A universal rule
The Pareto Principle, or Pareto Rule, or 80/20 Rule asserts that, in any situation, approximately 80% of the results are generated by 20% of the activities. Or, in other words 80% of effects are generated by 20% of causes.
The Pareto Principle gets its name from Vilfredo Pareto, an Italian sociologist and economist. Pareto made important contributions to economics, including with his study of income distribution and the relationship between wealth and population, in which he observed that 20% of the population at the time held 80% of the wealth.
Dr. Joseph Juran, a Romanian-born American Management Consultant and Engineer, who later came across Pareto’s work, noted that the Pareto Principle was actually a universal phenomenon and began applying it to business, including for quality management.
Dr. Juran also referred to it as “vital few and useful many” to emphasize both how critical the 20% were but also to remind all that the remaining 80% of the causes should not be ignored.
Business application
Today, Pareto’s Principle is mostly used in business where it is applied in multiple areas, including manufacturing, business process management, human resources, project management, time management, but also in wealth distribution, spending habits analysis, and much more.
Although broadly validated now, the Pareto Principle does not apply to every scenario and does not always conform to its precise, original 80/20 ratio. However, even where the exact percentages vary, the Principle’s assertion of uneven, unbalanced relationship between causes and consequences, between input and output, still guides businesses in their responses to the information.
Knowing that 80% of the output in any one process are attributable to 20% of the input, and motivated by the high impact that taking action on the 20% of activities would have, managers tend to develop and prioritize a discrete focus on that group of activities.
For example, when:
- 20% of a company’s customers are responsible for 80% of company’s sales, or
- 20% of a company’s product line are responsible for 80% of sales, or
- 20% of a company’s employees are responsible for 80% of company’s sales.
In those cases, customer focus, product focus, sales focus, will be adjusted based on the above observations. For example, inventory management, incentives, or even cash flow allocation could be increased for the better performing products.
Or, if 20% of customers are responsible for 80% of sales, a separate loyalty program designed to reward those customers for their loyalty and encourage them to remain customers of the company might be appropriate.
Or, by studying the characteristics of those top customers, companies could more easily identify the ideal profile of future successful clients and how to find them.
The rule can also be used to identify and troubleshoot challenges. For example, where:
- 20% of company’s employees are responsible for 80% of company’s absences, or
- 20% of company’s services are responsible for 80% of company complaints, or
- 20% of company’s processes are responsible for 80% of company’s production waste, or
- 80% of company defect come from 20% of company’s supply chain.
In all these cases and many more, Pareto’s Principle provides management with clarity of focus in identifying and addressing areas of improvements. Equipped with such information, managers can compare factors related to a quality problem for example and assess each factor’s impact. Or, they can use the statistical information to inform their prioritization of open tasks or improve their decision making.
Of course, the 80/20 Rule will not reveal whether the 20% of customers generating 80% of revenues are also the ones generating 80% of the company’s complaints, but a simple data analysis will.
And, while the exact percentages will vary, where 30% of the causes might be responsible 65% of consequences for example instead of 80/20, companies will still benefit from the insight that the information provides and perhaps proactively work to adjust those ratios to desired targets.
In all cases, the Pareto Principle, or 80/20 Rule, is an important guide of insightful business management. ProtonCG strongly recommends using the visibility that it provides for focused, high-impact decisions.