fifths of your habits?

Now that we have the above example fresh in our mind let us look at the Pareto Principle trap.

It is common belief that – and some of the examples we are about to read even statistically proven – eighty percent of record sales, ticket sales or books sales are attributed to twenty percent or less of artists, movies or authors. If you are an entrepreneur or involved in sales you are supposed to see those figures back in your sales: twenty percent of your clients are responsible for eighty percent of your revenue. Or that twenty percent of your products generate eighty percent of sales. Or that in whatever industry you are part of, twenty percent of the companies have a market share of eighty percent. For pretty much any twenty percent of effort there will be some type of eighty percent output.

The applicability and linearity of the Pareto Principle should never be taken as a fact as there is where the trap lays. In our current society, clusters of efficiency is what you will be frequently exposed to. Our marketing machines are made to promote what most want. More time and energy is spent on something successful, thus explaining why the principle can be applied to multiple cases.

Nonetheless, even though it can be applied on multiple cases it does a poor job at explaining aspects of a business which may need time to grow or, due to risk, should not be revised. With a reorganization for example, everything that is not working, will be thrown in the garbage bag and disposed of. Time and accountability are not important during reorganization, pure results are. Yet looking at pure results may not yield success after reorganization. Good cases for this are typical brick-and-mortar formulas that you could frequently encounter on the streets ten or twenty years ago – like Blokker, Hema, Paradigit, Dixons or V&D in the Netherlands – but after many reorganizations were not able – or find it really hard – to survive, because it failed to jump on the e-commerce boat on time.

Risk wise it can also be a problem using the Pareto Principle to improve efficiency. If you have five clients of which one of them is responsible for eighty percent of your revenue. Do you dispose four fifths of your client base? Needless to say, being dependable on one stream of income or clients can have disastrous results and this does extend to other areas as well.

What about when it is not apparent what is helping with actual sales, like branding? An example would be Zappos. In the case you do not know what Zappos is, Zappos is an online “shoe” retailer founded in 1999. The company was bought by Amazon in 2009 for roughly 1,2 billion USD. The unique selling point of the company is, arguably, how they communicate with their customers: customer service. If you would analyze the company with the Pareto Principle it could very well be that limiting the customer service would yield better results on paper. However, the customer service is their main differentiator, removing or adapting the customer service would likely have negative results on the long-term.

The Pareto Principle trap becomes even more obvious while analyzing starting businesses or new business units with it. Particularly in the field of e-commerce, where long-tail sales schemes can be profitable despite breaking the principle. Selling less products of a large catalog can be very lucrative if the organizations breath is long enough to withstand the initial cash burn.

Finally, remember that everybody seeks improvement and efficiency. Whether Pareto Principle can guide you there as a thinking or analysis framework is up to you.