Paretto Rules!

Pareto’s Principle: The 80:20 Rule in Action

The 80:20 “rule” is derived from the work of Vilfredo Pareto, an Italian economist, who studied the distribution of wealth in a numerous countries in the early 1900s. He discovered a common phenomenon: around 80% of the wealth in most countries was controlled by a 20% minority of the population. His observations of this “predictable imbalance” was the basis of the rule, or principle, and has since been widely applied to other situations where a small amount of people, work, effort, money and so forth result in the majority of a measured effect, result, reward, etc.

In the world of sales, the rule as most commonly used states that 80% of the sales are brought in by 20% of the reps. For example, a company with 100 reps has $1,000,000 in sales per month. The following can then be derived mathematically:

  • The Top 20 reps (Top Guns or Closers) sell 80% which is $800,000 ($40,000 each)
  • The Bottom 80 reps (Posers), sell 20% which is $200,000 ($2,500 each).
  • 1 Top Gun is worth 16 Posers (16 X $2,500 = $200,000).
  • Hiring 5 more Top Guns can replace 80 Posers for same sales revenue (25 X $40,000 = $1,000,000).
  • 25 Top Guns saves 75% on overhead (office space, phones, equipment, maintenance, utilities, supplies, support staff).
  • For a commission-only team, the total pay is the same.
  • For a salary + commission team, you would also save on salaries, payroll taxes, and benefits if you reduce the size of the team or go commission-only.
  • Recruiting and training time and expense is also vastly reduced in maintaining a 25 rep team of high performers versus a 100 rep team with too many non-hackers that need to be continuously coddled, prodded, and inevitably fired.

Example. Option 1. W2. Salary = $4,000. Commission = 10%

Before (100 reps)
Salaries = 100 X $4,000= $400,000
Commissions = $1,000,000 X 10% = $100,000
Payroll Taxes & Benefits = $500,000 X 15% = $75,000
Office Expenses = 100 X $500 = $50,000
TOTAL = $625,000
Percent of Sales = 62.5%

Top 20 earn $4,000 salary + $4,000 commission = $8,000
Bottom 80 earn $4,000 salary + $250 commission = $4,250

After (25 reps)
Salaries = 25 X $4,000= $100,000
Commissions = $1,000,000 X 10% = $100,000
Payroll Taxes & Benefits = $200,000 X 15% = $30,000
Office Expenses = 25 X $500 = $12,500
TOTAL = $242,500
Percent of Sales = 24.2%

Top 25 earn $4,000 salary + $4,000 commission = $8,000

You realize a huge increase in your profits and margins by reducing the team, firing the posers and replacing them with a small number of closers. Note that the better closers will resent not making more than the others and will prefer a commission only pay plan.

Example. Option 2. W2. No Salary. Commission = 20%

Before (100 reps)
Salaries = 0
Commissions = $1,000,000 X 20% = $200,000
Payroll Taxes & Benefits = $200,000 X 15% = $30,000
Office Expenses = 100 X $500 = $50,000
TOTAL = $280,000
Percent of Sales = 28.0%

Top 20 earn $8,000
Bottom 80 earn $500

After (25 reps)
Salaries = 0
Commissions = $1,000,000 X 20% = $200,000
Payroll Taxes & Benefits = $200,000 X 15% = $30,000
Office Expenses = 25 X $500 = $12,500
TOTAL = $242,500
Percent of Sales = 24.2%

Top 25 earn $8,000

Even staying with 100 reps a huge gain in margins is realized when the posers are paid what they are worth, which is not much. Additional savings are realized when the posers all quit or are fired and a few more closers are hired to obtain a team of 25 closers. One issue here is the minimum wage laws – $500 a month won’t meet the requirement – best to exit them off the team.

Example. Option 3. IC (work-at-home). No Salary. Commission = 25%

Before (100 reps)
Salaries = 0
Commissions = $1,000,000 X 25% = $250,000
Payroll Taxes & Benefits = 0
Office Expenses = 0
TOTAL = $250,000
Percent of Sales = 25.0%

Top 20 earn $10,000
Bottom 80 earn $625

After (25 reps)
Salaries = 0
Commissions = $1,000,000 X 25% = $250,000
Payroll Taxes & Benefits = 0
Office Expenses = 0
TOTAL = $250,000
Percent of Sales = 25.0%

Top 25 earn $10,000

By converting the team to Independent Contractor status you eliminate payroll taxes and benefits. Increasing the commission rate compensates the closers. Your margins stay the same as with W2 commission-only but you are freed from a lot of regulation, threat of employee lawsuits, minimum wage laws, and can recruit nationally if appropriate. Using work-at-home reps means no office space, equipment purchases, and so on. It’s a good trade for a bump in commission rate.