Enterprise Software

Think 80/20 is a new idea? Here?s how to wise up

Some CRM applications promise to find the top 20 percent of your customers and turn them into buying machines so you don't waste resources on the remaining 80 percent. Find out why this popular theory has major flaws.


Are you hearing about the 80/20 rule of customer relationship management? Many vendors and consultants are using the 80/20 rule as a popular sales pitch, touting it as the success strategy for businesses seeking out a customer relationship management (CRM) solution. But how does the 80/20 rule work in business, and what does it mean for CRM?

The 80/20 rule states that 20 percent of customers are driving 80 percent of your business. The idea is that applying it to CRM applications, such as data mining, campaign management, and sales force automation, will help your business identify your best customers—that 20 percent segment.

In this article, I’ll explain the origins of the 80/20 rule. And I’ll tell you why some economists disagree with this principle and argue that it would be harmful to apply it to a CRM strategy.

A popular rule
The 80/20 rule is not applied only to CRM applications, it’s frequently applied to a variety of business and management situations. Here are a few examples:
  • 80 percent of your profit comes from 20 percent of your customers.
  • 80 percent of customer service problems come from 20 percent of the customers.
  • 80 percent of human resource problems come from 20 percent of the employees.
  • 80 percent of your results will come from 20 percent of your effort.
  • 80 percent of a manager’s time is spent pushing papers while 20 percent is spent actually managing.

The list of examples of where “80 percent of x means 20 percent of y” can be applied is virtually endless.

Where did it come from?
The principle of the 80/20 rule is not new. It is called Pareto’s Principle and was developed by Vilfredo Pareto, an Italian economist and sociologist born in Paris in 1848.

Pareto was interested in class distinctions and the distribution of wealth among societal classes. He studied the class systems of different European countries and formulated that the distribution of wealth in each country fell roughly into an 80/20 division. He found that 20 percent of the people in each country made up the ruling class and controlled the other 80 percent of the population, and that the same top 20 percent controlled 80 percent of the wealth.

Pareto also believed that even if there were a major shift in a country’s social system, such as an economic recession or a military revolution, this disruption would not mean an end to the 80/20 ratio. Instead, society would eventually revert to 80/20 segments. In addition, Pareto developed the theory of the “circulation of elites,” which says that no matter what political system is in place (communism, fascism), an elite class will always surface, and the 80/20 cycle will continue.

Where does CRM fit?
So what do the ideas of an Italian economist at the turn of the last century mean to CRM? On the surface, it makes sense that marketing and selling to the top 20 percent of your customers will keep you from wasting valuable resources on the remaining 80 percent—the deadbeat customers. But many economists disagree with this idea for several reasons.

If Pareto’s Principle is followed to the letter, the 20 percent of customers CRM is designed to identify will eventually fall into another set of 80/20 segments. This continual breakdown of the top 20 percent will ultimately leave you with one customer, who is unlikely to create 80 percent of your profit. Following the principle also becomes problematic if you have failed to isolate the right 20 percent at the beginning. In a business, an entire 80 percent of your customer base cannot be ignored.

J.M. Juran, a Romanian immigrant to the United States who is also an economist, took Pareto’s Principle one step further. In the early 1900s, Juran said that it represents the relationship between the “trivial few and the critical many.” Common sense would tell any business that customers who buy, even if they do not belong to the elite 20 percent, are not trivial.

A modern-day interpretation
In a recent article, “Writing off 80 percent of customers is economics gone berserk,” published by American Banker, financial expert Jerry Weiner warns, “At some point, forcing unprofitable customers away would result in the loss of more incremental revenue than expenses.”

As for losing revenue, CRM applications also promise to take that 80 percent segment of “unprofitable customers” and turn them into customers who actually open their pocketbooks. But how is that possible if all of your energy in sales and marketing is targeted to the top 20 percent?

A more realistic theory behind CRM is that not every customer will be a highly profitable piece of your business, and not every customer is going to respond favorably to marketing campaigns. CRM applications are not a set of magical end-to-end business solutions. So if you’re feeling pressured to buy from a vendor or an application service provider (ASP) that’s telling you their product will create an 80/20 win-win situation for your business, ask them about Pareto.

Is CRM a passing fad or a new beginning?
Is your senior management team talking about implementing CRM? What issues are surfacing because of the talk? Post a comment below or drop us a note to tell us what you think.

 

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