Why Pareto Rules

The year is 1848. A boy is born in Paris. His father is an Italian marquis living in exile. The politics in Italy change, allowing safe return for the family and a good education for the boy, Vilfredo Pareto. As a young man, he gets good management jobs and makes astute observations about economics. His ideas become articles in economic journals that continue to influence economics 150 years later.

One of those ideas is known as the “Pareto Principle.” It says, in essence, that 20 percent of a cause creates 80 percent of the effect. We also know it as the “80-20 Rule.”

The Pareto Principle saves countless hours for those who use it. Every HME company manager should make it a standard tool. Here are some ways to save time with the Pareto Principle:

• Sales As a provider, 80 percent of your revenue comes from 20 percent of your products. It is a reflection of what your company has communicated (intended or not) that it does. If the list of products is not what your company wants to be known for, then there is waste in the time spent communicating. You need to redirect your communications.
• Gross Profit Eighty percent of your gross profit comes from 20 percent of your products. If the list of products does not include the highest gross margin products, then the company may be working harder for profit than it must. A low gross margin sale requires the same expenses for intake and billing as a high gross margin sale. So long as the high gross margin product is on the list of products the company wants to be known for, you should find ways to grow revenue from the high gross margin products more quickly than other revenue.
• A/R Eighty percent of your accounts receivable are attributable to 20 percent of your payers. If Pareto had a flaw in his principle, it is because he did not get to observe health care in 21st century America. My observation of many providers is that about 20 percent of the payers produce about 90 to 95 percent of the revenue, or about 10 percent of the payers account for 80 percent of the revenue. Take this list of payers for your company and make sure that the billing and collecting processes are as efficient as they can be.
• Budget Management Generally, about 15 percent of a company’s expense accounts reflect 80 percent of the expenses. When managers are reviewing the budget variance report, they shouldn’t spend their time analyzing an account that consumes 1 percent of your revenue. Priority should be given to the handful of accounts that consume 80 percent of the revenue. Keep them on track and your budgeting will work well. Steps should include submitting electronically to all of the accounts, then having them make electronic remittance.
• Marketing Eighty percent of your referrals come from 20 percent of your referral sources. Study this list to be sure that they are providing referrals that are efficient users of the company’s time. If the referrals are what the company wants, there are at least three other uses for the list. One is to make sure that these referral sources stay pleased. They are the “A” list and get invited to the company parties. Second is to become the only provider these sources refer to for the desired products. Third is to understand everything about these sources and the referrals they produce: payers, what diseases are and are not being referred, patient zip codes, etc. This information will point to success factors and can be used to find more referral sources that are like these.
• Purchasing If 80 percent of sales comes from 20 percent of products, it likely follows that 80 percent of purchasing activity comes from 20 percent of the products. Develop your entire logistics function, including purchasing, to be most efficient with these products. Set up an automated replenishment program, or copy the purchase order so that only the date needs to be added.
• Activity Costs Twenty-five percent of a company’s activities account for 80 percent of its expenses, so giving the same priority to streamlining for all activities is not efficient. Reengineer that 25 percent of your company’s activities that are consuming 80 percent of its costs. Using the Pareto Principle simplifies a great deal. Pareto rules.

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at [email protected].