What Is the Pareto Principle?
Have you ever heard of the 80/20 rule? It is the phenomenon that 80% of consequences come from 20% of causes. This principle can be seen in action across multiple areas of study like ecological environments, societal structures, work time management, and even language.
To wrap our minds around it, here are a few quick examples of the 80/20 rule in action:
80% of work is performed during 20% of the total work time.
80% of sales revenue comes from 20% of clients.
80% of problems can be traced to 20% of defects.
This principle helps businesses prioritize the key factors of failures and successes. If 80% of problems are caused by 20% defects, then by focusing on fixing those specific defects, you can create the most positive change. Likewise, if 80% of sales revenue is coming from 20% of clients, then it is beneficial to keep those clients.
The important question is, how do you find the right 20%?
KEY TAKEAWAYS
The Pareto Principle is the idea that 80% of consequences come from 20% of causes. Meaning that the minority often controls the majority.
Despite being called a rule, it is only observable as a natural phenomenon and will not always be an 80/20 split.
Companies use Pareto Analysis and the Pareto Chart to find the effects that are generating the most consequences.
Other names for the Pareto Principle are the 80/20 Rule, the Law of Vital Few, or the Principle of Factor Sparsity.
Brief History of the Pareto Principle
The Pareto Principle was named after Italian economist Vilfredo Pareto. In 1906, he observed that approximately 80% of the land in Italy was owned by 20% of the population. Upon seeing this distribution, he traveled across Europe and observed the same unequal distribution of wealth. He called this the 80/20 Rule. To Pareto, the 20%, or the powerful minority, is referred to as the Vital Few.
In 1937, American business theorist Joseph Juran discovered Pareto’s research and renamed the 80/20 rule to Pareto’s Principle of Unequal Distribution. He then applied this principle to the business world, focusing on the idea that if companies focus on the Vital Few, they can positively impact 80% of their operation and business.
Will It Always Be An 80/20 Split?
In short, no.
The Pareto Principle is merely an observation of common levels of unequal distributions. The most common of these distributions is the 80/20 split but by no means is this a rock-solid figure. You could have a case where 40% of processes are contributing to 60% of non-conformance issues. Or that 30% of workers are responsible for 70% of results.
So why use the Pareto Principle?
Because this doesn’t change the underlying principle: the minority often has the greatest impact over the majority.
Since the Pareto Principle is not a hard and fast rule, Pareto Analysis is used as a guide to help people and companies focus on the right determining factors within their operation. The outcomes may not be a perfect 80/20 split, but it will show you which factors are contributing the most to the effect.
How to Perform Pareto Analysis
Pareto analysis is the process whereby problems or successes are identified and prioritized. By looking through the proverbial Pareto lens, businesses can focus on fixing the issues that are having the greatest impact. If a company is experiencing a high number of defects, they can determine the greatest contributing factors by following these 4 steps.
Step 1: Identify the total defects that are affecting the operation.
Step 2: Compile a list of all defects with their frequency in a given time frame.
Step 3: Sort them in descending order, from largest to smallest.
Step 4: Calculate the cumulative percentage of each defect in regards to the total number of defects.
To put these steps into action, imagine you run a toy car factory where you fabricate high-end electronic wooden car models. Business is good but there’s a problem. In the past year, you’ve had a total of 994 defects. That’s an average of nearly 4 defects per working day. Something needs to be done!
Thankfully, you’ve recorded all defects over the past year. By following the above steps, you’ve built a table outlining the identified defects, the total number of defects, the cumulative number of defects, and the cumulative percentage of defects.
I know it sounds complicated but I assure you it’s fairly simple, and reading the data is even easier.
So here we can see you have 4 defects (highlighted in green) that account for approximately 80% of the total defects. By focusing your efforts specifically on this 20% of defects, you can theoretically eliminate 80% of the total defects.
How to Build a Pareto Chart
Building a Pareto Chart gives further insight into the issues at hand and how they relate to each other. The magic of the Pareto Chart is that it is both a line and bar graph. We get an accurate view of the number of defects while understanding their cumulative value next to each other.
So you might ask: how do we take this information and build it into a Pareot Chart?
Using the same information as the table above, we can compile the data into the below chart. Check out the Video at the end to see how you can easily build a Pareto Chart in Excel.
Each bar represents one defect category (again I’ve highlighted the top 4 in green) and the numbers on the left indicate their frequency. The orange line (arguably the most important part of the Pareto Chart) is the cumulative percentage. For this scenario, I have made the distribution an 80/20 split but as we’ve discussed this may not always be the case.
From the Pareto Chart we gain 2 key insights.
If we can resolve this 20% of defects, we can eliminate 80% of the total defect problem.
If we were to focus on the smaller number issues in the chart, we wouldn’t be affecting the greatest change.
After the fourth bar, the orange line doesn’t have that much higher to go. Indicating that the greatest impact has already been made. You’ll want to focus your defect mitigation efforts there first. Also, since the other defects are small by comparison, they can be left as secondary issues to solve at a later date.
As those issues are fixed, you can return and perform another Pareto Analysis to find the next Vital Few percentage of issues. Progressively you can knock down the most impactful problems in an intelligent and worthwhile order.
