Pareto analysis - HOW TO USE THE 80/20 RULE TO MAKE DECISIONS? - How the 80/20 rule fits into business?




Pareto Analysis

Vilfredo Pareto first developed the rule, or "Pareto's Principle,” in 1895 when he discovered that 80% of the land was owned by 20% of the population. Since then, businesses along with other industries, corporations and individuals have applied this rule in various shapes and forms.

The Pareto Chart or Pareto Diagram, named after the famous economist Vilfredo Pareto (1848-1923), is a common tool for quality control and is used as part of a Pareto Analysis to visually identify the most important factors, most occurring defects, or the most common problems, or in other words "the vital few".

Pareto Analysis is a statistical technique in decision making that is used for the selection of a limited number of tasks that produce significant overall effect. It uses the Pareto Principle (also know as the 80/20 rule) the idea that by doing 20% of the work you can generate 80% of the benefit of doing the whole job. Or in terms of quality improvement, a large majority of problems (80%) are produced by a few key causes (20%). This is also known as the vital few and the trivial many. The 80/20 Rule may be applied to almost anything, from the science of management to the physical world.

“The important thing is to begin to notice in your business which 20% of activities / people / products are responsible for 80% of your success. Spending more time on the things that have the best chance of milking the biggest difference can go a long way to making you more successful, with less effort."


The Pareto Principle, or 80-20 Rule, is a general rule-of-thumb or guideline that says that 80% of the effects stem from 20% of the causes. Dr. Joseph M. Juran, a 20th century evangelist for quality management, applied this principal to quality control and preferred the use of the phrase "the vital few and the useful many" to describe the 80-20 rule. Although the actual numbers may be different from case-to-case, the Pareto Principle is a guiding principle used in organisations .

How the 80/20 rule fits into business?

  • Management (e.g. 80% of the results come from 20% of the group)
  • Sales (e.g. 80% of the profits come from 20% of the products)
  • Quality Management for identifying the most important causes for defects (e.g. 80% of the problems come from 20% of the causes)
  • Inventory 80% of the business is done by 20% of the selection of products or services
  • Sales Productivity 80% of the sales is generated by 20% of the sales staff
  • Major Customers 80% of sales is generated by 20% of the customers
  • Customer Base 80% of customers come from 20% of the area a business reaches
  • Complaints 80% of complaints come from 20% of the customers
  • Advertising 80% of business come from advertising come from 20% of the customers
  • Employees 80% of work is done by 20% of the employees
  • Supplies/Suppliers 80% of what one buys comes from 20% of the vendors
  • Meetings  80%of the important discussions happen in 20% of the meeting time
  • Profit 80% of the business's profit comes from 20% of the sales or 20% of the customers
A pareto chart can help you quickly identify the most significant factors, but choosing which problems to fix may still require a cost-benefit analysis. If you have a single factor causing 50% of the problems, but it would cost you a million dollars to fix, and there are 3 other factors causing a total of 30% of the problems that would be much less expensive to fix, perhaps solving the 3 other factors first would be more beneficial.


How can the 80/20 rule be implemented in your business strategy?

4 steps to take for a business to succeed:
  1. Have a product range and put your effort into the 20% that give you 80% of your sales.
  2. With a good possibility 80% of sales come from 20% of your customers, it is key to cherish the big purchasers and repeat buyers.
  3. Once you discover where the sales are coming from, identify the advertisements that work and strategically place them where they really produce.
  4. Check which top 20% of keywords, search engines, and websites are bringing your business the most traffic and build on those strengths.
3 steps for marketers:
  1. Focus 20% of sales pitches and presentations on the best buyers. Even if what is said does not connect with 80% of people, that's ok cause it resonates with the best buyers and members.
  2. Focus on your best subscribers. The 80% majority will not be buying or investing in the business, but the 20% who are investing should be the focus of the marketing strategy. Emails sent to subscribers should be created in such a way that they relate to the top 20%.
  3. Focus on your best customers because 80% of profits are produced by 20% of your customers. Most the product development efforts and promotional offers should be focused on this 20%.


HOW TO USE THE 80/20 RULE TO MAKE DECISIONS?

IDENTIFY THE 80/20 TASKS
Take out a sheet of paper and write down what you do on a daily basis. Next, circle the tasks that produce the best results for your job. Finally, if you have a boss, ask him or her about what is most important. Do this for your personal life as well.

ASK A SIMPLE QUESTION
Whenever you’re faced with a new potential project or task, ask a simple question:
"Does this task help or hurt my 80% activities"?

ELIMINATE OR DELEGATE
Your project list shouldn’t be filled with items that don’t matter. If an activity isn’t bringing satisfaction or a measurable result, then you should get rid of it. Either pass it along to someone else (delegate) or completely eliminate it.

DON’T ADD, SUBSTITUTE
Remember, your time is limited. If you feel like a new project is important enough to work on, then it should take the place of a low-value activity.

PRACTICE CREATIVE PROCRASTINATION
When you know a project isn’t an 80% activity, then it’s perfectly fine to put it down on a "someday" list. You’ll delay this action with the understanding that you’ll only do it if it becomes more important later on in your life.

Practicing 80/20 is a skill that takes awhile to develop. At first, it’ll be difficult to let go of the projects you once thought were important. Eventually, however, you’ll develop an intuitive understanding of what is valuable and what is a waste of your time.

What is Pareto Chart ?

The Pareto Chart is one of the 'Seven Basic Tools of Quality Control.' It helps highlight the most important factors from among a group of many factors. In quality control, it is often used to represent the most common sources of defects or the highest occurrence of defects. It is a simple bar chart that displays the number of occurrences on the left vertical axis and the category of occurrences on the horizontal axis. While not required, you can add a right vertical axis which represents the cumulative percentage of the left axis to the total.


Example of Pareto chart

Look at a part of your business where you have had consistency problems. An example might be customer service problems. Say you collect data on your customer complaints for April and find that you have problems with:

  • delivery when promised (5 complaints)
  • quantity delivered (12 complaints)
  • invoice pricing errors (8 complaints)
  • invoice quantity errors (2 complaints)
  • damaged product (26 complaints)

Seven steps to identifying the important causes using Pareto Analysis :

  1. Form a table listing the causes and their frequency as a percentage.
  2. Arrange the rows in the decreasing order of importance of the causes, i.e. the most important cause first.
  3. Add a cumulative percentage column to the table.
  4. Plot with causes on x-axis and cumulative percentage on y-axis.
  5. Join the above points to form a curve.
  6. Plot (on the same graph) a bar graph with causes on x-axis and percent frequency on y-axis.
  7. Draw a line at 80% on y-axis parallel to x-axis. Then drop the line at the point of intersection with the curve on x-axis. This point on the x-axis separates the important causes on the left and less important causes on the right.

This is a simple example of a Pareto diagram using sample data showing the relative frequency of causes for customer service problems. It enables you to see what 20% of complaints are causing 80% of the problems and where efforts should be focussed to achieve the greatest improvement.

The value of the Pareto Principle for a project manager is that it reminds you to focus on the 20% of things that matter. Of the things you do during your project, only 20% are really important. Those 20% produce 80% of your results. Identify and focus on those things first, but don't totally ignore the remaining 80% of causes.