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? ›
While the 80/20 split is true for Pareto's observation, that doesn't necessarily mean that it is always true. That's because it is based on anecdotal evidence rather than scientific analysis. For instance, 30% of the workforce (or 30 out of 100 workers) may only complete 60% of the output.
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.
Prioritize the first 20% of your workday regarding the tasks you complete and know when it's time to pivot and make changes when working on the remaining 80% to ensure you don't waste too much productive time and energy.
What are three applications of the 80/20 principle to everyday life? ›
The List of Examples. 80% of a company's output is produced by 20% of its workers. 80% of social media shares are by 20% of posts. 80% of software glitches are caused by 20% of bugs.
The Pareto Principle is considered self-evident but has weaknesses such as imperfect relation to values like welfare and autonomy, changing preferences, and inconsistency with other ethical standards.
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.
Does 80/20 apply to everything? ›
Obviously, the 80/20 rule is not necessarily a rigid dictum to live by. Not everything will fit so nicely into its nice, neat categorization. But think of it as a tool, a lens to view aspects of your life through.
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? ›
So, here are some Pareto 80 20 rule examples:
- 20% of criminals commit 80% of crimes.
- 20% of drivers cause 80% of all traffic accidents.
- 80% of pollution originates from 20% of all factories.
- 20% of a companies products represent 80% of sales.
- 20% of employees are responsible for 80% of the results.
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 does the Pareto 80-20 rule say? ›
The 80-20 rule maintains that 80% of outcomes comes from 20% of causes. The 80-20 rule prioritizes the 20% of factors that will produce the best results. A principle of the 80-20 rule is to identify an entity's best assets and use them efficiently to create maximum value.
What does the Pareto Principle state of causes account for 80% of problems? ›
The Pareto principle states that 80% of the problems are the result of 20% of the causes. To this end, a relatively simple chart is used to highlight problems.
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.
