Most people have heard about the Pareto Principle or 80/20 Rule as it is also known. The idea is pretty simple that 80% of something is generated by 20%. Pareto originally observed this in Italy, noting that 80% of the wealth was held by 20% of the population. Since then it has been applied to sales (80% of sales from 20% of customers), profit (80% from 20% of goods or services) etc. etc. The question we need to answer here is how to effectively use the 80/20 rule that was formulated in the late 1800’s in the 2020’s?
For many years the past was a good guide as to the future, but no longer. Even the banks who base most of their lending decisions on past performance by the use of historic accounts Accounts Are Not Designed For Effective Decision Making are made by law through SEC 156 to point out to their investment customers that past performance may not be indicative of future results.
Whilst the 80/20 rule still holds good we know that things have changed and the past really is no longer a good guide to the future. We looked at this in the blog How To Predict The Future and so our question should not be what 20% generates the 80% but what 20% will generate the 80% in the future? Just because we have had a highly profitable product, service or customer in the past does not mean that they will always be so. The “trick” in running a great business is not to look backwards but look into the future. Remember Kodak clinging to the highly profitable film business even though they practically invented the digital camera. I’m sure an 80/20 analysis would have told them that film was the profit generator. That is until it wasn’t!!!
When looking at plans and investments it is vital that we don’t base them on the past. To effectively use the 80/20 rule, by all means look at the current status of all products, services and customers but then look forward as to where the 20% will be in the future. Base any investment decisions on that, not the current numbers. The past is important but not nearly as important as the future.
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