Pareto’s 80-20 Rule & Profitability

80% of Profits may come from 20% of Customers, but sometimes 80% of Losses come from a Different 20%.

(Copyright PR Loyalty Solutions, 2011)

Vilfredo Pareto was an Italian economist who observed that 20% of the Italian population in the early 1900’s owned 80% of the land.  From this developed what today is called the Pareto Principle or the “80-20 Rule”, where frequently about 80% of a result is accounted for by 20% of some factor.

Today, it is a commonly accepted belief that about 80% of sales for a typical business come from 20% of its customers. 

A small percentage of a business’s total customers typically do make up a large percent of its overall sales and profits.  Frequently, another portion of a company’s customer base is either only marginally profitable or actually unprofitable to serve.  In his 2000 book Loyalty.com, Frederick Newell suggests that for a typical business, 10% of customers account for 30 to 50% of total sales and 60% of customers generate at least 90% of both sales and profit (p.41).   And in their book Loyalty Myths, Keiningham et al. (2005) argue that, “as dire as Pareto’s prescription is, the everyday reality is probably even more severe.  It’s likely (especially in services) that 60 percent of a business’s customers could actually be generating negative profits – costing the business money” (p.4).  They then go on to say that, usually, about 20% of a business’s customers generate between 150 and 300% of all profits, 60 to 70% of the customers are “break-even” and 10 to 20% of the customers lose 50 to 200% of total profits (p.43).

So what can one conclude from all this?  That businesses need to focus on their most profitable and valuable customers, and not spend too many resources on unprofitable customers.  Also, it can often make sense for a business to actually fire customers that eat up profits.  According to CRMtrends.com, “the bottom 30% [of customers] can eat up to half the profits. …  Even in the supermarket sector, by some estimates, seven out of every ten customers cost more to serve than they contribute in profits.”

So long as there are not adverse socioeconomic consequences (like the inability of the poor to receive basic services) then this is something many businesses need to consider.  Other things to consider too are who is one’s target market, what are the ethics and values of the business, and what is making some customers unprofitable.  A business needs to identify its target market and then focus its strategy and efforts on that target (and make sure it’s one the business can profit from).

Click here to see our Bibliography and Academic References Resources.

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PR Loyalty Solutions is a customer loyalty marketing consulting firm specializing in reward program design, effectiveness audits, and coalition community reward program creation.  Need advice on how to create or improve a customer loyalty program?  Then Contact Us.

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