Why I Fire Clients to Make More Money

Today we're gonna talk about the Pareto Overlap. Now I'm smiling a little bit here because this is a term I've made up, perhaps suspect you've never heard of before, but you've probably heard of the Pareto Principle. It's not the overlap. And what we're gonna address is a common challenge that business owners have. In fact, most business owners get stuck because we overestimate our capabilities. We think we can do anything and everything. I, I call it the I can syndrome. I can do this, I can do that. In fact, when you started your business, you probably did the accounting, You probably delivered the product or service. You probably were the salesperson. So a small business, particularly in the very early stages, necessitates that the founder, the owners, or the initial core team does everything. And then there's this diluted belief that we're extraordinarily capable in everything. Reality is we're not. You are great in a few areas, just like every other human being on this planet. You have specialized talents, but the necessity of entrepreneurship has us doing everything, and we think that's the standard. So there's this I can do syndrome. And therefore many small businesses will start diversifying because it seems so easy to add on this additional product or this additional service. And you do get it done, but usually at a very marginal level, a standard level. And the elite companies, the companies that are very successful are the best in their category, inevitably. This is the old analogy, you've probably heard it in sports or like the Olympics or something. When someone wins the gold, they win it by 1/100th of a second or something. It's very close, but everyone remembers the gold medal winner No one remembers silver or bronze and forget anyone else, even though the whole contention is very close. The competition is all within split seconds of each other. So the difference between an extraordinary company and the ordinary company is usually a small difference, but that difference takes an extraordinary amount of effort to get you that 1/100th of a second, if you will, faster, better, and therefore beating the competition. So that's what we're gonna explore together today in how to really grow your business healthily and organically. One of the points of resistance is this concept of I can do everything. The second thing is there's a belief that perpetuates called captive audience. Once you have a customer, you have now a captive audience. Sell her more things because she's already doing business with you. In my book, The Pumpkin Plant, I talked about this phenomenon. I shared a story about my own landscaper, and Ernie is extraordinary at doing the work. He shows up, he's a friendly guy, and he maintains the lawn, but he realized he had a captive audience in me. So one particular fall season after or during the cleanup of the leaves, he noticed there was leaves also on my roof. He said, "Hey, if you like, we can clean off your roof, clean out the gutters. I can go up there and do it." I'm a captive audience. I said, "Sure, go do it." And he left for a bit to get apparently ladders or whatever. And he went up there with his colleagues and they started cleaning off the roof. He came back down and said, "I noticed there's some shingles loose and there's also a crack in your chimney." We can fix that, I think. Do you want me to do it? I'm like, yeah, sure, do it. Then he was gone to get more equipment. I don't know what you need to fix a chimney and replace shingles, but he had to get the supplies, equipment back. And he's working tonight. He worked so late that particular night, they had to then go back out again to get lights to illuminate the roof to finish off their work. Oh, and by the time he was done, the lawn, at least around the house, was messy again and he had to come back the next day to clean it up. Now, the concept for the small business owner is, my gosh, I have a captive audience. Look how much money I made from me. 'Cause he billed me, of course, for each service. But I think the other landscaper was laughing at Ernie because while Ernie did that one big kind of additive project with me, the other landscaper maintained 10 properties, 15 properties. He was doing the same thing with the same equipment over and over again. Ernie had to buy some additional equipment. He had to run down to the store. There was all this distraction. He didn't do a good job 'cause he never had done this work before. So we lose these efficiencies, requires additional skills. As we do more things, as we cater to a captive audience and we diversify We diversify our offering, it also puts more demand on our organization to have greater breadth of skills, more equipment, and elements like that. Greater diversity, greater demand on the organization, we become less efficient. So that's another trap we run into. We also see the competition introducing products or services. And this can be a common illusion because we look at multiple competitors and say, that competitor does X and this other one does Y. And the last one does Z, clearly we need to do X, Y, and Z. But they may be different competitors, or you have one competitor who's doing multiple things, and so you're like, I have to do multiple things, but they're struggling and you don't even know it. So the challenge is we have many demands on us psychologically based upon confirmation bias, looking at the environment around us that we diversify. But there's one big factor, and the big factor is this, that in the early stages, the easiest way to grow is simply do more things. Acquiring that next customer is hard. You don't have a market reputation, customers don't know you, exist. So you have that first customer, or the first few customers, they're captive, offer more. It's easier. And in the beginning, you can get by, by hook or crook. I think most businesses can grow in the service industry at least to about a million dollars in revenue by being diverse, by adding new features and benefits. But then as you get beyond that million-dollar point— and I'm not saying that's a hard number, it's just my observation— the reason is, on a million dollars, you need to start bringing on full-time help and so forth. As you do this, you start losing efficiencies because people have to relearn and retrain. They have to diversify themselves. I want you to think about the McDonald's model, and this is true with any fast food restaurant. Have the fewest ingredients. You can package them different ways. You can make a hamburger with 2 patties as opposed to 1 and give it a new name and it's perceived differently, but it's the same ingredients. So reduce your ingredients, aka variability. Follow as few processes as possible to get the end result. Maybe package them differently to give the variability. That's how you're going to scale. It's about reduction. And that's why we're going to dig into the Pareto overlap, because this isn't considered, I think, by most businesses. So this is how the Pareto overlap works. I want you to consider two columns, and this is deploying the 80/20 principle. So column 1 represents our existing clients. Column 2 represents our products or services. I'm just going to call it our offer. Now I'm going to break this into 20%. So here's 20%, here's 80%. I'm going to do the same thing for our offering. And just to show an interesting dynamic here, I'm also going to identify the lowest 20%. And so in this case, in the lowest 20%, which is here, this now above it represents the 80%. And so of course in the middle it's 60. So now you see how the 80/20 works. And a little history lesson In Pareto's principle, Vincenzo Pareto was an Italian economist. He was directed by the king of the time to study the economy and found something fascinating, that the minority of the Italian economy was maintained by the majority of the people. So 80% of the population had 20% of the wealth. And interestingly, the minority of the people, 20% of people, maintained majority of the economy, had 80% of the wealth, became the 80/20 rule. 80% had 20% and 20% had 80%. But this phenomenon wasn't just with finances in Italy. It plays out in so many aspects. Vincenzo Pareto was looking at his garden and identified that 20% of the plants were giving 80% of the fruit and 80% of the plants were giving 20% of the fruit. 80/20. In fact, you'll see this phenomenon play over and over again. If you look at your collection of clothing, your closet or whatever, chances are you wear a small portion of that clothing, 20% of it, 80% of the time. When you're traveling roads around your community or to work or something like that, the minority of roads you travel all the time— your driveway, if you have a driveway, the street that leaves your apartment or home— those streets are your main active roads that you're using. That's the 20% of roads that you're using 80% of time. Well, this phenomenon plays out in your business, and once you understand this, we can apply it to really grow a healthy business and break out of this entrepreneurial entropy of trying to do everything and become masterful at one thing, generate higher degree of profitability, and serve your clients better. So going back to this chart, let's look at the clients. So what you want to do is analyze your clients and sort them out from most revenue to least revenue, and look at your clients over the last year, last 12 months. If you get a better perspective of your client demand by looking at it on a 2-year basis, 24-month period, you can do that too. So what you do is you take your clients, sort them out from most revenue. So this is on a dollar basis to least revenue. Then what I want you to do is look at what your cumulative revenue was. So just for an easy number, I'm gonna say $1 million that I generated in revenue. I multiply that by 80% 80%, and that's $800,000. $800K. And then what I do is I go through my list here and identify where is the $800,000 cumulative stop. So the first client may have been a $100,000 client. The second one was a $50,000 client, and this was a $50,000 client. So that's $200,000 combined, and so forth. And you go down until you get to the $800,000 mark. And when you get there, usually— and it's not in all cases, but usually it's the minority of your clients that are yielding the majority of revenue. Every business is different. So this is not a hard, fast rule. This is just a common dispersion of demand. So draw that out. Once you've done this, you've identified your top clients, the ones who spend the most with you, up to 8% of the revenue. Also, you can do this in reverse. Identify going from the bottom up how many clients it takes to get to the remaining 200,000 clients. The $200,000, and you'll often see there's a lot more below than there is above. The clients that demand the most from you, meaning they spend the most money with you, they enjoy working with you, they give you positive reviews. Those are clients that identify as the best clients. So the clients— let's just hold this up here— here are not just the top revenue generators. They often have the most appreciation for the work you do. They value the most. They refer you elsewhere. Interestingly, if we look down here, the 20 percenters at the bottom, these are generally unfit clients. They're bad for business. I'm not saying they're bad people necessarily. I'm saying they're bad for business. These clients don't pay well. They don't pay at all sometimes, not on time. They can threaten and say, you know, if you don't do this right, I'm gonna sue you, or I'm gonna give you a 1-star review. They are there for the transaction and they have an inordinate demand or expectation from you. Interestingly, sometimes and often your best-paying customers often are the most engaged in getting the outcome that they desire, so they actually support the transaction and are the least demanding in certain ways. They're participative in getting the results. So top 20, lowest 20. So I want you to do that analysis. Now do this same analysis for your offering, but your offering, what we're looking for is profitability. So this is a profit analysis. Now you need to dig into your accounting system to know what products do you have. So list out all your products and what kind of profitability does it result in. So you can do a quick analysis. You're going to sort out all your products and then ask yourself or investigate, and hopefully it's already in your accounting system, what is the hard cost? So I sell a can of soda or seltzer here I have in my hand. I sell one can of seltzer. What's it cost to purchase this? And I sell this, we'll say, for $2. I purchase it for $1, so my hard cost is $1.. Now you may also have costs in service or manpower. Those costs need to be baked in too. So maybe the transportation costs, the handling costs and so forth are another $0.20 per can. So it costs me $1.20. I sell for $2. I make $0.80 per can. So that's the analysis. If you can't go in that depth, you can do a rough rule of thumb. And the rough rule of thumb is Products or services you charge more for typically, typically are more profitable. It's not always the case, and many times it's not the case, but that's just the poor man's version of doing this analysis of price-based sorting of your offering. But I'd prefer you to do a profit-based sorting and sort it out from most profitable to, you guessed it, least profitable. So same analysis as we're doing here, but we're doing it now on the products. And if the Pareto principle plays true, and again, it's not a hard, fast rule, it's not gonna be 20% of your offerings are yielding 80% of your profitability necessarily. It may be 25% or maybe it's 40% or maybe it's 12%, but it gives you a perspective. Then once you figure this out, what are your best stuff is, your best folks, the unfit folks, the stuff that's not profitable. Actually, many cases I see businesses losing money here Now we can do this analysis. So here's how the analysis works. There's gonna be 4 core principles I wanna look at. The first one is your best clients buying your best stuff, meaning your clients that pay a premium, they do a lot of business with you, they like you, who are buying items that are profitable. This is the heart of your organization. I would argue this is the most important yet most overlooked component of building a healthy business. Is who are my best clients that are buying my best stuff? They are everything to my organization. Now, if you multiply 20 by 20, it's roughly 4%. So I'm just going to do a round number, about 5%. 5% of your transactions are absolutely key to your organization. Without them, it could be the death nail in your coffin. And yet most people don't know who these top 20% customers are. Or the products. Therefore, they don't focus on this. Here's the change I want you to make. Once you identify who your best clients are, now you know how to do it. Once you identify who these folks are, buy your best stuff, call upon them, cater to them, protect them. When you have orders coming in and multiple people call upon you, it's this client that's buying the best stuff that gets called back first. They're the ones who get catered to. Prioritized every single time. They are the heart of your organization. My mother had a saying, she said, "Mike, you know, treat everyone the same." And I hate to say this, but my mom was lying to me. Treat your best the best. And now you know how to identify them. Now there's more scenarios. So let's go back to the overhead that you need to get familiar with here. And the second scenario, hopefully it's just as obvious as the first, is unfit clients. Again, I'm not saying they're bad people, it's not a good fit for your business, buying items that you're not profitable on. In many cases, you know, I've worked with thousands of businesses in my investment company, it's called Prosper Group. We have a couple dozen folks we're walking through this right now. And it's still, it doesn't surprise me anymore, but it's still kind of a shock to the system to see how many businesses for a long time are selling products that are not making any money. They're losing money on them. So you can actually be losing money. There was a study from a company in Chicago called Strategex back in the day that they shared with me that for many businesses, they broke into quartiles, but we'll roughly do this, that most of the profitability, actually 150% of the profitability occurs here, which already makes no sense because they're going to be 100% profit. So how could it be 150? Well, they said, because we're losing 50% of our profits down here. So we're making all the profits there. And this is about break-even in the middle. So interestingly, We lose money here and yet we keep on selling this. If we just got rid of these bad products, we could have more profitability. If we just got rid of these unfit clients, we could focus more time and energy on our best clients. Bad clients buying bad stuff is poison for your organization. And you know what to do with poison? Spit it out. In fact, you can refer this business right here to your competition. And I know that sounds absurd and crazy. So here's what happened. You fire this client who's buying stuff that's not fit for you. Therefore, you ban this stuff. Your competition will be like, oh my God, you are sending all this business my way. You're what a fool. I'm lapping it up. Yeah, yeah. They're lapping up poison. It's killing your business. These are the customers that you can't sleep at night because you're thinking about them. These are products that are losing you money and you struggle to be successful at. Stop doing that. One thing is you stop providing that product or service, these clients by default will go away. Now let me just draw on here, 20% times 20% is 4%. I'm just going to round it to 5%, but about 5% of the scenarios, worst clients buying worst stuff, that's about 5% of your business if your business is consistent with the Pareto principle, is harming your business severely. Spit out the poison. All right, let's go to the next. Your best clients, high demand, buy from you repeatedly, value your services, who are buying your worst items. This is about another 5% of these transactions will be happening this way. Best people buying worse stuff. This is an education opportunity. What I mean by this is call upon these great customers of yours, say, I value you doing business with us. I want you to know we have alternative products and services you can buy. And try to move them up the chain in demand. Try to get them buying things where you offer something that's profitable. Maybe by just canceling these products, you can say, We're no longer providing XYZ, but now we have these alternatives and we push them up. It's an education opportunity. The other scenario I want to talk about, I call it prostitution. It's where you have your worst customers. These are people that are not kind to you. They don't pay on time, but they're buying profitable things. If you sustain this relationship, this is actually the most difficult scenario. If you're sustaining it, you're saying, I will take any kind of abuse just to make some money. So that's prostitution. We got to get out of this scenario immediately. So how do you do that? You do this through the hard conversation. And I would say about 1% of the hard conversations result in a better client. You know, people are wired the way they're wired. So when you call upon this customer and say, we appreciate buying from us, but the way you behave is not appropriate, you're not paying us on time, the way you treat my colleagues is not appropriate, or the way you treat me, whatever it is, you need to shape up or ship out. And that's this conversation. The majority are gonna go by the wayside. They're gonna leave, but that means they're poisonous. Let them go to your competition. You're gonna be grateful. Your team's gonna be grateful that you had the hard conversation. You were willing to do this to protect your organization. So you actually serve the organization. What happens is you start upleveling your business by removing these unfit products and services. You are now focusing in this area and you can become elite, do a better job at this. I'll actually do a video on exactly what you need to improve at the upper level. By focusing on the proper client, you're going to start seeing client commonality because they're commonly needing the same products and services. Then you're going to be able to have repeatability, which means systemization, efficiencies, and so forth. So there you have it. I call this the Pareto Overlap. Now, what we did here was we explored just 4 scenarios. Of course, there's the 60% buying the 60%, the 20 buying the 60. You can keep playing this out. There's a lot more scenarios, but these were the core 4 you need to know. If you do nothing else, let me give you the 2 things I challenge you to do that will transform your business forever. One, call upon your best customers and say, "Thank you for being such an extraordinary customer. We value you," and prioritize responding to them. So acknowledge their value to your organization by calling upon them. Usually they don't get those accolades. Secondly, start prioritizing them. My other thing is get rid of these products that will trigger getting rid of these clients. I challenge you to get rid of these products. Ironically, the greatest way to grow a business healthily and efficiently is the discipline of dishing what doesn't work. We don't want to add more. That's what got you in this place in the first place. That's what got you stuck here. There's a saying, what got you here will keep you here. Yeah, by diversifying, by doing all these things got you to this point, but it's no longer working. So you have the discipline of removing this, it'll start a cascade effect. And maybe, just maybe, have the courage to have the hard conversation, get rid of these customers, and watch how it transforms your business. So that is what I call the Pareto overlap. It's a deployment of the Pareto principle and the intersection of the two. And now you can use this in your business.