Friday, February 6, 2009

The Pareto Principle

Firstly, my apologies for taking so long to post! There have been quite a few life changes in the last couple of months for Carly and myself- times are busy sisters!

About a month ago, I stumbled upon something called The Pareto Principle while I was studying marketing techniques. Wikipedia describes The Pareto Principle as this:

The Pareto principle (also known as the 80-20 rule, the law of the vital few and the principle of factor sparsity) states that, for many events, roughly 80% of the effects come from 20% of the causes. Business management thinker Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who observed that 80% of the land in Italy was owned by 20% of the population.[3] It is a common rule of thumb in business; e.g., "80% of your sales come from 20% of your clients."

They go on to say (for perspective):

The Pareto Principle also applies to a variety of more mundane matters: one might guess approximately that we wear our 20% most favored clothes about 80% of the time, perhaps we spend 80% of the time with 20% of our acquaintances, etc.

The Pareto principle has many applications in quality control.[citation needed] It is the basis for the Pareto chart, one of the key tools used in total quality control and six sigma. The Pareto principle serves as a baseline for ABC-analysis and XYZ-analysis, widely used in logistics and procurement for the purpose of optimizing stock of goods, as well as costs of keeping and replenishing that stock (Rushton et al. 2000, pp. 107-108).

In computer science and engineering control theory such as for electromechanical energy converters, the Pareto principle can be applied to optimization efforts. (M. Gen & R. Cheng, Generic Algorithms and Engineering Optimization. New York, Wiley, 2002)

Microsoft also noted that by fixing the top 20% of the most reported bugs, 80% percent of the errors and crashes would be eliminated.

The Pareto principle was a prominent part of the 2007 bestseller The 4-Hour Workweek by Tim Ferriss. Ferriss recommended focusing one's activities to those 20% that contribute to 80% of the income. More notably, he also recommends firing the 20% customers who take up the majority of one's time and cause most trouble.

(On a side note: Four Hour Work Week will be our next give away on March 15th- you must be a follower by the 1st to be in the drawing).

So what does this mean? How can we use this to make our business more efficient? Let's put it to the test (Keep in mind please that this is a VERY basic scope of how this can work for you.)! This is going to be different for every business out there. Carly and I spoke about the 20% of clients that bring each of us the most income. To get to that conclusion, you must first make a list of the types of clients you receive. Be as specific as possible. For example (using our tree business- your list may be completely different):

1. Clients in urban and suburban areas

2. Clients in rural areas

3. Men clients

4. Women clients

5. Clients who find us from Craigslist

6. Clients who find us through fliering

7. Clients who find us through our website

8. Clients who find us through word of mouth

9. Homeowners

10. Land developers

Now in practice, you should be literally writing down every client you've ever had and where you've found them. We will use my ten above as a test- though we get clients from more than 10 sources.

From the ten sources above, the principle states that two of them deliver 80% of our clients. The top two on that list for us are clients in rural areas, and clients through word of mouth (very specific word of mouth/ generally professionals in the tree business that do not do quite what we do, and therefore send clients our way).

So now we have a starting place. We need to focus more of our energy and advertising dollars on clients in rural areas and clients through word of mouth. We have to start getting creative about how this can work. Off the top of my head- we can take out an ad in rural newspapers. We can do fliering in rural areas (where so far our fliering has been in suburban areas). I have a very specific idea for how to create more word of mouth leads: cold calling tree businesses that I know don't do what we do. Then we can offer a finders fee for any leads they send our way, or offer to send the clients that contact us regarding what they do their way. I am leaning towards the former, because I will hopefully end up with quite a few professionals offering to send clients our way. If that's the case, I can't in good conscience promise them each that we'll send clients their way since there'll be more than one of them.

Another spin off from the Pareto Principle is Six Sigma. Six Sigma is process improvement for the sake of your business.

From Wikipedia:

Six Sigma is a business management strategy, originally developed by Motorola, that today enjoys widespread application in many sectors of industry.

Six Sigma seeks to identify and remove the causes of defects and errors in manufacturing and business processes. It uses a set of quality management methods, including statistical methods, and creates a special infrastructure of people within the organization ("Black Belts" etc.) who are experts in these methods. Each Six Sigma project carried out within an organization follows a defined sequence of steps and has quantified financial targets (cost reduction or profit increase).
Read more in depth here:

I have also come across an online book called "Six Sigma For Small Business" that you can download for more in depth learning.

So now you have an idea of how you can use process improvement to advance your business. This is a topic that a gajillion books have been written on, so I feel almost silly posting something so remedial, but my hope is that it will make your thirst for more information grow and you'll get out there and figure out how to make this work for you!!!!

Godspeed ladies!