What is the '80-20 Rule'
The 80-20 rule is a rule of thumb that states that 80% of outcomes can be attributed to 20% of all causes for a given event. In business, the 80-20 is often used to point out that 80% of a company's revenue is generated by 20% of its total customers. Therefore, the rule is used to help managers identify and determine which operating factors are most important and should receive the most attention, based on an efficient use of resources.
BREAKING DOWN '80-20 Rule'The 80-20 rule is also known as the Pareto principle, the principle of factor sparsity and the law of the vital few. At its core, the 80-20 rule is a statistical distribution of data that says that 80% of a specific event can be explained by 20% of the total observations.
The 80-20 rule was first introduced by Italian economist Vilfredo Pareto, who, in 1906, observed that 80% of Italy's land was controlled by 20% of its population. From there, it was developed by Joseph Juran, a 20th century figure in the study of management techniques and principles. Jurin took the rule and applied it to a number of different facets of business and the economy. It is now used to describe almost any type of output in the real world.
Real World Example of the 80-20 Rule
For example, the 80-20 rule in economics refer to the fact that 80% of a country's wealth is usually controlled by 20% of its population, although this can sometimes be explained by the Gini index. Nigeria was found, on June 22, 2016, to have this exact distribution of wealth within its country's borders. The minimum yearly income needed to sustain a living in Nigeria was $1,000 as of June 22, 2016, yet more than 74% of the population lived below this poverty level.
This distribution came after the country's population grew by 12% while its GDP rose by 54% from 2010 to 2014. However, the allocation of the increased wealth was not even, and it exacerbated the income inequality, thus adding to the Pareto principle.
Practical Application of the 80-20 Rule
The 80-20 rule is most commonly used for analyzing sales and marketing. If a company can identify its highest-spending customers, it can effectively market to them in order to retain existing customers and acquire similar consumers. Therefore, companies should dissect their revenues and understand who makes up their top 20% of customers.
From there, it's been found that the top 4% of a customer base accounts for 64% of total sales, meaning that the more granular a company can get in its analysis, the more accurate the understanding of its customers becomes. This then allows companies to launch targeted marketing campaigns aimed at resonating with the most impactful consumers.