by Trey Pruitt
When it comes to customer revenue, does the 80/20 Rule hold? Do 20% of customers really generate 80% of revenue?
The 80/20 rule, also known as the Pareto Principle, states that for many outcomes, roughly 80% of consequences come from 20% of causes. Mathematically, the Pareto curve is one of a class of "power law" statistical distributions. The sizes of cities, earthquake magnitudes, word frequency, and personal wealth all appear to have power law distributions. In business, this principle has often been stated as "80% of sales come from 20% of customers." While not a "law," this phenomenon can often be observed in the data.
In any series of elements to be controlled, a selected small fraction, in terms of numbers of elements, always accounts for a large fraction in terms of effect.
Through the analysis of many customer data sets over the last two decades, I have often found that the majority of revenue is generated by a minority of customers. It's not always 20% generating 80% of revenue. I have seen the top 20% of customers generating anywhere from 40% to 90% of revenue. This ratio depends on the business and the time frame measured. More often than not, the chart of customer and revenue data usually looks like the following:
Plotted as a cumulative chart, the top 20% (2 deciles) contribute about 60% of revenue, the next 2 deciles get us to almost 80%, and the remaining 6 deciles (60% of customers) contribute the last 20% of revenue.
If plan to make investments in customers based on their expected value, it's worth understanding the revenue distribution of your customer base and how to identify your best customers.
Are you wondering what percentage of your customers generate 80% of your revenue? Get in touch with me and we can discuss.
