Pareto Principle

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Definition: Pareto Principle


Pareto Principle


Full Definition of Pareto Principle


Pareto principle is a theory that states that 80% of the effects are the result of 20% of the source(s) or participants, of any given event. A few items contribute the most; these are the vital few, as opposed to the trivial majority.

The Pareto principle, also known as the 80-20 rule, states that eighty per cent of the result is obtained due to 20 per cent of actions. In simple terms, most of the results are obtained due to minor actions. The rest of the actions are either wasted or produce little value. The Pareto principle was developed by Italian economist Vilfredo Pareto. He invented a mathematical formula that dealt with the unequal distribution of wealth. Pareto principle is mainly used in determining the extent of unequal distribution of wealth.

The Pareto principle means that 20 per cent of people own 80 per cent of the wealth of the world. This principle can be applied to anything from economics to management and science to the physical world. For any project, it can be obtained that from 80 per cent of resources and time only 20 per cent of work is complete. The Pareto effect is often referred to in discussing wealth distribution.

The Pareto principle can be used in varied ways. If a company realizes that only 20 per cent of workers contribute to completing 80 per cent of work, then the company can take special initiatives to reward these employees so that more work can be expected. If a computer engineer can understand that only 20 per cent of bugs are responsible for 80 per cent crashes then more focus can be put on fixing these bugs. If a seller gets the concept that 20 per cent of customers lead them to earn 80 per cent of revenue then, the sellers can work on satisfying these customers.

The entire concept of the Pareto principle can be related to diminishing marginal benefit. The Law of diminishing returns advocates the Pareto principle. The law states that for each additional man-hour each worker is adding less advantage to the final result.

Pareto Chart

Pareto chart is one of the statistical tools that are used to measure quality assurance. The Pareto chart is represented by using several bars arranged in descending order. This chart was invented by Vilfredo Pareto and was widely used by Joseph M. Juran and Kaoru Ishikawa.

Examples

  • In a company’s clientele, a few top customers can account for the bulk of sales
  • The bulk of GNP contributions are by a top few per cent of industries
  • The top few per cent of individuals in a population own the bulk of the assets
  • In a workforce, most labour problems arise from a minority of union members
  • In a production line, there can be a few vital or bottleneck machines
  • In an inventory, a top few items account for most of the dollar value
  • 80% of a nation’s income goes to 20% of the population

Application

The Pareto principle is often used in business. Manufacturing, supply chain management, inventory (in particular vendor-managed inventory), sales, and revenue, in general, are areas where the principle is often seen.

ABC analysis

The Pareto principle can often be used to solve problems. For example, if an excess inventory of a certain item is tying up capital (funds, space, resources), it is often enough to classify the inventory and then address it. It might look like this:

  • Class A (vital few) items
  • Class B (intermediate)
  • Class C (trivial majority) items

By keeping tight control on an inventory of class A items, 80% of the problem is solved.

Class A:

  • Tight control; Partnering, just-in-time-type systems
  • Good systems & procedures
  • Audit, storage, physical counts, etc.

Class C:

  • Can order infrequently, in larger lots, arm’s length relationships
  • But don’t neglect them: sometimes assembly lines stop for want of a “trivial item”

Six Sigma

Six Sigma is a quality management methodology that employs the Pareto principle.

Project Management

Project management Critical Path Mapping (CPM). The red line is the critical path. The orange events take longer to complete and therefore if anyone is delayed a bit may not have adverse consequences on the final schedule.

In project management, often the critical path represents the “vital few”. The critical path is the longest, with no slack. The project cannot be completed in less than this time. This path is vital because it is tightly scheduled, and any delays in it will result in delays in the project.

Therefore, focus on these “vital few” the Pareto principle teaches us, and control the effects of the critical path.


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Definition Sources


Definitions for Pareto Principle are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 29th March, 2020 | 0 Views.