March 7, 2021

Ecommerce and the Pareto Principle of 80-20

Dr Peter Mowforth

The ‘unfair’ power curve

The ecommerce industry is dominated by a few massive players such as Amazon and Alibaba capturing the lion's-share of the market. At the same time there are a huge number of small ecommerce businesses that turnover very little. The same split can sometimes apply to an ecommerce electronic catalog of products. Here, just a few items can fly off the shelves in high volume while many others languish. A few customers keep coming back and repeat buy regularly while most may only visit once. With search marketing, a few things that you sell may bring in lots of SEO traffic while others barely make a difference. Ecommerce Managers may spend lots of time focussed on things that have little effect on the profits they generate. Alternatively, they might spend just a few minutes on something that, almost by accident, can transform the business. What all of these things have in common is that they are connected by a common idea called the Pareto Principle or, more commonly, the 80-20 rule.The principle was first recognised and recorded by an Italian economist called Vilfredo Pareto. In 1896, he wrote about how 80% of the land in Italy was owned by just 20% of the population. If you then look within the this top 20% of the Italian landowners then again you see another 80-20 split. Within the 20% rich group there are a small elite group of super-rich landowners. You can call this a form of power curve that disproportionately favours the few. Equally, you could also refer to it as an ‘unfairness’ curve because you see a very small number of standout individuals. Jeff Bezos may be at one end of curve while a very large number of struggling business owners may occupy much of the remainder.This simple observation of skewed performance has been found to explain a wide variety of things in nature. Across many observed events, tasks and activities, the principle is that around 80% of effects come from just 20% of the causes.The following simple experiment demonstrates how the Pareto effect happens:

This effect is nothing to do with unfair bias but reflects a fundamental mathematical principle of how things work. Each of the paperclips is the same. Paperclips in the long ‘successful’ chain are no different to those that didn’t join up. The aggregation of long (successful) chains is a general property of nature and not because some paperclips are inherently better. If longer chains equate to success then you can say that success breeds success. The effect has been used to explain:

  1. Why extreme wealth accumulates for just a small proportion of the population.
  2. Why the tax system is organised the way it is.
  3. How population usage for healthcare operates.
  4. How betting businesses work.
  5. Why youtube downloads are skewed the way they are.
  6. Why election results happen the way they do, or,
  7. Why bushfires spread following fixed patterns of observed behaviour.

Consequences for ecommerce

We can use the principle to make changes to the way we run and grow an ecommerce business so as to optimise its performance.Many ecommerce manager may say that they have lots of things to do and never enough time to do all the hundreds of things that they need to. Thinking that every task contributes equally to the desired outcome for the ecommerce business produces a growth line that follows the red curve in the above graph.A good ecommerce manager will use the Pareto Principle. They look at all those hundreds of tasks and recognise that over half will have almost zero impact on improving the business. If they then rank those tasks in terms of cost, timescale and likely return they will find that fixing just a handful of items will quickly have a large and positive impact on the business. My point is that an ecommerce manager that is able to correctly prioritise tasks and takes very long lunch-breaks will dramatically outperform an ecommerce manager who works three times harder but doesn’t correctly prioritise work.With any ecommerce business, the ultimate Key Performance Indicator against which all optimisations should be measured is Profit. In my experience, reasons why many ecommerce managers don’t follow the principle include:

  1. They operate fixed ‘Things-To-Do’ lists without task prioritisation.
  2. They do prioritise … but on the wrong things.
  3. They gravitate to things they like doing (e.g. social media) rather than things that have the potential to make a greater positive impact (e.g. deep statistical analysis of their Google Analytics).
  4. They always do things that the boss tells them to do rather than telling the boss “OK, I can do that if you really want me to but I am positive that it will have zero impact on sales”.
  5. They are not using proper mechanisms for feedback such an a business dashboard. If you cannot directly see the consequence of your ecommerce management actions then there is no basis for learning or improvement.

The Pareto Principle has been used to refine business optimisation strategies such as Six Sigma. Key to this approach is a never ending series of marginal gain refinements. Once the top factors have been identified, do what you need to do to improve performance. At each step, measure the result to confirm that it has improved as expected and then choose the next item to optimise. Repeat that over and over and, as if by magic, your business will improve with ever larger performance increments.It’s not magic, it’s just maths, logic and diligent focus.

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