Pareto Principle: What it is and how to apply it
Updated: Nov 28, 2022
The Pareto Principle, also known as the 80/20 Principle, states that 80% of effects (results) are generated by 20% of causes. For example, if we analyze how many defects occur in a factory's production, we see that approximately 20% of all types of defects represent 80% of total defects.
This principle is obviously not an exact rule, but it is a great parameter to focus on what really matters. Knowing exactly which 20% generate 80% of results, we know where to invest our time and effort to improve. It is not uncommon for long meetings to occur in which possibilities for improvements are discussed in points with low impact, making this concept even more relevant to be applied.
This principle can be used in different ways for the business. Assuming that a company is raising all expenditures planned for 2022 and realizes that, when adding up all the value of the first version, it is 15% over the limit. Instead of simply randomly choosing any expense line to reduce the amount, the best option is to group the expense lines according to their nature and order them in descending order, so we have 20% of the generating lines of the 80% of the expenses. Starting with the most representative spending group will facilitate and speed up the budget review process for 2022, as it is much easier in most cases to reduce BRL 10,000 from BRL 100,000 than from BRL 30,000.
The same happens for the company's revenue generation. Spend time on discussions, money and time on the company's marketing strategies for products that generate very little result for the company (and that have no clear growth potential), that is, they are not part of the 20% that generate or can generate 80% of the recipe, it makes no sense. By the way, we've also written a post talking about how to assess the potential of each product line from the BCG Matrix.
Along with this principle is the Pareto diagram, a traditional chart that helps us identify the representativeness and importance of each item we are analyzing.
Note that when assembling the Pareto Diagram we can clearly visualize the absolute value of each of the causes as well as the accumulated value in percentage, making it much easier to identify that the first 3 causes (20%) represent 80% of the result.