What is the Pareto or 80-20 Rule?

The 80-20 rule, also known as Pareto Analysis, is the principle of factor sparsity. It is a business rule which states that 80 percent of many events come from 20 percent of the causes. The business personnel uses this 80-20 rule to explain how 20 percent of the clients, are contributing to 80 percent of the revenue. This means that 20 percent of the actions you take contributes to 80 percent of the results you are likely to get. A simple way of explaining this would be, on any to-do-list, two items out of ten will turn out to be beneficial than the other eight put together. Since in business most people are more concerned about the output (profits), this rule emphasizes that you focus your investment on the two items (20%) which are more beneficial to your business instead of wasting time on the other eight (80%) which are less productive. This rule helps businessmen to channel their investment only in areas that bring more returns to their businesses.

How does the 80-20 Rule Work? 

The 80-20 rule also known as the Pareto principle can be traced back to 1906. The Pareto principle was named after its founder Vilfredo Pareto, an Italian economist. He came up with this rule after he had carefully studied how people in the society were naturally dividing themselves into what he termed as the vital few. This vital few is what came to be known as the 20 percent in, this case, referring to money and influence according to Pareto. The other division according to him was the trivial many which is the bottom 80 percent. Pareto discovered afterward that all the economic activities were subject to the principle. For instance, he noticed from his study that, 80 percent of Italian wealth at that time, was being controlled by 20 percent of the population. His study pointed out how small things or rather small actions could influence or cause great things to happen, hence the term the vital few. In 1940, Joseph Juran expanded the 80-20 rule to business production methods. He used the rule to establish how you can control the quality of a product in business production. In this case, he incorporated the phenomenon of the vital few and the trivial many to show how 20 percent of weakness in production caused 80 percent of the problems. Since 80 percent of the problems emanated from 20 percent of the causes, focusing on the 20 percent was crucial to ensure effective quality control and proper utilization of resources. Juran then included these principles in his book Quality Control Handbook.The publication of the first edition of this handbook was done in 1951. To date, the publication is viewed by many as classic management theory. In Japans history, his concept of quality control has had a major impact on the country's post-war economy. This resulted from his series of lectures in Japan after World War II.

Applying the Pareto Analysis

There are eight steps to Pareto Analysis which allow you to identify the principal causes that need your attention:

1. Put causes on the x-axis on a vertical bar chart. Put the number of occurrences (count) on the y-axis.
2. The bar chart should be arranged with the causes in descending order relative to their importance. Put the cause that has the highest count first.
3. For each cause, in descending order, calculate its cumulative count.
4. In descending order, calculate the percentage of each causes cumulative count. For the calculation: {single cause count} / {total count of all causes}*100
5. Make another chat with the calculated percentages on the y-axis in descending order in increments of 10 starting with 100 percent.
6. On the x-axis, plot each cumulative count percentage of the causes.
7. Connect the points to create a curve.
8. At 80 percent point, draw a line on the y-axis that runs parallel to the x-axis. At the intersection point with the x-axis curve, drop the line. The point on the x-axis cuts apart the significant causes on the left or the vital few from the trivial many, which are the less important causes on the right.

Modern Use of 80-20 Rule

The 80-20 rule is currently being used to address issues in different areas such as: In Business Management The 80-20 has been expanded and is currently being applied in businesses to address several issues. For instance, if a firm notices that most of its sales (80%) is generated from a few clients (20%), then the company increases its sales with a focus on the 20% of the clients who are known to bring in most of its revenue. In Work (manpower) Also, if an organization realizes that most of its output (80%) relies heavily on a few employees (20%), then the organization will focus on rewarding the few productive employees (20%) handsomely. This strategy helps the organization to retain those employees and at the same time motivate them to continue being productive. In Project Management In project implementation, there are many tasks involved in order to ensure project success. When implementing a project, there are possibilities that 80% of the problems you will encounter will be as a result of a few key concerns (20%). In this case, the manager needs to quickly identify sources of these problems and then focus on fixing them. Since the few key issues (20%) is the cause of 80% of the problems being experienced, the only way out is to focus on addressing cause (issues) rather than the problems. Addressing the root cause of the problem will guarantee project success.

Advantages of Using the 80-20 Rule

• The 80-20 rule is able to tell where the major problems rest. It is also able to show how various factors are limiting the progress of your business.
• The 80-20 rule requires you to only focus on the 20 percent of the issues causing the majority (80%) of the problem and not on the problem themselves. This is easier and manageable compared to where you have to address the 80 percent of the problems which can prove to be difficult. Addressing the few causes in exchange for great returns is productive to a business than dealing with major problems.

Limitations of the 80-20 Rule

• Through the 80-20 rule is able to point out what the major problem in the business is, it is difficult to measure the severity of that problem and what it will take to bring your business to normalcy and also be able to generate more revenues.
• The 80-20 rule is only able to generate observable qualitative data. It does not give elements of measurement from which one can measure variability or changes.
• It may fail to address critical issues such as a change in policies, government regulations, economic conditions, and so on. This will give you misleading information which is likely to affect your business should you decide to use it to make important decisions regarding your business.

The Bottom Line

Though the 80-20 rule has its own flaws, it is still one of the most useful concepts and essential for strategic planning. It forms a solid foundation for your project, sales, and marketing objectives. Understanding this rule will help you to learn how to prioritize your tasks and efficiently manage your time. As a business person, you can apply this rule to help you establish and organize projects and or objectives in order of importance. This way, it will be easier for you to point out projects that require the most attention as far as allocation and use of resources is concerned. Since 20 percent generates 80 percent of the desired results, it is critical that your focus is on the 20 percent for more output.