Pareto principle.
Also known as the 80–20 rule states
that, for many events, roughly 80% of the effects come from 20% of the causes.
In practically every industrial
country a small proportion of all the factories employ a disproportionate
number of factory operatives. In some countries 15 percent of the firms employ
70 percent of the people. This same state of affairs is repeated time after
time. In retailing for example, one usually finds that up to 80 percent of the
turnover is accounted for by 20 percent of the lines.
This effect, known as the 80 :
20 rule, can be observed in action so often that it seems to be almost a
universal truth. As several economists have pointed out, at the turn of the
century the bulk of the country’s wealth was in the hands of a small number of
people.
This fact gave rise to the
Pareto effect or Pareto’s law: a small proportion of causes produce a
large proportion of results. Thus frequently a vital few causes may need
special attention wile the trivial many may warrant very little. It is this
phrase that is most commonly used in talking about the Pareto effect – ‘the
vital few and the trivial many’. A vital few customers may account for a very
large percentage of total sales. A vital few taxes produce the bulk of total
revenue. A vital few improvements can produce the bulk of the results.
The Pareto effect is named after
Vilfredo Pareto, an economist and sociologist who lived from 1848 to 1923.
Originally trained as an engineer he was a one time managing director of a
group of coalmines. Later he took the chair of economics at Lausanne
University, ultimately becoming a recluse. Mussolini made him a senator in 1922
but by his death in 1923 he was already at odds with the regime. Pareto was an
elitist believing that the concept of the vital few and the trivial many
extended to human beings.
Observing the
Pareto Principle in Action
Here are some 80/20 rule
applications:
•
Does 20 percent of your sales force produce 80 percent of
revenues?
•
Do 20 percent of your products account for 80 percent of product
sales?
•
Do 80 percent of your visitors see only 20 percent of your Web
site pages?
•
Do 80 percent of delays arise from 20 percent of the possible
causes of delay?
•
Do 80 percent of customer complaints arise from 20 percent of
your products or services?
We all waste lots of time on
trivial, repetitive tasks. That often means people are kept busy whether it is
important or not, equipment is running whether needed or not, sales are made
whether they are profitable or not.
Is the assertion that a small
number of events produce the majority of results valid? It may not be a hard
rule with a fixed ratio, but the observation has merit:
•
A handful of customers out of many produces the bulk of
revenues.
•
A handful of products out of many items in a line produces the
bulk of orders.
•
A handful of salespeople out of many produces the majority of
new business.
•
A handful of scientists produces most research and development
innovations.
•
Most grievances come from a few employees, and most absenteeism
can be narrowed down to specific individuals.
•
Most accidents occur in clearly identifiable groups.
•
Truly poor (or great) performance is achieved by a few easily
identifiable individuals.
The Pareto chart
A Pareto
chart is a graphical representation that displays data in order of priority. It
can be a powerful tool for identifying the relative importance of causes, most
of which arise from only a few of the processes, hence the 80:20 rule. Pareto
Analysis is used to focus problem solving activities, so that areas creating
most of the issues and difficulties are addressed first.
Some
problems
Difficulties associated with Pareto
Analysis.
- Misrepresentation of the data.
- Inappropriate measurements depicted.
- Lack of understanding of how it should be applied to particular problems.
- Knowing when and how to use Pareto Analysis.
- Inaccurate plotting of cumulative percent data.
Overcoming the difficulties
- Define the purpose of using the tool.
- Identify the most appropriate measurement parameters.
- Use check sheets to collect data for the likely major causes.
- Arrange the data in descending order of value and calculate % frequency and/or cost and cumulative percent.
- Plot the cumulative percent through the top right side of the first bar.
The 80/20 rule for
business planning and decision analysis.
For
today’s business leaders, the old axiom “knowledge is power” should probably be
amended to say “knowledge is power ONLY IF it reflects a strong understanding
of real-time information, enables meaningful foresight, and results in prudent
business decisions”.
More and more,
companies are making significant investments in business intelligence systems
and services to ensure that executives, line managers, and individual
contributors alike have access to, can make sense of, and can act upon the most
granular data relevant to their day-to-day operations. This data is
analyzed and compiled in executive dashboards reflecting key performance
indicators (KPIs) and used to update driver-based forecasts with the overall
aim of providing proactive and precise support for critical business decisions.
Unfortunately, what often results is analysis paralysis. too many variables,
not enough insight, and an inability to distinguish the forest from the trees.
No matter how sophisticated or crude a company’s analytical capabilities
may be, knowing what to focus on and what not to, ultimately determines success
or failure.
In a sense,
simplicity is always best. There may be hundreds of variables impacting a
business at any given time but effective business leaders typically focus on
only a small handful of key drivers. As any decent golf instructor will tell
you, the best players limit their thoughts to two or three basic mechanics
before striking the ball and rely on muscle memory to do the rest.
Similarly, most
successful business leaders will tell you that 20 percent of the key drivers
produce 80 percent of the results. Knowing how to eliminate the other 80
percent of variables with marginal impact is critical to robust business
planning and strong decision making.
Posted by,
Ankit Agrawal
(Team J)
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