The 80/20 Conundrum: How to Improve Your Margins

In most companies, the top 20% of customers generate close to 80% of profits. But there are ways to improve the performance of the other 80% of customers. By using the Pareto Principle — also known as the 80/20 rule — in tandem with the true cost of complexity, you can effectively tailor specific actions to your portfolio and successfully raise your margins. Unfortunately, standard financial absorption costing does not provide accurate guidance on how to best allocate your resources on the remaining 80% of your customer population. By segmenting both the 20% and the 80% into distinct strategies, performance improvements can be achieved.

Don’t be held ransom

Many businesses using the 80/20 rule are hesitant to raise their prices for those customers in the 80% bracket, for fear that they will lose sales. In fact, businesses tend to focus on their lower-performing customers because they see them as potential growth opportunities. Dig a little deeper, and you’ll discover that 40% of U.S. business revenue comes from repeat customers — but these customers account for only 8% of all customers.

What does this mean for the growth-oriented business? Break out of the cycle of working for a dime, not a dollar — don’t be held ransom by fear.

Making 80/20 work for your business

All this means making some big decisions. But don’t be discouraged; there are a number of ways to strategically apply the 80/20 rule within a business portfolio to generate profitability and reduce complexity across the board.

  1. Pricing — Resist the urge to apply a one-size-fits-all approach to pricing. Refine your cost structure by layering true profitability segmentation with the 80/20 rule to optimize pricing results and reduce pricing leaks. Why? Margin-driven profiles of clients and products allow for a clearer understanding of which need specific pricing actions. As a result, businesses will be able to observe which clients and/or products are most profitable within their portfolio, including those in the 80% bracket. Isolating profitable products not only drives revenue but also reduces complexity by removing focus on redundant processes.
  2. Assess complexity — Assess the scope of complexity within your organization by identifying the reasons behind particular clients and/or products not generating the intended margin. By evaluating complexity from a true profitability perspective, you restate the contribution margins of the 20% of your customers who make 80% of your profit and define different portfolio priorities. This process makes it easier to determine specific problem areas.
  3. Divide and conquer — Illuminate redundancy while enhancing productivity and effectiveness by defining specific 80/20 tasks that deal with not only product complexity but also the underlying drivers and processes. Don’t allow the groups to exist in a vacuum; look to align them with key priorities and ensure that effective lines of communication exist. Strong communication will allow those dealing with process complexity to provide valuable insights into platform redesign, Direct Material Optimization (DMO), product modularization, or commercial processes that avoid excessive complexity and inefficiency.
  4. Spring cleaning — Most businesses are burdened by more processes, clients, products, suppliers, etc., than are needed for positively impacting their true bottom line. Despite this adding to operational complexity, organizations tend to expand their operations over time, meaning that obligations become increasingly expensive and cumbersome without ever evaluating their true worth. Is it easy to throw away your favorite pair of sneakers? No, but in the end a good spring cleaning is more important than sentimentality — and the same idea can be applied to businesses. Conduct an 80/20 audit (known as managing the long tail) on vendors, clients, processes, products, etc., and get ready to cut some of those losses.

The AlignAlytics approach

At AlignAlytics, we’ve found that most product simplification approaches only focus on the symptoms; few companies have a formal process to manage portfolio optimization, product line simplification, or complexity governance. This is why we developed 80/20 Align, a system that provides data-driven complexity management by illuminating the true cost of complexity, its related causes, and the actual margin impact.

Complexity doesn’t need to get the best of your business, nor does its ebb and flow need to be dictated by the standard patterns of the 80/20 rule. With some honest evaluation of every aspect of your business and widespread data analysis, you can find ways to tighten margins and improve profitability while reducing complexity.

Want to maximize the 80/20 rule to help your business to grow? Reach out below or follow the author link.

Author: Patrick Mosimann

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