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What is the Pareto Principle?

Learn about:

  • What the Pareto principle is
  • How to use the Pareto principle in retail
  • What to do to mitigate the Pareto principle effects

To be successful in retail, you need to know which goods make sales. Knowing what makes your inventory and supply chain forecasting more effective is the key to a better business.

Vilfredo de Pareto, an 18th-century Italian sociologist, noticed that around 20% of Italy’s population owns 80% of the country’s land. To his surprise, he found that the rule applies to other aspects of society and even other countries.

Suppliers can exploit the Pareto principle to gain a better understanding of their business management. Here, you’ll get an in-depth knowledge of the Pareto principle and its effect on improving sales.

What is the Pareto Principle?

Many new suppliers looking to improve their profits do some research and get stuck on a simple question: What is the Pareto principle?

The Pareto principle means that 20% of causes produce 80% of overall results. Put simply, 20% of drivers cause 80% of car accidents. Or, 20% of a nation’s retail stores sell 80% of the nation’s consumer packaged goods (CPG)

In retail, that means that 80% of overall sales come from 20% of products in-store. It also means that 20% of customers account for 80% of overall sales.

Pareto’s 80-20 rule might sound simple, but it is a powerful tool in your arsenal. You can apply the rule to pinpoint both your weak spots and strengths. 

Unlike other principles used in business, the Pareto principle isn’t a law. Instead, the principle is an observation that can help create a better understanding and a stronger foundation for future business plans.

For example, a general goods retailer might think that every item in the store brings roughly the same profit. However, around 80% of profits may come from dairy products or maybe fruit and vegetables. 

The main advantage of Pareto’s 80-20 rule is that it offers a clear view of what’s helping and what’s hurting your business. The main disadvantage comes from the fact it’s an observation. Meaning, the 80-20 rule isn’t “set in stone.” 

What sounds simple on the paper might prove to be difficult in practice. What products are running your business? Should you focus on restocking or pump into further marketing of the well-performing items?

How to use the Pareto Principle in retail

Using the Pareto principle in retail depends heavily on the inventory type a supplier has, such as finished goods or raw materials. Depending on the inventory type, the supplier’s customers will also be different, and the supplier will therefore need to create a matching plan.

Stock-Keeping Unit (SKU) rationalization

To create a successful plan, suppliers have to track their inventory.

A stock-keeping unit (SKU) is an item code that a supplier creates for a product. The code helps vendors track inventory’s movement and is the best way to understand what rates specific products are selling. SKUs track services as well. 

A high SKU rate means that a specific product is selling well. Suppliers can use this knowledge in several ways, often depending on particular aspects of a product. Is the reason for the item selling because it’s a seasonal product? What if business shifts that are outside the supplier’s control provide the necessary push?

It’s hard to discontinue products once the store shelves hold hundreds, maybe even thousands of distinct products, but an effective stock-keeping unit rationalization can help discover genuine reasons to reduce the number of different products and better streamline the ones to keep

That doesn’t mean suppliers have to remove 80% of selling products. Instead, suppliers should seek to use the Pareto principle to cut some weight from the product bag and create space to enhance the well-performing sales.

Every product in a supplier’s supply plan requires attention. Discontinuing a couple of low-performing items provides the valuable time suppliers need to focus on the goods that bring profit.

The Pareto Principle and retail replenishment

It’s improbable that suppliers will have the time to zoom in on every single product, but they can use the Pareto principle in retail to mark the ones that might require attention. The next step is to anticipate what the future holds for that item.

Having an excellent replenishment plan means that stores don’t run out of items that are bringing money. However, just because an item is selling well now doesn’t mean it will sell well in a month. Walmart might see a boost in turkey meat sales in November, but that doesn’t necessarily mean an upward trend for December and the following year. 

Related Reading: Replenishment 101: What Is Replenishment?

How to mitigate the effects of the Pareto Principle

Unfortunately, discovering that a product isn’t selling doesn’t come with a clear solution. Instead, suppliers must analyze the effects of why one product is selling while another isn’t. There are a couple of steps to go from figuring out a problem to a solution:

  1. Gather feedback: Besides listing possible issues, a vendor should gather feedback from employees, suppliers, and customers. Creating a survey or a helpdesk can provide the necessary information.
  2. Identify fundamental causes: Some causes vendors can impact while others are out of their reach. Shortlisting the ones the supplier can affect will save time.
  3. Score causes: Although sometimes challenging to figure out, some causes are more impactful than others. Suppliers can use costs to score, or if their focus is marketing, they can score by how many new customers each campaign brings.
  4. Group results: Suppliers should group the possible results using the same cause. Maybe three different products are selling well because they are the first items customers see when entering the store. The same logic can apply to poor-performing items.
  5. Score groups: Suppliers should then score the created groups. They can also use cost or any other element. The top-scoring group is the one they should focus on first.
  6. Carry out actions: The group that’s at the top of the scoring list requires the supplier’s immediate attention.

Remember that just because something takes the first place doesn’t mean it requires the most extensive planning and has the highest costs. The Pareto principle helps find the most impactful elements of your retail business, not the toughest to handle.

The 80-20 rule won’t provide a clear picture every time. If a retailer starts a marketing campaign and a product ends up selling well, it might think it’s because of focusing the campaign on the right product. However, maybe it’s because the competition had supplier issues and wasn’t able to restock on time. 

Rather than looking at the Pareto principle as a tool that provides definitive solutions, a supplier should use the principle as the initial guidance towards the solution.

Use data to analyze your products

Use the SupplyPike Sales Forecast to compare sales data for your SKUs and estimate growth. Find pain points in your replenishment and tackle the 80-20 rule head-on.

Retail Intelligence – SupplyPike Sales Forecast
Retail Intelligence – SupplyPike Sales Forecast

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Updated on May 18, 2021

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