The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.
Understanding the Pareto Analysis
The Pareto Analysis was named after Italian economist Vilfredo Pareto, who noted that 80% of the total income earned in Italy went to 20% of the population.
In a modern business context, the principle is evident in a variety of settings.
For example:
20% of a product range accounts for 80% of profits.
80% of customer complaints relate to 20% of products or services.
20% of the workforce accounts for 80% of company revenue.
80% of meeting decisions come in 20% of the total meeting time.
Conducting a Pareto Analysis
Although the applications of a Pareto Analysis are vast, certain principles will apply to most situations.
Following is a six-step process that businesses can use.
1. Identify the problems
Start by writing a list of the problems that need resolving.
2. Identify root causes
Then, identify the fundamental cause of each problem. Note that there could be multiple causes of a single problem.
3. Score the problems
In step 3, it is time to score each problem.
The scoring method being utilized will depend on the industry and the nature of the problem itself.
For example, a business trying to increase profits might score each problem based on how much it is costing them.
Indeed, cost is a common problem in business.
But problems can also be scored based on duration or the number of times they occur in a specified period.
4. Group problems
Group the problems according to the root cause.
Perhaps a group is focused on customer satisfaction, while another on quality control.
5. Tally the scores
Now, add the scores for each group.
The group with the highest score is the top priority, as it is part of the 20% of factors causing 80% of the problems.
Sometimes, two or even three groups may be causing the majority of problems.
6. Action
Lastly, allocate resources to the problems with the highest scores and thus the most potential to impact on profits, customers, or sales.
Advantages of the Pareto Analysis
Efficiency
The analysis allows businesses to quickly and accurately identify factors that are contributing to a significant proportion of their problems.
Problem-solving ability
Many workplace problems are intangible in the sense that personnel does not agree on their scope or even on their definition.
The Pareto Analysis allows people to come to a consensus on the main problems facing an organization.
This also increases morale and cohesiveness in the process.
Improved decision making
A company that can quantify its main problems is better able to make decisions to counteract them.
Quantifiable problems are also better prepared for so that they have less chance of recurring in the future.
Pareto Analysis Case Study
As we saw, the Pareto analysis starts from the premise that a small number of factors (typically 20%) account for most of the impact (typically 80%) in a given situation.
One example of Pareto analysis is a study of customer complaints at a retail store.
Imagine that the retail store collected data on all customer complaints over one year.
They can leverage the Pareto analysis to identify the top 20% of complaints that accounted for 80% of these same complaints.
From a Pareto analysis, it would be simple to show how the top complaints were related to product quality, customer service, and shipping delays.
That information could be used to develop strategies to address these complaints and improve the overall customer experience.
Thus, the retail store can improve the quality of its products by implementing stricter quality control measures and conducting more frequent product testing.
And they can provide additional training for their customer service representatives and implement more flexible return policies.
Or perhaps to address shipping delays by investing in new technology to track and manage shipments more efficiently.
In other words, Pareto analysis can help businesses identify the key factors causing most of the issues.
Thus employing strategies that make it possible to tackle these issues and improve, with minor efforts, the overall experience for customers!
Key takeaways
Fundamentally, the Pareto Analysis is a statistical technique that identifies a limited number of factors that produce a significant overall effect.
The Pareto Analysis has a vast range of applications in business settings, allowing organizations to target problems that erode profits or budget expenditure.
The Pareto Analysis is an efficient technique that brings personnel together to quantify and then work to address tangible problems.
What is the Pareto Principle in simple definition?
The Pareto Principle is a theory that postulates that for most human endeavors, 20 percent of the input determines 80 percent of the output. This postulate, of course, will depend on the context, where the Pareto Law might get less skewed (like in cases in which the 30% of input determines the 60% of output) and more skewed (where 5-10% of the input determines the 80-90% of output).
How do we use Pareto Principle in everyday life?
One way to apply the Pareto Principle to your life is by enhancing productivity or well-being by identifying the less impactful activities and yet giving you more stress. Take the case of minor tasks you do daily (like checking up on your smartphone) which have little impact on your life. With the Pareto Analysis, you can identify these low-impact inputs to enhance your life and productivity.
How to apply Pareto Principle to your business?
In times of constraints and crisis, the Pareto Analysis can help identify these parts of the business with low impact and yet require considerable maintenance. Take the case of a company that sells a product to a thousand customers. Yet, of these customers, only 100 impacts the bottom line, and yet the remaining 900 smaller customers are the ones that require the most support, thus, consuming the company’s resources and requiring a large team. This is an extreme case of Pareto, where 10% of the input determines 90% of the output. In this case, the company can cut out the smaller customer segments, which is not profitable to make t business viable.
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The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
