Why the Pareto principle, aka the 80/20 rule, is so important in marketing

by Alice Alessandri and Alberto Aleo 

Anyone who is in marketing has heard of the Pareto principle, better known as the 80/20 rule, at least once. In the late 1800s, following empirical observations supported by statistical evidence, the Italian economist and sociologist asserted that 80% of overall results come from 20% of all causes. In time, this principle has found several applications in various fields, especially in economics. We believe that the 80/20 rule is particularly useful in marketing as it helps us identify real growth strategies and is a valuable tool to guide our actions. How can such a simple and outdated rule still be so effective and relevant? Let’s find out together.

A golden rule to describe results

Over the years, the 80/20 rule has been applied to almost every field of human endeavour, proving how undeniably reliable it is. We could even say that the Pareto principle rules over most natural cause/effect phenomena, from bees pollinating flowers, to national wealth distribution and even company revenues. The fact this ratio is so frequently observed leads us to believe that this way of allocating “efforts in relation to results” is just and harmonious because it is dictated by Mother Nature. 

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So, if you are entrepreneurs or marketing managers in a company, and you realise that 80% of your revenue comes from 20% of your customers or of the products in your catalogue, know that you in accordance with the natural laws of the cosmos!

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Photo by Aaron Burden on Unsplash

On the other hand, diverging from the 80/20 rule could have more serious consequences as it truly is the “golden ratio” of results. If much more than 20% of your customers or products are needed to achieve 80% of the sales, or conversely if you need much less than 20%, there is something discordant in your business. Let’s find out in the next paragraph.

Market fragmentation or concentration

Imagine you have a business with a revenue of 1 million Euros which is all due to one single client. In quantitative terms, you might be satisfied with your revenue, but can you also be satisfied with the quality of your market action? Relying entirely on one client (or very few) exposes us to a serious concentration risk that results in a series of side effects such as the inability to directly control results (which depend on the performance of those few customers), a weakened position in negotiation, credit risk, and so on.

Let’s analyse the opposite situation. Your revenue results from collecting very little from countless “microclients”. In this case, your revenue becomes too fragmented, and you risk driving commercial costs through the roof (managing many customers is expensive even if they are small), failing to dedicate them enough time to gain their trust, or losing your brand identity if the fragmentation is related to a wide variety of products, which would result in failing to firmly position yourself in the mind of the consumers.

We are aware that these are extreme examples where danger is easily identified, but we can assure you that many companies are not aware they are in a critical situation because they only observe total results, not their distribution. 

Photo Ux-indonesia on Unsplash

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The Pareto principle helps us notice these threats. You simply need to compare the distribution of revenue to the 80/20 rule. If it takes much less than 20% of your customers (or products) to get 80% of revenue, you are at a risk of excessive concentration. If, on the other hand, you need much more than 20%, then you are fragmented.

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In either case, you will need to take action.

Questioning you intuition

If understanding the risks that poor result distribution poses is difficult, understanding how to solve the issue is even harder, especially because the cure might initially seem counterintuitive. In fact, to overcome concentration, we would need to approach new customers, or go back to the drawing board if the results are related to few items on the catalogue. This is what would happen: you’d look at your balance sheet and see that it all easily adds up as you aren’t managing many customers and have limited offer. How willing would you be to start knocking on new doors or face new difficulties for the sake of research and development? But that’s exactly what you should do because the only thing that can save you is horizontal growth, i.e., expanding the market through the activation of new clients and new sales opportunities.

Now, imagine you have an overly fragmented business. You are busy managing a lot of relations and an infinite list of products. You might even be frustrated because none of your endeavours is providing the satisfaction you are looking for. Days aren’t long enough to manage everything, and due to a principle discovered 200 years ago, someone is telling you that you are not managing your time effectively, that you should slow down, stop chasing every opportunity, reflect, and only dedicate your time to the ones who deserve your attention. You can overcome fragmentation by choosing vertical growth, which is possible only by increasing the revenue deriving from particularly deserving customers. This would involve dedicating more time to gain their loyalty and activating cross-selling and up-selling strategies that allow you to increase sales of specific products with the ones who have the potential to purchase them.

As we have seen, the Pareto principle, or 80/20 rule, can actively help us understand how healthy our business is, choose the most sensible challenge, and identify which strategy we should use to overcome the challenge. Of course, you need more than this to come up with a good marketing plan.

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Regardless of it being vertical or horizontal growth, we should identify which new customers, products, or services we should focus our actions on and understand who among our current customers offer the highest chances for growth.

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In order to do this, you need an in-depth analysis of the offering system, the potential, and the customer profiling, and subsequently start effective new business actions. However, without Pareto and his 80/20 rule, you wouldn’t have a compass to guide you!

EXERCISE: identify your growth challenge with the 80/20 rule

1. Find a file with data related to your revenue, preferably related to a complete time frame, such as a year.
2. Classify the results according to client and provided product or service, making sure you create a list ordered from the largest to the smallest element, where each element corresponds to a row (see example below). You will now have a client or product list sorted in terms of importance, from most significant results to least significant.
3. Calculate the figure that would correspond to 80% of the total result in the considered period. Now, add up the rows starting from the top. Stop when you reach a figure that corresponds to 80% of the total result.
4. Count how many rows you have had to add up and compare that to the total number of rows in your list. Is it higher or lower than 20%? If it’s lower, you are focusing on too few customers or products. If it’s higher, you are fragmented. In the first case, your challenge is horizontal growth, while in the other, you need to grow vertically. Do you need help? Contact us.

Client	Yearly revenue	%
1	280,00 €	28%
2	200,00 €	20%
3	150,00 €	15%
4	124,00 €	12%
5	100,00 €	10%
6	70,00 €	7%
7	45,00 €	5%
8	15,00 €	2%
9	11,00 €	1%
10	5,00 €	1%
	1.000,00 €

80% of the results in achieved with 4.5 clients, which is equal to 45% of the total clients. This means the business is fragmented.

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