We have all heard of the 80/20 principle. But how far does it reach?
Growing up, I thought I understood the 80/20 principle.
80/20 says 20% of your efforts will lead to 80% of your results. The other 80% of your efforts will only generate 20%.
That was as far as it goes. Or so I thought.
As time progressed, the concept began to mean less and less to me. It just became a buzzword people used when they were referring to clients, work, productivity, etc.
Never would I have imagined this principle was anything beyond a simple rule of thumb.
That is until I watched Perry Marshall, author of 80/20 Sales And Marketing speak at Entrepreneur’s Growthcon conference.
Perry went into details of exactly how far the 80/20 rule reaches:
80/20 is an exact science
The 80/20 rule doesn’t just apply to efforts at work. It applies to nature. Everything from the craters on the moon to sand in a jar, the 80/20 rule is universal and has far reaching implications.
80/20 rules the stock market
80/20 can be 70/30, other times 90/10. But that inequality is always there. 30% of the stocks on the S&P 500 generate 70% of the growth.
80/20 rules the Forbes 400.
30 percent of the Forbes 400 own 70% of the wealth.
But here’s where it gets interesting.
Within every 80/20, there is another 80/20 inside of that, then another 80/20 inside that.
To demonstrate, Perry made each of us stand up. He asked people who had over 5 pairs of shoes to remain standing. Then he asked people who had 10 to continue (to stand). Then 50. Then 100. Then 200. Then 300. He kept doing this until no one was left standing. He did the same thing with web domains.
In the audience, there were a few people who had more than 250 pairs of shoes! There were also a few people who had over 300 web domains!
But what does this mean?
This means that if you are not adhering the pricing of your products to the 80/20 principle, you are losing money!
With simple math, Perry explained that if you break down the 80/20 principle, it can help you to understand more about your customers:
- 4% of your customers will generate 64% of your revenues
- 1% of your customers will generate 50% of your revenues
- .2% of your customers will generate 40% of your revenues
How does that calculate?
Perry laid out a great example.
Let’s say you have a coffee shop. Each cup of coffee you sell is for $1.40. If you sell 10,000 cups of coffee, you will make $14,000. But for every 10,000 cups of coffee you sell, one person will spring for a top of the line espresso machine.
Let’s say you sell it for $2,700. 80/20 nearly guarantees you’ll make one $2,700 sale on top of the original $14,000. All of a sudden you’ve made nearly 2,000 times the money from your top customer as you made from someone who bought a $1.40 coffee. What if you could find a way to leverage that knowledge to make more money with less effort?
The question companies need to ask themselves is: “Do we have a high end espresso machine we could sell?”
Many companies fail because they don’t offer that higher-end experience.
What Perry recommends is that you multiply the most expensive product you have by 5-10X to increase your returns, then to do the same for the next product, then the next, then the next.
If you have 10,000 customers who are buying a membership for $10 a year, and that is your only product, you will be earning $100,000 a year.
But if you add a $40 membership, 80% (8,000) of your clients would still only spend $10, earning you $80,000. But the other 20% (2,000) are probably willing to buy that $40 package instead of $10. This generates an extra $60,000. By creating this second package, your yearly earnings go up 60% to $160,000.
Now, if you add a third tier at $160, 4% (400) of your clients will buy, picking up an additional $48,000. Your revenues rise again by 30%, to $208,000.
What if you included a fourth package at $640? Just how much more you would be earning each year? You now have 80 clients paying $640 a year. That’s an additional $38,400 a year, on top of what you were already earning. Your total revenue is$246,400. You were only bringing in $100,000 with single-tier pricing.
In total, you are probably leaving as more than half your money on the table if you are not obeying the 80/20 product pricing rule.
The rule is simple: 1/5th the people will spend 4 times the money. This keeps going until you literally run out of people.
So if you have a product with only one or two price points, now is the time to reconsider your pricing structure. If you don’t, you may run the risk of leaving money on the table, or worse yet, failing, because other businesses who do follow the 80/20 pricing strategy will be better capitalized than you.
The same principle applies to bad customers, product defects and missed revenue streams that drain resources. We will discuss that in a future article. If you aren’t compensating for low-revenue accounts with higher ticket sales and providing commensurate additional value, you will ultimately be doomed.
Have you tried a premium-priced offering recently? How has it worked in your business? I’d love to hear more! Comment below.
Originally posted on Inc.
Leonard Kim is Managing Partner at InfluenceTree. At InfluenceTree, Leonard and his team teach you how to build your (personal or business) brand, get featured in publications and growth hack your social media following.