The 80/20 Rule
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What is the Pareto Principle?
The Pareto principle, also known as the 80/20 rule, was one of Vilfredo Pareto’s most noteworthy theories, which found that 80% of outcomes often come from 20% of the related inputs. Pareto was an Italian economist in the 19th and 20th centuries who helped develop modern economics as we know it today.
Pareto first saw the situation when evaluating income distribution in Italy, where he saw that 80% of the country’s income went to only 20% of the population. His theory stretches far beyond just income and can be found throughout many business and consumer fields.
As a whole, the theory suggests that many aspects of life are not distributed evenly. The Pareto principle is also referred to as the “vital few” and “useful many.”
Summary
- The Pareto principle, commonly referred to as the 80/20 rule, suggests that 80% of results/outcomes will result from 20% of the actions/inputs that can be associated with it.
- The rule can be viewed in two ways, either the vital few, which a small number (20%) of factors result in the vast majority (80%) of results or the useful many that find that many sources account for a small number of results.
- The Pareto principle is an analytical tool to help organize thoughts and develop solutions to business and consumer problems.
Practical Applications
The Pareto principle can be seen across many sectors of business and within consumerism. Below are a few examples of where it might be found:
- 80% of the work in a group project is done by 20% of the group
- 80% of revenues come from 20% of the products
- 80% of engine failures come from 20% of possible causes
Importance of the Pareto Principle
The Pareto principle is a helpful rule of thumb when trying to optimize the allocation of resources. The correct distribution of resources can make a significant difference in the efficiency and profitability of a business.
For example, think about if a new CEO is hired to boost client retention for a small business. If 80% of the reason their clients are leaving is caused by 20% of the possible problems, it would be a no-brainer to focus on the first 20%.
The 80/20 rule is a great decision-making tool to help optimize resource allocation for a business. It helps organize the thought process and make much more educated decisions.
The rule also plays into the law of diminishing marginal return/benefit. Keeping all else equal, when the consumption of inputs increases, the marginal benefit of each additional output will decrease.
Benefits and Limitations
The Pareto principle offers several benefits, mostly surrounding the analysis that it can be used for. It can help analyze problems within a company, organize the thoughts behind them, and provide the most effective solutions.
An important note to remember when thinking about the Pareto principle is that it is merely a rule of thumb and not a hard law that is always followed.
Other Related Pareto Theories
Pareto analysis is an analytical tool used to aid decision-making. It is a statistical approach to rank problems within a business and uses the data to make decisions. Pareto diagrams and tables can be used to help visualize the findings. The findings will often resemble the Pareto principle as either:
- The Vital Few: A small number of inputs lead to a large majority of the outputs.
- The Useful Many: A large number of inputs lead to a small part of the entire problem.
Other similar theories developed by Vilfredo Pareto include Pareto efficiency, Pareto inefficiency, and Pareto improvement. All of which relate to the Production-Possibilities Frontier. Any point on the frontier that is Pareto inefficient will enjoy the opportunity of a Pareto improvement to move towards Pareto efficiency.
More Resources
CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)® certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
FAQs
The basic idea is 80% of effects come from 20% of causes. So in theory if you focus 20% of resources correctly, you can get 80% of the results you need. You reach 'good enough' and can be much more cost-effective, instead of using 80% more resources stretching to a 'perfect' 100%.
What is the Pareto 20 80 problem solving rule? ›
The 80/20 Rule
The Pareto Principle states that 80 percent of a project's benefit comes from 20 percent of the work. Or, conversely, that 80 percent of problems can be traced back to 20 percent of causes. Pareto Analysis identifies the problem areas or tasks that will have the biggest payoff.
What is the 80% rule Pareto? ›
The 80/20 Rule (also known as the Pareto principle or the law of the vital few & trivial many) states that, for many events, roughly 80% of the effects come from 20% of the causes.
Does Pareto Principle always work? ›
For instance, 30% of the workforce (or 30 out of 100 workers) may only complete 60% of the output. The remaining workers may not be as productive or may just be slacking off on the job. This further reiterates that the Pareto Principle is merely an observation and not necessarily a law.
What is the better explained Pareto Principle? ›
The Pareto principle states that for many outcomes, roughly 80% of consequences come from 20% of causes. In other words, a small percentage of causes have an outsized effect. This concept is important to understand because it can help you identify which initiatives to prioritize so you can make the most impact.
What are real examples of the 80/20 rule? ›
20% of customers account for 80% of the profits of many businesses. 20% of criminals account for 80% of criminal losses. 20% of motorists cause 80% of the accidents. 20% of those who marry represent 80% of the divorces (serial marriage failures)
What is the 80-20 rule in relationships cheating? ›
80% of your needs are being met by your partner, and you're figuring out the other 20% on your own. When the 80/20 rule is applied to infidelity, the theory is that when someone cheats, they're attracted to the 20% in someone else that they were missing from their partner.
How to apply 80/20 rule in life? ›
Steps to apply the 80/20 Rule
- Identify all your daily/weekly tasks.
- Identify key tasks.
- What are the tasks that give you more return?
- Brainstorm how you can reduce or transfer the tasks that give you less return.
- Create a plan to do more that brings you more value.
- Use 80/20 to prioritize any project you're working on.
The 80% of crap you use 20% of the time (throw it out or sell it). The 80% of the clothes you wear 20% of the time (same thing). Identifying the 20% of the food you eat 80% of the time will probably explain whether you keep a healthy diet or not and how healthy it is.
What is the Pareto formula? ›
Example: The equation for the first percentage is the most common defect divided by the total defects and multiplied by 100, or (15/45) x 100 = 34%. In order to calculate the next cumulative percentage, take the next most common defect, add it to the first data point, divide it by the total and multiply it by 100.
Pareto principle in business
Maybe in your business 20% of your clients are providing you with 80% of your profits, while the worst 20% of them are just being a pain and making up for 80% of your frustration at work. Cutting out those worse 20% might make your job a whole lot more enjoyable at not much cost.
Does the 80/20 principle always apply to positive outcomes? ›
The important thing to remember is that 80/20 is a guide, not a rigid rule. The proportions can look a little different (10/90 or even 30/70) but the concept stays the same—find the few causes that get you the most results (whether those results are negative or positive)!
What is Pareto's principle in simple words? ›
The Pareto principle, also known as the 80/20 rule, is a theory maintaining that 80 percent of the output from a given situation or system is determined by 20 percent of the input.
What is an example of Pareto? ›
80% of sleep quality occurs in 20% of sleep. 80% of results are caused by 20% of thinking and planning. 80% of family problems are caused by 20% of issues. 80% of retail sales are produced by 20% of a store's brands.
What is a Pareto good? ›
Pareto efficient (optimal) level of provision of public good is such that cannot be altered in any way so that at least one person would be made better off without making anybody worse off.
What is meant by the 80-20 principle explain how it is applied to identify problem locations? ›
The Pareto Principle specifies that 80% of consequences come from 20% of the causes, asserting an unequal relationship between inputs and outputs. Pareto analysis states that 80% of a project's results are due to 20% of the work, or conversely, 80% of problems can be traced to 20% of the causes.
What is the 80-20 rule in learning? ›
How Does The 80/20 Rule Apply To Our Studies? When we are looking at this principle in relation to our education, the primary factor we should consider is that 20% of the time you spend studying will be leading to 80% of the results you see.
What is an example of 80-20 rule time management? ›
For example, a business may find that 80% of its sales come from 20% of its products and could focus on improving those products to boost sales further. Similarly, an individual may find that 80% of their productivity comes from 20% of their work tasks and could prioritize them to achieve better results.
What is the 80-20 rule in leadership? ›
80% of ideas should come from your team; 20% should come from you. If you are appropriately delegating, empowering, enabling, coaching, and guiding your team, then 80% of the ideas you and your team implement or execute on should come from them, rather than you.
