Pareto Principle (80:20 Rule)
Use this framework to determine where effort is most justified
In 1896 an Italian economist, Vilfredo Pareto, determined that 80% of the wealth in Italy belonged to about 20% of the population. This law shows how a small proportion of a population accounts for a large proportion of consumption, ownership or output. It is also known as the 80:20 rule.
The concept of unequal distribution in a population is particularly useful in business. 20% of your time produces 80% of your business results; 20% of customers account for 80% of revenue and shows where efforts will have most reward. Such inequality can be taken further. For example, 5% of the population usually accounts for two thirds of consumption, or wealth, or some other characteristic. This unequal distribution is the basis for organising a key account management strategy. The Pareto principle gives us a framework that can be used in all types of business and financial analysis as well as organising work and life.
The Pareto principle applies to most statistical distributions. 80% of the profit comes from 20% of customers, 80% of product faults are the result of 20% of the most reported bugs in a system. Scatter graphs and histograms are tools for analysing a population to determine how the Pareto principle applies.
We must be careful with this principle because there is a temptation to jettison the tail end of customers who account for very few sales. This may seem to be a perfectly justifiable strategy but first it is worthwhile checking whether some of the small customers have a potential which isn't being tapped at the present. Some of the customers may buy little from you but there could be much more to go for. Some customers may be small but growing fast. Some could be profitable, especially if they are serviced with a light and inexpensive sales touch.
Jack Welsh, the management guru in charge of General Electric between 1981 and 2001, drove the company to greater efficient using the Pareto principle. He described his workforce as reflecting a 20-70-10 system. By this he meant that the top 20% of the workforce was the most productive, the 70% in the middle worked adequately, and the 10% at the bottom were non-producers and should be fired. With this in mind he culled the bottom 10% of the workforce each year. This improved the quality of the workforce but had serious implications on the morale of those that remained. They knew that they would be in line for similar considerations next year.