The Pareto Principle Meets the Peter Principle – How Corporations Fail their Customers

I had professional contact with two companies this past week which both have fallen into the same trap. In both cases, they have had business units merged and grow. As is typical in a mature business, upper management moved on, and line staff got promoted into decision making roles. What I noted is with both companies, the current team is choosing to focus the entire business on their ideal customer and have abandon their average customer. Looking at recent product reviews and in my contact with some mutual customers, I am struck by how many are voicing feelings of abandonment.

The 80-20 Rule and its Application

The Pareto Principle, commonly called the 80/20 rule, says that many business factors come in groups of 80% vs 20%. For instance, 80% of your business income might come from 20% of your customers. In Small Business application it indicates that you should focus your effort to the small percentage of business that is driving the majority of revenue. One can ask; is this an action step? While widely quoted, it is ambiguous whether the 80/20 rule is an observation of facts, or indicates some action that you can take.

The Peter Principle

The Peter Principle, expounded by Laurence J. Peter in his 1969 book, states satirically that every worker will through success on their job, get promoted to a job that requires new skills. Then, if they are successful they will be promoted, and if they are unsuccessful, or incompetent, they will stay at the job in which they cannot perform well. Peter humorously points out that this process continues until all people are assigned jobs for which they are incompetent. While intended as humor, the Peter Principle sadly explains why most corporate middle managers are unable to make decisions that appear sensible to people outside the corporation. The Peter Principal affects all of us, including Small Business owners, who seek to excel in all areas but get turned back when we lack competence in our own tasks.

Where Peter and Pareto become Toxic

Upper management is focused on results. What they want is continuous process improvements, where a company makes higher revenue and incurs lower costs. This drives a metric driven focus on the 80/20 rule and defines a process that defines staff time spent on low revenue opportunities as a failure. Staff, in order to not be a failure, become quick to jettison low revenue customers. It is easier to tell a person “we don’t do that” than to engage in extended support to a customer with a past purchase.

Freemium, Education, and Leadership are a form of Marketing

Any successful company gives away 80% of their production, to apply the Pareto rule. That is; as they start out, they give out free trials, they educate customers to the appropriateness of the product, and they lead their followers to a buying decision. Companies make products first, sales second. You have to have something to sell. Therefore – you have to undergo a launch period where you expend cost without having revenue.

As a corporation matures, it moves from a state where freemiums and service are the norm, to an environment where these items start to have a price. This is not an intentional move. It is normally driven by out-of-touch managers who do not understand the ramification of the staffing decisions that they make. They demand unrealistic goals from the staff, and in trying to accommodate the goals, the staff cuts the level of service.

Mergers and Acquisitions drive Incompetence

Corporate mergers come about when an outside firm sees more value in a company than the insiders of that company. The insiders give up control. Most mergers are qualified by the idea that the combined company can lower costs and overhead, but increase revenue of one or more product lines. Eighty percent of the time, this thinking is entirely fallacious. What really happens is the management team that knows the true value of their company leaves, and spends some quality time in a sunny location like Aruba, while the line staff get promoted to levels of incompetence by a management that applies unreasonable expectations of them to reduce cost and increase profit.

Customers get the Shaft

The real victim in this process is the customer. People commit to a product or idea because they encountered the stages of Free, Education, and Leadership that brought them into loyalty. Many have not only invested, but they have spent substantial sums over time to buy into the product, the training and the upgrades over the years. Post-merger, they are callously jettisoned by the same staff members that fought so hard to land them. The reason is the customer has already spent their money. The staff, in seeking to appease management by focusing on revenue, cannot allocate time or resources to support the past customer base.

Customers strike back by leaving bad reviews, buying a competing product, or simply moving on to another company that values them. Value is shown by the same process of Freemium, Education and Leadership. It can be amazing how much abuse a customer can take, as the old firm raises prices, or makes subscription demands, to try to gain the same revenue stream as back in the time that they were popular.

Case Study – Company #1

A software company had over 1.5 million paying customers in 2002. After a major product update with a much slower and buggier database engine, five mergers, ten CEOs, and higher product prices, the customer base was whittled down to 250k by 2015. Management made a commitment to push the platform to SaaS and force all customers to subscriptions that cost per year almost double what the product cost in 2002. Even from the outside, it is clear that insiders resisted this change. Three more CEOs turn over in five years. Yet no amount of quitting has been able to stop the corporation as a whole from committing Peter Principle suicide.

Case Study – Company #2

An App vendor has 1 million paid App customers in 2005. Originally created for a technology platform that became obsolete, the App vendor made a successful move to a new platform, with minor success on a second platform. The founder sold out. Monetizing a phone app is always a challenge. This vendor tried many schemes, including a micro-purchase strategy where each customer could individually purchase 10 or more different features. Later versions returned to a simple strategy of one price for purchase and one price for subscription service which gave premium features. Post-merger management has chosen to feature only the premium subscription, abandoning their customers who desire a one-time purchase. For other reasons, the freemium “trial” portions of the App have been removed. You can try all features by signing up for a premium service, but you cannot simply see what the product does until you sign up. The focus on the ideal customer has left loyal past customers feeling abandon, and future customers unable to make a low-commitment trial. Success on the updated product is blocked by one-star reviews left by frustrated past buyers.

Loyalty is an Intrinsic Benefit

All businesses want the ideal customer. We want low costs, friendly patrons that spend large amounts of money on our products. We know the business climate goes through cycles, and while some are predictable, our Covid economy of 2020 has tested the cycle bridging capabilities of all businesses. It is our choice to continue through this pain knowing that growth lies as the cycle begins an upturn. But some companies will miss out on this growth because they have been abandoning their loyal customers, who will no longer reward them with upgrade sales and consumer recommendations.

It is important for all levels of management to listen carefully to customers, to know what value they see, and what pain points they have. This doesn’t mean sending out SurveyMonkey to ask a few questions. This means really understanding what all your customers are seeing and feeling right now. You have to view these customers through their eyes, and then through the eyes of your front-line staff.

Build Value by Being Generous

So we come full circle to the Pareto Principal – Even though we get 80% of our business from 20% of our customers, we have to focus on the entire customer base. We don’t know what the next 20% are, where they come from, or why they choose our service. We need to bestow development, upgrades and benefits to build value on the purchase they already made, as well as to attract new sales. Generosity spent on our current customers will be rewarded by future business from their associates. We need to be Generous.

Lead through Humility

To offset the Peter Principle within ourselves and our own staff, business owners needs to lead by being humble. The greatest sign of success is if your staff says “We did it” (Tao 17). To be an example means that every day and every hour you are available to the worst customer and can offload work from the most stressed staff member. This is not about the burden on your own day. This is the burden that you, as the owner, have put on your staff and your customers through your own incompetence – the Peter Principle applies to you. Own your incompetence, apologize and grow through it. Your generosity will shine as a light through your organization. Your focus on helping others becomes and end of its own, and something that is truly satisfying.