Pareto Principle

Pareto Principle
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In the late 1800s, when Vilfredo Pareto, an Italian mathematician, created what we've come to know as the 80/20 rule, it changed how we think about life and business. And it layed the groundwork for TQM and Six Sigma.

Pareto Principle

The Pareto Principle is a power law. Instead of numbers spread evenly like butter on bread, Pareto found that 20% of the people held 80% of the wealth. But that's not all, because Pareto's Rule is a power law, it also applies to itself. This means that as little as 4% of people hold 64% of the wealth. In America, for example, 4% of Americans hold over half the wealth. And as little as 1% may hold over half of the wealth.

Pareto also suggested that even if the wealth was redistributed equally to everyone in society, in a very short time it would revert to the 80/20 distribution.

Applications of the Pareto Principle

On the revenue side of a business, this means that if you have 100 customers:

80 will buy a single product
20, on average might buy 4 products
4 of the 20 will buy 16 products
1 of the 4 will buy 80 products

The goal, of course, is to figure out the mental and geographical demographics of the top four customers, and find a way to snag more of them.

For example, I watch golf on TV. What are the most promenant types of commercials for golf matches? Erectile disfunction and prostate problems. What does this mean about the demographics of golf viewers? We're older and may have either of these two health problems.

Analyze your customers and their buying patterns. Who represents the pareto principle in your customer base? How can you reach more of them?

Pareto Pattern of Defects

Joseph Juran, one of the father's of the quality movement, restated the Pareto Principle as the difference between the "vital few and the trival many."

Shewhart, Juran and Deming found that errors, mistakes and defects were not evenly spread over a business; instead they tended to cluster in a few steps of the process. If the delivery of a product or service takes 100 steps, one often finds a pareto pattern to the distribution of defects:

80 steps will be error free
20 steps will cause 80% of all errors
4 steps will cause 64% of all errors
1 step alone may cause over half of all errors

The quality movement even invented a chart to display this pattern, called a pareto chart:

Pareto Chart Example

Pareto Pattern of Delay

The same is true of delays. Delays occur between steps in a process. One or more of these delays causes over half of all product or service delays.

If a business wants to be faster, it must eliminate the delays between steps, not try to make the steps faster.

Key Concepts

The Pareto Principle (a.k.a. the 80/20 rule) is a power law.
There is a pareto pattern to the distribution of money, delay and defects that can be leveraged to maximize profits and minimize costs in any business.
The Pareto Chart is a useful way of displaying this pattern.

The Pareto chart is just one of the tools included in the QI Macros for Excel SPC Software for Excel.

Download the FREE 30-day Evaluation copy of the QI Macros Excel SPC Software for Six Sigma

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