By Anant Gupta
Ever analysed what clothes you end up wearing frequently despite the heaps you actually own? Chances are, you follow the 80/20 rule when making your selection. The “Pareto Principle” which states that 80% of occurrences happen due to 20% of causes, seems to encompass all fields of study – from business & economics to sociology and Darwinian evolution.
The first sign – Pareto’s pea pods
Vilfredo Pareto, a sociologist by profession and a gardener by passion, first noticed the correlation of the 80/20 rule when he was picking his peas. He observed that only 20% of his pea pods yielded 80% of the overall healthy peas.
Fascinated by his observation, Pareto delved into further study and found, quite surprisingly, that the same correlation existed for land distribution in Italy, where 20% of the population (that would comprise of the royalty and elites) owned 80% of the land. Rigorous analysis of land distribution in places around the world such as Basel in Switzerland, Britain and Germany revealed a strange coincidence with the 80/20 rule. Though Pareto is credited for hypothesising the 80/20 rule, it was Joseph. M. Juran – world’s foremost quality control expert – who formalised the principle in Pareto’s honour.
Impact of Pareto principle on businesses
The Pareto principle can be applied to many fields, but perhaps has the greatest impact in the business world. Company managers and executives benefit by knowing the top 20% factors which bring in 80% of their revenues. These factors can be product categories, high-performing sales rep or a company’s largest markets. It allows them to trim the remaining 80% fat and keep their finances in good shape.An example of Pareto chart.
The Pareto chart is an excellent visual representation of the Pareto principle. All factors contributing towards a specific purpose are listed on the x-axis. The vertical bars are used to show the frequency of occurrences in descending order, and a line chart shows the cumulative total of those occurrences. In percentage form, the line chart sums up to 100%. Though frequency is commonly represented on the y-axis, it can be replaced by revenue or profit, depending on the factors being analysed.
The Pareto chart simply compels the management to focus on the select few causes responsible for the majority of the occurrences. Few areas where Pareto gives insights to businesses are as follows:
- Helping companies understand who are the top salespeople bringing in majority of the revenue.
- Helping analyse the top 20% causes responsible for 80% of quality defects
- Corporate/Product Portfolio
- Companies can determine which are the top brands responsible for the major chunk of profits for them.
- Helping answer questions such as: Which are my top markets from where I earn most of my revenue?
- Even within a single market, the Pareto analysis can be used again to further drill down to demographics, since some products may be lapped up by a certain age group more often.
By paying attention to the factors which drive bulk of the business, companies improve productivity, reduce waste, and play to their strengths.
Case Study: How P&G created value by reducing their size
Procter & Gamble, the beauty and personal hygiene behemoth, streamlined their list of expansive product categories after studying their brands’ Pareto charts. Apart from being home to some of the most iconic personal care brands, P&G also produced food, snacks and beverages business in 2014. However, having such a wide range of products made the management feel like it was losing control over some of its product categories, and deviating from its core strength of beauty and personal care products.
In A.G. Lafley’s words—the company’s chairman, president, and CEO until October 31, 2015—the future P&G would be “a much simpler, much less complex company of leading brands that’s easier to manage and operate”. The analysis from the Pareto chart solidified this belief. Inevitably, the next step was the culling of some of P&G’s home-grown brands, which though profitable, sadly did not fit the bill.
By selling off the entire category of its food & snacks business (including Pringles), electric cell brand Duracell, and many other similar brands, P&G downsised its product category count by more than 100 brands, to laser-focus on 65 core brands. Now by having a tight grip on a significantly leaner portfolio, P&G was able to administer innovative changes and improve profitability in existing businesses. P&G’s success story also led to many more companies following suit, making the Pareto chart the go-to for firms looking to restructure their businesses or seeking divestiture of assets.
Does the Pareto principle apply to my daily life?
The generic nature of Pareto principle is eerily enchanting. From the distribution of wealth to which clothes you wear, almost every aspect of our lives seems to follow the 80/20 rule. Just like businesses, we can identify the areas in our day to day life which are not in the top 20% and start to put things in order.
For instance, for a working individual, it may be that 20% of your office time is primarily when 80% of your work gets done, while rest of the time goes in replying to emails and attending meetings. Shifting to-do lists to your calendar can be an effective way to conclude meetings within a stipulated time limit, thus freeing up time for the more urgent tasks.
There are other countless examples of our day to day activities which align with the Pareto principle. In fact, I just realised, it took 20% of my time (of the entire time spent on the article) to pen down most of (read 80%) the article. The Pareto principle does seem to apply to most of us, in some small way or the other.
Anant Gupta is a writing analyst at Qrius
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