Finance: Fast Track to Success

What is it?

Pareto profiling is a tool for analysing the true profitability of products,

customers and suppliers.

Why use it?

As organisations develop, they often add new customers, products and

activities, but they are often poor at stripping out unprofitable ones. This

is made worse by the fact that most performance systems support the

continuation of historic activities (i.e. salespeople are incentivised on

sales – often without any true measure of how profitable the sales are).

In addition, standard costing systems tend to hide the true profitability

(or unprofitability) of areas of the business.

How do you use it?

So how do you start? Simply order your product list (or customers or

suppliers) on a spreadsheet from high revenue (or contribution) to low

revenue (or contribution) – with the highest at the top. This simple activ-

ity is often enough to get the team to think about two key issues:

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1 Why are we n ot focusing more on our most important prod-

ucts (or customers or suppliers) and finding ways to increase

pro fitability? Many organisations fail to treat their most impor-

tant customers (or key accounts) differently. The rule of 80/20

suggests that 20% of your products or customers will deliver

over 80% of your revenues.

2 Why are we continuing to sell products (or deal with cus-

tomers) that deliver such a small contribution to the bottom

line? Many products and customers will actually be unprof-

itable, since the rule of 50/5 suggests that the bottom 50% of

your products or customers will deliver less than 5% of your

revenues cumulatively (see figure). Just think what level of

overhead cost is incurred in servicing this ‘tail’. Pareto analysis

such as 50/5 can be a great spur to taking a decision that

would otherwise be shirked, such as cancelling a product set

because of its low contribution.

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ART D DIRECTOR’S TOOLKIT

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Removing the

complexity:

the rule of 50/5

Suppliers Activities Customers

Inputs

(supplies)

Outputs

(products)

Prospects

CONTRIBUTION

VOLUME ADJUSTED

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