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Applying the 80/20 Rule to Drive Revenue

Share current LOB: SmallBusiness

Profit-oriented business owners observe one of the most fundamental, yet often ignored, rules of profitable growth — the 80/20 rule, also known as the Pareto principle. The rule suggests that 80 percent of the benefit comes from 20 percent of the effort. Many businesses apply this common-sense principle to find ways to save money, and the rule generally holds true.

Many business owners forget this rule also applies when it comes to making money through top-line growth and profitable sales. The tendency to allocate the same resources to every potential sale and customer leaves many businesses with a mixed bag of deals, some of which may not be conducive to growth and profitability.

If they looked, most owners would find they do in fact have unprofitable customers and products. Owners should know their “pockets of profitability” or the products, customers and markets that are creating the profits, and focus on them instead of the ones that cost time and money.

If resources are tight, one of the quickest ways to free up time and money, while still making a profit, is to actively manage your most unprofitable customers. You can do this by raising prices, changing terms and renegotiating contracts to reflect your true economics. You might also consider cutting back or even dropping your most unprofitable product lines.

Unfortunately, most business owners don’t take the time to look for pockets of profitability. SunTrust Business Owner Research shows the majority of business owners are not tracking profits by market, customer or product line. Fortunately, there are tools to help you get started.

Using accounting software, such as QuickBooks®, makes tracking sales and costs associated with specific customers and products as simple as asking your accountant to set up a coding and input process for time, invoices and expenses. This process allows you to run regular customer and product profitability reports to help you answer three important questions:

  • Who are my most and least profitable customers?
  • Which are my most and least profitable markets?
  • What are my most and least profitable products?

You can even look at your profits by market segment using a field in QuickBooks called “customer type,” which lets you group customers into different markets. Once you have identified your most profitable markets, customers and products, it is much easier to sell to existing customers than to new ones.

Businesses that ignore the growth potential of their customer bases are leaving profits on the table. Customers are the most important growth assets your business has for the following reasons:

  • Most new revenues come from existing customers.
  • Most new business comes from referrals.
  • It is more cost-effective to sell to an existing customer than to a new one.

Many businesses fail to focus enough on cross selling, referrals and customer retention in their growth plans. In other words, they do not diligently manage and develop their best customer relationships.

SunTrust research indicates 53 percent of businesses do not measure customer retention, and 40 percent do not track which customers refer business. Even fewer, only six percent actively ask existing customers to introduce them to people they know. To fully leverage your customer list and identify your top 20 percent tier, you need answers to these key questions:

  • Which customers are “net promoters” of my business?
  • Who are the top people — about 50 to 100 — who matter most to my profit growth?
  • Where can I find new customers who “look like” my most profitable customers?
  • Which top customers have additional needs or upsell potential?

Use the answers to these questions to make a list of your best and most profitable customers. Then use that list to determine how you allocate sales and marketing resources.

A Case Study

A small technology company analyzed its product profitability and found that although most of its sales came from IT support services, security systems were actually four times as profitable. By shifting more marketing energy to selling security systems, this company began to generate more profit with exactly the same resources.

Additionally, when they grouped customers into a few simple market segments, they learned the dental market generated a greater share of profits, despite the fact the majority of sales were generated in the veterinary market.

This allowed them to assess their sales and marketing allocation with a focus on profit and total sales potential.

Source: Kensington Business Solutions case study

After analyzing its product profitability, a small technology firm shifted more of its marketing energy from its most sales generating products to its most profitable products and began to generate more profit with exactly the same resources.

About SunTrust Business Owner Research: SunTrust surveys small business owners and advisors as part of its ongoing business seminars and symposiums. The small business owners attending these events include both SunTrust client and non-client business owners and are representative of the broad spectrum of businesses located in the SunTrust markets. The research cited in this report is extracted from these 5,425 small business owner surveys collected between 2007 and 2011.

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

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