A common adage in business is “80% of your sales will come from 20% of your customers.” It’s called the 80-20 rule, or officially, the Pareto Principle. But as with most old adages, it is just that: old. Our economy looks so different today than when the Pareto Principle was first described, business leaders might want to reconsider if it is a universal truth before using it to make important decisions.
Where did the Pareto Principle come from?
The Pareto Principle was first observed by the Italian economist, Vilfredo Pareto, in 1906. He noticed that 80% of the peas in his garden were produced by just 20% of the pods. He used this insight to look at land ownership in Italy and found that 80% of the land was owned by just 20% of the people. The Pareto Principle has since been used to describe many phenomena where roughly 80% of consequences are attributed to just 20% of causes.
What is different today?
The world we live in today hardly resembles the world of 1906. For example, I can only guess that Vilfredo might have had a more consistent yield if his garden consisted of genetically modified pea plants!
The way we buy and sell goods and services has also changed. Two significant examples are e-commerce and subscription-based companies.
Alongside e-commerce, subscription-based companies have surged in popularity. Take, for example, Netflix. Whereas before, a typical consumer might purchase one DVD every few months and the movie-buff might buy several DVDs every month, Netflix turned each of these consumers into equal subscription-based customers, both paying $10.99 per month.
In addition to movies and TV, we can find subscription-based companies selling just about everything. Loot Crate, a monthly “Geek Subscription Box” of collectables, was named by Deloitte as the fastest growing company in 2016. Blue Apron pioneered meal-prep subscriptions, forging a new industry of weekly uncooked meals delivered to your doorstep. Even companies like Microsoft have transitioned products like the Microsoft Suite into annual subscriptions rather than an upfront purchase.
Is there evidence the Pareto Principle is relevant today?
The question then looms, does the 80-20 rule hold true in the modern economy?
I have now been a collaborator in two studies on the Pareto Principle and found striking results. On one hand, we can certainly see that generally, there is a concentration of sales among the top 20-30% of customers. On the other hand, we see new business models lessening that concentration.
My first look into this focused on companies that sold consumer-packaged goods (CPG), or what you would typically see on the shelves of grocery stores. The study was conducted in 2017 and included data from 22 CPG categories and purchase histories from more than 100,000 households. We found that by and large, the Pareto Principle remained true with an average of 73% of sales attributed to the top 20% of customers.
In 2018, we used the same method to study data representing a much wider selection of companies, excluding CPGs. With this data set of 339 publicly-traded companies, we were able to take a closer look at subscription-based services. Our first conclusion was that even excluding CPGs, we still found evidence of the Pareto Principle; 66% to 67% of product and service sales in our study were attributed to the top 20% of customers. While it’s not 80%, it still indicates a high concentration.
However, we found a big difference between subscription and non-subscription businesses. Non-subscription businesses attributed 68% of sales to the top 20% of customers. Subscription businesses attributed 59% of sales to the top 20% of customers.
So, what does this mean? Some companies, especially subscription businesses, may not need to rely so heavily on a small concentration of top customers to keep their business afloat. Since the group of top customers is getting larger, this might raise questions about how to best invest in customer service.
But more importantly, this new information means that as business leaders make decisions about structuring business models and how to spend company resources, they may not be able to rely on the old 80-20 rule for guidance.