What is the Pareto Principle (80/20 Rule)?
The 80/20 Rule or Pareto Principle states that about 80% of the results (outputs) come from about 20% of the causes (inputs).
When examining systems or businesses, there are a minority of elements or people that generate much more impact than a majority of elements or people. This principle shows that there is an unequal and unbalanced relationship between the inputs and outputs for a system. Note that this is not a hard-and-fast mathematical rule but empirically follows from the power-law distribution (or Pareto distribution) for a certain set of factors.
Origins of the Pareto Principle
In 1896, the Italian economist, Vilfredo Pareto wrote about the relationship he observed between the distribution of wealth (land ownership) in a population. Pareto originally thought of the idea during gardening as he noticed that 20 percent of the pea pods contained about 80 percent of the peas. He expanded the principle to economics to find that land ownership by people in Italy seemed to be divided naturally into two groups. The top 20 percent, or “vital few,” owned about 80 percent of the land, while the bottom 80 percent or “trivial many,” owned about 20 percent of the land.
Why Use the Pareto Principle?
The Pareto Principle provides a framework to focus your efforts as a company or an individual. With most things in life, there is a multitude of factors that can affect the outcome of an event. Additionally, we only have a limited amount of resources (skills, time, energy, attention, and money) to allocate to our lives and businesses.
The Pareto Principle will show us what resources to put toward 20% of factors will provide most or 80% of the results. Note that the Pareto Principle is not a hard-and-fast rule and can be adjusted to fit a given scenario roughly in the range of 60/40 to 90/10. This shows that the rule is observed and is not strictly that of an 80/20 split of outputs to inputs.
Double Pareto Principle (64/4 Rule)
The 80/20 Rule can also be extrapolated into the 64/4 Rule or Double Pareto Principle. This expanded rule states that about 64 percent of the results come from about 4 percent of the causes:
- 80% x 80% = 64%
- 20% x 20% = 4%
Applying the Pareto Principle
The Pareto Principle can be used to analyze the various departments of any given business.
Sales and Marketing: About 20% of the salespeople will make 80% of the sales. Additionally, about 80% of the revenue will be generated from 20% of the customers. Thus, the Sales and Marketing department can focus its efforts to reward those salespeople that will generate the most sales and the customers that bring in the most revenue.
Operations: About 20% of the workers will produce or fulfill 80% of the goods or services. Thus, the Operations department can focus its efforts to train and retain those workers that will get the most work done.
Finance: About 20% of the assets will generate 80% of the value. Thus, the Finance department can focus its efforts to efficiently use those assets that will maximize value.
The Pareto Principle is typically used in economics and business, however, the idea can be used to analyze situations in your finances, decisions, and relationships.
Personal Finance: About 20% of your credit card purchases will account for 80% of your spending for that month. Thus, to reduce your spending, you can establish budgets for the things you tend to purchase more off. It also can be observed in a financial portfolio that 20% of your assets will cause 80% of the gains or losses.
Relationships: About 80% of your time will be spent with 20% of the people in your life. Jim Rohn has said that “You are the average of the five people you spend the most time with.” The people you spend the most time with shape who you are. Thus, you can either double down on the most rewarding relationships or reach out to others that you have been neglecting.
Exercise: Analyze an aspect of your life using the Pareto Principle. Then, focus your resources on the 20% of inputs to maximize the results.