How the 80/20 Rule Affects Your Distribution Channels And Why It Matters to You
Have you ever seen one of your favorite products shut down? I have personally seen products that are beautiful and useful yet they have a hard time finding customers. What is happening here?
Developers and non-marketers like to believe that the best products will always win and that if “you build it, they will come” but life isn’t like the Field of Dreams movie.
Peter Thiel, investor and co-founder of PayPal, even said this in Zero to One:
“The conventional thinking is that great products sell themselves; if you have a great product, it will inevitably reach consumers. But nothing is further from the truth.”
Once you build a great product, you need the right distribution for it. I’m using the word distribution as a “catchall term for everything it takes to sell a product”.
Lucky for you, there’s hundreds of potential distribution channels that you could try. Blogging, Adwords, and Facebook Ads are just a few examples but what some people don’t realize, is that there’s 1 or 2 channels that will outperform all the other ones combined. This is an example of the classic 80/20 rule.
How Does the 80/20 Rule Affect Distribution Channels and Why Should I Care?
The 80/20 rule “states that, for many events, roughly 80% of the effects come from 20% of the causes.” In the distribution world, it means that 20% of all distribution channels will drive 80% of the results e.g. traffic, leads, new customers, etc.
This means that finding the “20%” of distribution channels for your business isn’t just profitable but required for success. After all, we are all in a race against the clock which is usually when we run out of money or time.
To better understand the impact that one great channel can have, we need to look at the music industry. The most important question for music labels is this:
What distribution channels will ensure that songs become a hit? The answer to this question is radio.
Radio stations are crucial in creating awareness for upcoming hits and have been for years. Music hits depend on familiarity and radio provides this at scale. John Seabrook, who wrote The Song Machine: Inside the Hit Factory said this about the power of radio:
“Big Radio is still the best way – some would argue, the only way – to create hits. If the song seems to be playing everywhere at the same time, all at once, it is perceived to be a hit and becomes one.”
The effectiveness of radio stations has even led to criminal investigations against music labels who tried to purchase more playing time for their songs. The role of radio has changed over the last few years especially with new channels like Spotify, Pandora and YouTube, but this is an example where one channel outperformed all the other ones.
How PayPal Found Their Early Adopters By Experimenting with Different Customer Segments
Distribution channels are also affected by customer segments. A channel like Adwords might work on one segment but fail miserably on a different segment. A great example of this is the early history of PayPal, back in 1998. PayPal experiment with a few different customer segments including Palm Pilot users.
These users were savvy and loved technology. Seems like a great fit for a startup that wants to send money through the internet right? As it turns out, these users were spread out all over the country making them hard to reach.
PayPal then decided to go after the Power Sellers in eBay. This segment had a high need for PayPal especially since the alternative at the time was to use checks. They happily embraced PayPal and were crucial in helping them “nearly double their user base every 10 days”.
Sometimes it can be hard to grasp how consistent exponential growth looks like so here is a chart that shows what your customer base would look like if you were able to achieve a 7% weekly growth.
This type of growth is possible if you are able to find the most effective distribution channel and the best customer segment for your business.
The Mathematics Behind the Best Distribution Channels
Since you don’t have the time and resources to try every possible distribution channel, we need a way to filter through the available options and narrow down to the ones that could be profitable.
While every channel is slightly different, we can use two metrics to find the best channels for us. These two metrics are:
You can click through on each link to understand and calculate each of those metrics. Once you do that, come back to this article.
Imagine that your CLV is $400. This means you could spend up to $399 in CAC (this is a simplified example) and still make a profit. Your CLV provides an estimate of how much you could spend while also limiting which distribution channels you can use. Some channels have a low CAC e.g. digital advertising while other channels have a higher CAC e.g. inside sales team.
The graph below, from Zero to One, provides guidelines on typical CLV and corresponding distribution channels.
Of course, it is possible that AdWords won’t work for you (cost per click in your industry may be too high) and perhaps you can make a sales team work with a low CLV. The point of this exercise to is to filter down from 100 options into a handful of channels that are likely to work.
Systematically Testing Your Way to the Best Distribution Channels
With a handful of distribution channels, you can now run experiments and test different campaigns. There’s a great article on what it takes to create a growth machine but the main point is that you need an established process that will make it easy to test different ideas.
Make sure to also explore different customer segments and see how each one affects your distributions channels. Testing customers segments is driven primarily by one question:
Who wants to buy my product and how can I best reach them?
Don’t overestimate the impact that one channel can have on your business and how it can help you grow faster. Finding the best distribution channels might just be the thing that saves your company.
About the Author: Ruben Ugarte helps venture backed startups use analytics to make better decisions through his blog at Practico Analytics. You can also reach out to him on Twitter @ugarteruben.