Pareto Principle: Definition, Pros, Cons & Examples

Pareto Principle: Definition, Pros, Cons & Examples

pareto principle definition

What is the Pareto Principle

The Pareto Principle is a theoretical rule that states 80% of effects come from 20% of causes. In other words, the vast majority of results come from a small proportion of effects.

Also known as the 80/20 rule, it shows how small factors can have overwhelming effects. For example, some businesses may obtain 80 percent of its income from 20 percent of its products.

The rule originates from an Italian economist named Vilfredo Pareto. In the late 19th century, Pareto coined the rule after he observed that 80% of the land in Italy was owned by 20% of the population. At the same time, he noticed that the principle could be applied to other fields such as economics, productivity, and time management.

The Pareto Principle can be a useful tool for individuals and organizations to prioritize their efforts and resources, identify critical factors that contribute the most to desired outcomes, and optimize their overall performance.

Key Points
  1. The Pareto Principle is the idea that 80 percent of results come from 20 percent of causes.
  2. It originates from Italian economist Vilfredo Pareto, who noticed that 80 percent of Italy’s land was owned by 20 percent of its population.
  3. Although the principle is also known as the 80/20 rule – the percentages do not have to match up exactly. The main principle is that the majority of effects are as a result of a minority of causes.
  4. The principle has many other applications in the real world including economics, business, productivity, time management, and personal relations.

Pareto Principle in Economics

In economics, the Pareto Principle, also known as the 80/20 rule, can be applied in a variety of ways, including:

  1. Income distribution: There are often many nations which have a top heavy distribution, which the Pareto Principle helps describe. In other words, a large proportion of the top earns create the vast majority of wealth.
  2. Business management: In businesses, the Pareto Principle can help identify the products which contribute most significantly to revenue. For instance, a supermarket might find that 20% of products may contribute to 80% of revenue. In turn, it would look at what those products are, and perhaps expand its offering. For example, its premium range might be doing well, so it may offer a greater variety to increase profits.
  3. Resource allocation: In resource allocation, the Pareto Principle can be used to identify the critical 20% of resources that are responsible for 80% of the output or results. This information can help policymakers and businesses allocate their resources more efficiently and effectively.
  4. Productivity: The Pareto Principle can be used to help identify areas which can improve productivity. By looking at what variables create the most productive results, we can identify the best way to increase overall productivity. For instance, studying in a library may be more conductive than at home where there are distractions.
  5. Market segmentation: In marketing the Pareto Principle is often used to find out who the 20% of customers are that create the majority of revenue. By doing so, the marketing team are able to better target that audience. For example, if the over 50’s provide the greatest stream of revenue, the marketing team may decide to specific target this demographic.

Pareto Principle Examples

One example of the Pareto Principle can be seen in business sales. It is quite common for businesses to see 80% of its sales come from 20% of its customers. These may be loyal customers that love the brand and keep coming back for more. By identifying the characteristics of that 20%, the business is better able to focus its efforts.

Another example of the Pareto Principle is that of time management. By identifying the 20% which creates 80% of results, we are best able to maximise our efforts. For example, a student may find that they only need to study 20% of the syllabus to obtain an exam score of 80%. Therefore, by focusing on that specific 20%, they are able to maximise their score and reduce the amount they may need to study.

In project management, the Pareto Principle can be applied to identify the 20% of tasks that account for 80% of the project’s progress. By focusing on those critical tasks, project managers can ensure that the project stays on schedule and achieves the desired outcome.

How you can use the 80/20 rule

Also known as the 80/20 rule, there are some useful ways that you can use the Pareto Principle:

  1. Identify the 20 percent: Identify the crucial 20% that contributes most significantly to results. This will then help focus on the areas which are most effective.
  2. Prioritize time: Apply the rule to your schedule and see which items are producing results. There may be needless meetings that are unproductive. By prioritizing the tasks which produce better results, we can see a more efficient use of time and energy.
  3. Analyze sales: where are the majority of sales coming from? Perhaps young people, or perhaps a specific product or range? By identifying the highest performing areas, sales teams can focus on those clients. Alternatively, product development teams can look to create further product lines for those same customers.
  4. Optimize workflow: by identifying the 20 percent of jobs that contribute most significantly to output, we can optimise those steps and increase productivity. For example, we may find we’re more productive in the morning, so it may make more sense to do the more challenging tasks then. At the same time, if we’re low on energy in the evenings, it may make more sense to do easier tasks then.
  5. Focus on quality: Apply the 80/20 rule to quality control by focusing on the 20% of defects that account for 80% of the problems. Address those critical defects to improve overall quality.
  6. Social Evaluation: with your goals and aims in life, there are some friends which help, and others which work against them. Finding out those small group of friends which help you move onto the next level can be crucial to future career goals.

Advantages of the Pareto Principle

The Pareto Principle, also known as the 80/20 rule, has several advantages, including:

Prioritization

The Pareto Principle can help individuals and businesses find out what is the most effective use of their time. It can allow them to focus on what contributes most significantly to the end goal. For example, if a company wants to make more sales, it can look to its best selling products and create further product lines related to it.

Time management

When it comes to time management, we all only have 24 hours in each day. So it’s crucially important to use each hour as effectively as possible. Therefore, by identifying the 20% of the day which is most productive, we are able to then try and replicate that through the rest of the day. For example, it might be more efficient to talk to people over a call instead of having to travel to meetings.

Resource allocation

When it comes to resource allocation, the areas of the business which contribute most significantly to profits may deserve additional resources. For example, a high growth sector of the company which contributes a large percent of revenue may require further investment to continue its growth.

Strategic planning

When trying to identify a strategy, it is important to have some kind of goal. Businesses may look at its high performing sectors – those which contribute most significantly to profits. From there, it may look at why this sector is performing better and create a strategy. This may be to enhance its product line, or perhaps create an entirely new product altogether.

Disadvantages of the Pareto Principle

While the Pareto Principle has many advantages, it also has some limitations and disadvantages, including:

Oversimplification

The Pareto Principle assumes a direct cause and effect. Just because 20 percent of products create 80 percent of revenue, it doesn’t mean its more important than others. For example, Apple makes the vast majority of its profits through its iPhone. However, without the development of its AppStore, it would likely not be as successful.

Subjectivity

When looking at the most important 20% of causes, it can be subjective on the corporations goals. This can range from profit maximisation to corporate social responsibility to international expansion. By using the Pareto Principle, we cannot determine the subjective nature of these goals.

Lack of context

The Pareto Principle is a simplified snapshot. It does not consider all the other complex and interdependent factors which are occurring. It lacks context to be able to be consistently reliable. For example, identifying the top 20% of customers that generate 80% of revenue is meaningless without considering the wider context. What are their characteristics, behaviours, and other preferences?

Time frame

The Pareto Principle can show us what 20% of cause 80% of effects. However, this is just a snapshot. Over time, this changes and what might be applicable one year, may very well change the next.

Implementation

Even when the 20% of causes is found, the next step is using that information to make informed decisions. On its own, the Pareto Principle is merely just a guide. Whilst it can be a useful barometer, it needs to be used in conjunction with other information to overcoming existing limitations.

FAQs

What is the Pareto Principle?

The Pareto Principle, also known as the 80/20 rule, states that 80% of the effects come from 20% of the causes.

What are some examples of the Pareto Principle in action?

The Pareto Principle can be observed in many areas, such as in business where 80% of sales may come from 20% of customers, or in personal productivity where 80% of results may come from 20% of effort.

How can the Pareto Principle be applied in business?

By identifying the 20% of customers who generate 80% of revenue and focusing resources on them, or identifying the 20% of products that generate 80% of profits and focusing on those.

Can the Pareto Principle be used to improve personal productivity?

Yes, by identifying the 20% of tasks that generate 80% of results and focusing on those, or by identifying the 20% of distractions that consume 80% of time and eliminating or minimizing them.


About Paul

Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.


Further Reading

What is a trade deficit Trade Deficit: Definition, Causes & Effects - A trade deficit occurs when a nation imports more goods than it exports. In other words, a nation buys more…
Accounting Cycle - The accounting cycle refers to the process of recording, classifying, summarizing, and reporting financial transactions of a business over a…
Consumer Surplus Definition Consumer Surplus: Graph, Examples & How to Calculate - The consumer surplus is the difference between what the consumer is willing to pay, and what they actually pay.