Some headlines sound just too good to be true, and they generally are. Making more money by doing less sounds like a ‘contradictio in terminis’ as the old Romans used to say, ‘a contradiction in words’.
But it is not. We probably all know how to do it, we’ve all learned about it in university or college, but kind of forgotten about it or didn’t believe it was applicable. The answer is a basic economic law that arose in the same country that gave birth to the old Romans who gave us so many posh sayings.
Born in 1848 as Fritz Wilfried Pareto in Paris, son of an exiled Italian (Genoese) noble and a French mother who was so impressed by the German revolution of 1848 that she gave her son a German first name. When the family moved back to Italy when Fritz Wilfried was 10 years old, they ‘Italianized’ his name to Vilfredo Federico, as we still know him today.
Vilfredo Pareto. received an excellent education and worked for many years as a civil engineer in the railroad industry where he eventually became the CEO of 2 Italian railroad companies. It wasn’t until his early forties that he started to publish on economic theories. He wrote most of his works in his “Villa Angora” in Celigny where he lived together with his wife and their 18 Angora cats. His work gave rise to the behaviourist movement in economics during the seventies of the previous century with some of the most famous disciples being Nobel prize winner Daniel Kahneman and his research companion Amos Tversky.
Vilfredo was the first to describe what is now commonly known the 80/20 rule. Based on his research, he found that throughout history 80% of the wealth was owned by 20% of the population. He also observed that about 20% of the peapods in his garden contained 80% of the peas. (Peas were a big thing a century ago, never understood why they went out of fashion)
Not only peas showed this behaviour, but also quality issues. During the forties of the previous century, people found out that the 20% of the issues caused 80% of the quality problems. In healthcare, researchers found that 20% of patients consume 80% of the healthcare budget. The list of applications of this rule go on and on.
Also in business. There we found that 20% of the customers are responsible for 80% of the business and 20% of the products generate 80% of the revenue.
So, what does this all mean to our quest of making more money by doing less?
Can the answer be as simple as just stop serving some customers or discontinue some products? Well not exactly, but close. It is in mapping the 2 analysis on each other that the magic happens. What if some of those 80% of customers, who really don’t contribute much to your revenue, are the ones that order loss generating products nobody else takes? These cherry pickers tremendously increase both your cost base and your working capital. They should be dealt with.
With the following 3 steps, you will be able to make more money by doing less. Get out your spreadsheets, and start mapping;
Step 1: Analyse your product portfolio; Look at your products from a contribution point of view. In its simplest form, you take sales in volume multiplied by nominal margin (how much you earn per product in currency, no percentage) and plot it out. This will quickly show you which products contribute most to your profit, and allow you to do an ABC classification of your products.
Step 2: Analyse your customer portfolio; Similar as step 1, plot you customers from high to low based on the profit they bring you per annum (or whatever time period makes sense in your business). Result is an ABC classification of your customers.
Step 3: Put the 2 together; learn which C-Customers only take C-products and which C-products are only purchased by C-customers
Behold the opportunity for doing less and making more money.
However, before you do anything rash like immediately kicking these C-classes out, talk to these customers. Find out if there is opportunity to grow, learn how they can contribute to your current or future success. Remember, it is easier to grow a customer than to find a new one. See if you can convert them to the path of profitability and steer them away from products or services that only cost you money. Only if all this fails, pull the plug, your CFO and shareholders will love you for it.
Let me know what you think and share your personal insights. Want to have a more in-depth discussion on the topic, don’t hesitate to reach out to me on www.WidePeak.com.