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.