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:
T3 PARETO PROFILING
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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.
ART D DIRECTOR’S TOOLKIT
the rule of 50/5
Suppliers Activities Customers
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