What is the Pareto Principle?
In the early 1900s, esteemed economist, Vilfredo Pareto observed that 80% of Italy’s wealth belonged to 20% of the population. This observation that most things in life are unevenly distributed can be applied to many situations, so the Pareto Principle, or “80/20 rule”, was born.
There is a common misconception that the Pareto Principle always leads to a true 80/20 distribution, but that isn’t the case. Whilst not always exact, the 80/20 rule is still an excellent, albeit rough guide about typical distributions. As a business mentor I am still amazed at how many times the rule works out! I use it time and time again to help business performance.
A fun simple way you can test this out for yourself is to turn all of your coat hangers around in your wardrobe, and then when you wear something, turn the hanger around the right way. Over time, we will see that approximately 80% of our clothes aren’t worn! We tend to wear about 20% of our clothes 80% of the time!
Using the 80/20 rule for business
Of course, the 80/20 rule is an extremely useful tool for focussing your attention on the customers, products or issues that have the most significant impact on your business, whether positively or negatively!
In some circumstances, it’s simple to apply the Pareto Principle. For example, “how can the 80/20 rule boost our sales and profitability?” If you can identify the 20% of customers (or products) that make up 80% of your sales/profit, then you can concentrate your efforts on these valuable clients (or products.)
Then investigate the characteristics this 20% “significant impact” group possess and aim to find other similar customers.
However, it doesn’t mean that you should completely forget about the other 80%. But it does mean you can reduce your focus and resource on the long “tail” of customers and products comfortable in the knowledge that this will have minimal impact on your business.
This can be a simple but impactful way to grow your business. It just means that your time and resources will be best spent on on the key areas.
Given the remarkable consistency with witch Pareto works out, when I am coaching businesses as their Business Mentor, I am often surprised at how infrequently it is used. Try applying the Pareto Principle to more complex scenarios. For example, you know you have problems to fix, but how do you decide which issues have the biggest impact on your business?
Here is how you can approach this situation:
- Identify and list problems. List all the issues you need to resolve. If you can, gather as much information from customers and team members to help you achieve this.
- Find the root cause. Try to get to the root cause of each problem you have listed.
- Score each problem by importance. For example, if you are trying to improve customer satisfaction, you could score problems by how many complaints you have received about each situation.
- Group problems. If several your problems are caused by the same issue, group these together.
- Add up each group. The group with the highest score should be your priority. The group with the lowest score is your lowest priority.
You’ll find again that around 20% of the problems are having 80% of the impact upon your business.
Note: this approach is great for identifying root causes, but it doesn’t consider the cost of rectifying them. Where costs are high, you would need to look at other techniques, such as a cost/benefit analysis.
When you know which issues have the most significant impact on your business, you can correctly focus your time and resources to dramatically improve it. Once you have gone through this process a few times, it should be a lot easier for you to see how Pareto analysis can be applied, becoming a regular tool for continually driving your business forward.
As a business mentor and coach based in Somerset, I support small businesses throughout the South West of England, including those based in Bristol and Bath. I would love to have an initial chat, learn more about you and your business, and see how we could work together. So, give me a call and let’s get started!
Nigel Browne, Director & Business Mentor
Bristol & South West
Mobile: 07771 920942