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The Pareto Principle (also known as the Law of the Vital Few) is a theory that suggests for most events, roughly 80% of the effects come from 20% of the causes. This has also lead to it being known as the 80/20 rule, although in many cases the rule can be generalized, so 90/10 is also possible.
Origins and Evidence
The first person to notice this effect was Vilfredo Pareto, who noted that 80% of the land in Italy was owned by 20% of the people, and that 20% of the pea pods in his garden produced 80% of the peas. This same ratio or law seems to appear in many places. For instance, economist Edward N Wolff, of New York University calculated that the top 20% of US households owned 85% of the wealth.
A study by Tan and Sessie in 2009 used Netflix’s ratings as a rough method to define movies viewed (with a sample size of over 100 million movie titles), and found that the top 20% of movies accounted for 90% of the viewing share. Evidence has been found for this effect in a wide range of phenomena, including word frequency in books, and the traffic to sites on the internet.
The Pareto Principle in eCommerce
If the Pareto Principle is found in so many places, it logically follows that there must be implications for business and eCommerce. A study of Yahoo Auctions demonstrated that 20% of the sellers attracted more attention and sales and constituted 80% of the auction market. Another study was conducted using the GfK group’s data on book sales in France, where it tracks book sales in almost all outlets (including 3,500 outlets). They found that the top 20% of the best-sellers amounted to 87% of online sales, and almost 93% of offline sales.
By paying attention to your own business, you can identify similar patterns, and use these insights to improve your service. There are a wide range of claims made for the eCommerce implications of the Pareto Principle, but it would be a bad idea to apply across every aspect. Not all the ideas have been validated (nor invalidated), but should be paid attention to in order to see if the pattern matches in the particular case of your store.
Here are some applications of the Pareto Principle in eCommerce:
- 80% of your sales come from 20% of your products
- 20% of your customers will take up 80% of your customer services time
- 20% of your efforts will bring in 80% of your returns
- 80% of a company’s profits come from 20% of the time its staff spend
- 80% of a company’s sales are made by 20% of its sales staff
Applying the Principle
These are eCommerce metrics that are easy to measure, and if proven true in your particular case, can be used to increase the efficiency and quality of your sales. For example, evidence does suggest that the top 20% most popular products will constitute 80% of sales. If your store also matches this pattern, it makes sense to ensure that such products are always in stock.
When it comes to customer service, if it turns out that 20% or less of your customers take up 80% of your customer service time, it is worth assessing whether the customers in question are high-value. If so, the time spent may be justified. However, if you’re spending 80% of your customer support time supporting a subset of customers that don’t constitute a large amount of your sales, it may be worth considering restructuring how you run your customer service.
How to Use the Principle Effectively
The Pareto Principle does appear in numerous aspects of eCommerce, but should not be treated as dogmatic or a “hard rule”. A wise approach would be to set up your metrics to track data that might capture such relationships, and determine where efficiency and productivity can be improved. For instance, tracking the time you spend on your business and examining the effects of the work will give you a better idea of where you should focus your efforts.
Identifying customers that account for the majority of your sales may mean dedicating more time to them, and paying more attention to their habits, behavior, and needs. Rather than blindly applying the rules, the approach advocated here is to collect more data on your business and identify where the Pareto Principle applies with a degree of certainty, you will find many of the patterns mentioned, but being certain before making changes would be prudent.
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