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Wednesday, May 2, 2012

Pareto Principle



You’ve heard it time and time again, “70 percent of your sales come from 30% of your customers.” Or if you are in retail you will hear that “80 percent of your sales come from 20% of your inventory.” Whereas this may be true one must realize that 90% of all statistics are made up on the spot.

In redneck terms, don’t trust what someone tells you, do the math yourself.  If you have a store and you want to determine what percentage a particular item has of your sales you take the total sales revenues of the item and divide it by your total sales.

Example:

If you sold $50 worth of moon pies today and your total sales were $300 then you would have

Sales of Moon pies ÷ Total Sales
So, in this case $50  ÷ $300 = 16.67%

The whole thing was named after an Italian economist named Vilfredo Pareto. It seems that a business management consultant named Joseph M. Juran came up with the concept and named it after Pareto.

So, how does this apply to you? Peter Drucker is often credited with having said, “What gets measured gets done.” That being said, it is important to measure how well your products are performing or how well your efforts are paying off. Ideally everything you have to sell is pulling its own weight. As I said in earlier posts, each product has to pay its rent. A business should from time to time review and see what products are bringing in the highest percentage of profit. That way a concentrated effort can be made to improve the placement of those products. At the same time the business needs to know what products aren’t doing so well. Those products need to be reviewed. If a change can be made to improve the sales of those products then by all means change them. But, if no improvement can be made the product must be removed from the product mix. This makes room for more of the better selling products and, hopefully, frees up some of the money tied up in unsellable inventory.



Disclaimer
The opinions or advice listed in this blog or website should be used as a place to start only. It is not a substitute for the use of a professional.
Please be sure to consult your attorney and/or accountant with any specific questions.
There is no one right answer to any business question that will cover all circumstances.
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