The Pareto Principle

The Basic Idea

If you’ve ever gone trick-or-treating on Halloween, you may be familiar with the Pareto principle. When going door-to-door in search of candy, there definitely wasn’t an equal distribution of candy donations from your neighbors. Some of the homes were likely vacant for the night, some residents may have avoided answering the door, and others might have doled out only a single treat to your growing supply of sugary goods. A few generous neighbors probably contributed the majority of your candy, kindly doling out handfuls of lollipops, full-size chocolate bars, or even small gift bags.

The observation that the majority of effects (such as a Halloween candy haul) come from a minority of causes (homeowners) is not only applicable to trick-or-treating but to a wide variety of circumstances including marketing, healthcare, and quality control. As economist and sociologist, Vilfredo Pareto noticed, 20 percent of causes are often responsible for 80 percent of effects or outcomes.1 This ‘80/20 rule’ is most commonly known as the Pareto Principle, or as Joseph. M. Juran has also called it, the law of the ‘vital few and the trivial many.’2 The Pareto principle serves to this day as a useful basis for analysis which can help both individuals and organizations to set priorities and make effective decisions.

Why do 80% of effects come from 20% of causes?

Key Concepts

The Pareto Principle: Also known as the 80/20 rule, or the ‘law of the vital few and trivial many,’ the Pareto Principle names the general observation that 80% of effects or outcomes come from 20% of causes or inputs.

Pareto Analysis: Inspired by the Pareto Principle, Pareto Analysis is a form of analysis that considers which and how many causes or inputs are responsible for the majority of outcomes.2

History

The Pareto principle was first observed by its namesake, Vilfredo Pareto, in the early 20th century. The 80/20 Rule, or Pareto Principle, is said to have originated when Pareto realized that 20 percent of his pea plants produced 80 percent of his pea harvest. Later, while conducting a study on Italian land ownership, Pareto noticed that 80 percent of the land in Italy was owned by 20 percent of individuals.3 After some reflection, Pareto realized that a similar 20 percent to 80 percent ratio applied to patterns of income and property distribution not only in Italy, but around the world and throughout history. These observations were the basis of Pareto’s conclusion that the 80/20 ratio of effects to causes was something so universal as to almost behave as a natural law, both in the physical world and in the study of human behaviour.

Although Vilfredo Pareto was the father of the ‘Pareto principle,’ the concept was not explicitly coined as such until Joseph. M. Juran picked up the idea and used it for his own purposes.2 Juran was interested in ways to improve industrial processes, particularly in the area of quality control and item defects. What Juran noticed is that approximately 20 percent of quality control issues (such as defects) were responsible for about 80 percent of complaints received about merchandise.2 Furthermore, approximately 80 percent of manufacturing errors came from 20 percent of factories, and 80 percent of defects within factories came from 20 percent of the workstations.

By realizing this, Juran was able to help companies improve quality control processes by prioritizing the 20 percent of quality control issues that had the greatest impact. This is why Juran speaks of the “vital few and the trivial many,” since often even a small improvement to the important 20 percent is more effective than a large improvement to the less important 80 percent.

People

 

Vilfredo Pareto

Vilfredo Pareto was an Italian civil engineer born in 1848 and did not become a significant presence in the fields of economics and sociology until he was in his 40s. Even though Pareto’s interest in these subject areas blossomed later in life, he made a large impact in both fields through his contributions to economic analysis as well as his speculations about the nature of power and wealth distribution.4

Joseph M. Juran

Joseph M. Juran was an engineer and management consultant born in 1904, and became well known for his emphasis on improving quality control processes in manufacturing. He was the first to explicitly formulate the Pareto principle as we know it today.2

Consequences

Since its origins in the work of Pareto and Juran, the Pareto principle has enjoyed a great deal of popularity and has been applied to a wide range of topics. Perhaps part of the concept’s popularity is due to its appealing simplicity, and to the surprisingly large range of areas where it can be observed (at least approximately). To list just a few applications that have been made:3

  • About 80% of wealth is owned by 20% of people
  • About 80% of healthcare costs come from 20% of patients
  • About 80% of sales revenue comes from 20% of customers
  • About 80% of tasks are completed by 20% of employees
  • About 80% of investment growth comes from 20% of investments
  • About 80% of crime is done by 20% of criminals
  • About 80% of test score improvement comes from 20% of time spent studying

The major benefit of identifying the Pareto principle in real-world settings is that it allows us to focus our efforts on the 20% of causes with the most effect. As we saw, Joseph Juran applied this to quality control, but the principle can also be applied to improve studying techniques, marketing strategies, hiring practices, or taxation rates across income brackets. For example, when a business sees that the majority of their income comes from a minority of their customers, they may focus their efforts on those 20% of customers through loyalty programs or enhanced customer service for their valuable clients.7

The study of which causes or inputs are responsible for producing the most outcomes is called Pareto analysis and has been used in a variety of fields.2 Pareto analysis involves firstly identifying the ‘inputs’ or causes involved in a given situation and then quantifying how many outputs or effects of interest are produced by each input. This process makes it easy to pinpoint which inputs require the most attention.

A further consequence of the Pareto principle has come from the realization that the ratio of effects to causes is not 80% to 20% all of the time, and the ratio can change over time.5 Understanding which proportion of effects are produced by which proportion of causes can be a powerful piece of knowledge in itself – for example, when studying rising income inequality or when considering a company’s relationship to their clients.

Controversies

As noted, while the 80/20 ratio of outcomes to causes is seen often, this ratio is not always exactly the same everywhere, and useful insights can be gained from studying changes to the ratio of effects to causes. There has been debate in some fields whether the ratio is closer to 70/20, or 85/20, for example.5 However, these debates do not negate Pareto’s principle. It was never formulated as an absolute law, but rather is a general observation or aphorism about the tendency towards inequality between outputs and causes.

A more fundamental controversy comes from the philosophical and political background behind the origin of the Pareto principle. Vilfredo Pareto was a classical economist and believed in the freedom of the market with little government intervention.4 This stance positioned him as an opponent to the growing socialist sentiment of the early 20th century. In fact, Pareto was a believer that some inequality can be a good thing for society. Pareto speculated that a certain degree of inequality makes society better by encouraging people to be active and enabling the use of all available resources.

We can see a glimpse of Pareto’s anti-socialist outlook in the Pareto principle since according to Pareto, inequality between inputs and outputs or causes and effects (although it may fluctuate somewhat) is a natural phenomenon, baked into human nature. Applied to topics such as income inequality or power distribution within politics, the 80/20 rule, when interpreted as a fact about human nature, can justify policies that do not attempt to fully alleviate inequality.

Regardless of our normative stances towards political and philosophical issues like human nature, socialism, and income inequality, the Pareto principle remains useful as a reminder to evaluate which causes are the most important for producing the effects we are interested in, and to focus our strategies for change around this knowledge. We do not have to agree that the 80/20 ratio is an inherently good or natural thing to agree that it appears in many different scenarios and can be a useful piece of information.

Case Study

Personal Productivity

The Pareto principle has enjoyed a particularly high amount of popularity when it comes to advice related to self-help and personal productivity, with entire books being written on the subject. In a Forbes article titled “The 80/20 Rule and How It Can Change Your Life,” Kevin Cruse mentions the importance of reflecting on the personal priorities that really make a difference for the outcomes we want to achieve.8 For example, when studying for tests, students tend to spend a great deal of time reviewing material that they already are familiar with, and may also spend time studying material that is not likely to be on a test. By focusing on the material that is least familiar and most likely to be on the test, students can use a form of Pareto analysis to improve their test results. One can see the same principle applied in other areas of personal life such as exercise, with HIIT (high-intensity interval training) routines rising in popularity as people focus their energy on the 20% of exercises which have the biggest impact on their fitness goals.

Marketing and Sales

The Pareto principle has also been a common bit of wisdom for those involved in sales and marketing, in more than one way. In any company that sells products, it is likely that a majority of sales will be generated by a minority of the products that are sold. Furthermore, the majority of revenue is likely to come from a minority of the customers. Companies can use this information to focus on the products that perform well and the customers who spend the most money. Regarding the product side of things, there has been some interesting work done in an article published in Management Science by Erik Brynjolfsson and colleagues.6 Their study shows that while brick-and-mortar retail stores tend to have a high percentage of sales from a small number of products, online shopping has flattened the 80:20 Pareto ratio in product sales by enabling customers with easy access to a wide variety of niche items. This means that in online retail it may not only be important to focus energy on top-selling products, but also to ensure that there is a wide variety of products available. These findings are potentially important, as online shopping is becoming increasingly widespread in a process accelerated by the COVID-19 pandemic.

When it comes to their customer bases, companies can use the Pareto principle and Pareto analysis to understand who their top clientele are and cater to them. In order to retain their top clientele, businesses can put in place additional incentives — for example, by implementing loyalty programs, VIP shopping experiences, and a prioritized customer service experience for top customers.7

Related TDL Content

Why do we focus on trivial things?

If you are interested in the application of the Pareto principle to personal productivity and effectiveness, you may be interested in this article about Bikeshedding, a term used to describe our tendency to focus disproportionate amounts of energy on trivial issues instead of more pressing ones.

Data-Driven Decision Making

Inspired by pioneers like Joseph. M. Juran, modern organizations are using data about their customers and products to inform their decision-making processes. This article provides an introduction to how data is being used for organizational decisions.

Sources

  1. Brock, Thomas. (2020). The Pareto Principle. Investopedia. https://www.investopedia.com/terms/p/paretoprinciple.asp
  2. (2019). Pareto Principle (80/20 Rule) & Pareto Analysis Guide. https://www.juran.com/blog/a-guide-to-the-pareto-principle-80-20-rule-pareto-analysis/
  3. Hall, Mary. (2020). Real-Life Examples of the 80-20 Rule (Pareto Principle) in Practice. Investopedia. https://www.investopedia.com/ask/answers/050115/what-are-some-reallife-examples-8020-rule-pareto-principle-practice.asp
  4. (2021). Vilfredo Pareto. https://www.britannica.com/biography/Vilfredo-Pareto
  5. McCarthy, D. M., & Winer, R. S. (2019). The Pareto rule in marketing revisited: is it 80/20 or 70/20?. Marketing Letters, 30(2), 139-150.
  6. Brynjolfsson, E., Hu, Y., & Simester, D. (2011). Goodbye pareto principle, hello long tail: The effect of search costs on the concentration of product sales. Management Science, 57(8), 1373-1386.
  7. Koch, Richard. (1998). The 80/20 Principle: The Secret of Achieving More With Less. Nicholas Brealey Publishing. http://leadershipcoachingblog.com/wp-content/uploads/2012/03/the-80-20-principle-to-achieve-more-with-less-effort1.pdf
  8. Kruse, Kevin. (2016). The 80/20 Rule and How It Can Change Your Life. Forbes. https://www.forbes.com/sites/kevinkruse/2016/03/07/80-20-rule/?sh=6b1ea525381

Read Next