Pareto Analysis (the 80:20 rule)
The Pareto effect.
In practically every industrial country a small proportion of all the factories employ a disproportionate number of factory operatives. In some countries 15 percent of the firms employ 70 percent of the people. This same state of affairs is repeated time after time. In retailing for example, one usually finds that up to 80 percent of the turnover is accounted for by 20 percent of the lines.
This effect, known as the 80. 20 rule, can be observed in action so often that it seems to be almost a universal truth. As several economists have pointed out, at the turn of the century the bulk of the country s wealth was in the hands of a small number of people.
This fact gave rise to the Pareto effect or Pareto s law: a small proportion of causes produce a large proportion of results. Thus frequently a vital few causes may need special attention wile the trivial many may warrant very little. It is this phrase that is most commonly used in talking about the Pareto effect the vital few and the trivial many . A vital few customers may account for a very large percentage of total sales. A vital few taxes produce the bulk of total revenue. A vital few improvements can produce the bulk of the results.
The Pareto effect is named after Vilfredo Pareto, an economist and sociologist who lived from 1848 to 1923. Originally trained as an engineer he was a one time managing director of a group of coalmines. Later he took the chair of economics at Lausanne University, ultimately becoming a recluse. Mussolini made him a senator in 1922 but by his death in 1923 he was already at odds with the regime. Pareto was an elitist believing that the concept of the vital few and the trivial many extended to human beings.
Much of his writing is now out of favour and some people would like to re-name the effect after Mosca, or even Lorenz. However it is too late now the Pareto principle has earned its place in the manager s kit of productivity improvement tools.
This method stems in the first place from Pareto s suggestion of a curve of the distribution of wealth in a book of 1896. Whatever the source, the phrase of the vital few and the trivial many deserves a place in every manager s thinking. It is itself one of the most vital concepts in modern management. The results of thinking along Pareto lines are immense.
For example, we may have a large number of customer complaints, a lot of shop floor accidents, a high percentage of rejects, and a sudden increase in costs etc. The first stage is to carry out a Pareto analysis. This is nothing more than a list of causes in descending order of their frequency or occurrence. This list automatically reveals the vital few at the top of the list, gradually tailing off into the trivial many at the bottom of the list. Management s task is now clear and unavoidable: effort must be expended on those vital few at the head of the list first. This is because nothing of importance can take place unless it affects the vital few. Thus management s attention is unavoidably focussed where it will do most good.
Another example is stock control. You frequently find an elaborate procedure for stock control with considerable paperwork flow. This is usually because the systems and procedures are geared to the most costly or fast-moving items. As a result trivial parts may cost a firm more in paperwork than they cost to purchase or to produce. An answer is to split the stock into three types, usually called A, B and C. Grade A items are the top 10 percent or so in money terms while grade C are the bottom 50-75 percent. Grade B are the items in between. It is often well worthwhile treating these three types of stock in a different way leading to considerable savings in money tied up in stock.
Production control can use the same principle by identifying these vital few processes, which control the manufacture, and then building the planning around these key processes. In quality control concentrating in particular on the most troublesome causes follows the principle. In management control, the principle is used by top management looking continually at certain key figures.
Thus it is clear that the Pareto concept the vital few and the trivial many is of utmost importance to management.
The Pareto chart
A Pareto chart is a graphical representation that displays data in order of priority. It can be a powerful tool for identifying the relative importance of causes, most of which arise from only a few of the processes, hence the 80:20 rule. Pareto Analysis is used to focus problem solving activities, so that areas creating most of the issues and difficulties are addressed first.
Difficulties associated with Pareto Analysis:
- Misrepresentation of the data.
- Inappropriate measurements depicted.
- Lack of understanding of how it should be applied to particular problems.
- Knowing when and how to use Pareto Analysis.
- Inaccurate plotting of cumulative percent data.
Overcoming the difficulties
- Define the purpose of using the tool.
- Identify the most appropriate measurement parameters.
- Use check sheets to collect data for the likely major causes.
- Arrange the data in descending order of value and calculate % frequency and/or cost and cumulative percent.
- Plot the cumulative percent through the top right side of the first bar.
- Carefully scrutinise the results. Has the exercise clarified the situation?
Even in circumstances which do not strictly conform to the 80. 20 rule the method is an extremely useful way to identify the most critical aspects on which to concentrate. When used correctly Pareto Analysis is a powerful and effective tool in continuous improvement and problem solving to separate the vital few from the many other causes in terms of cost and/or frequency of occurrence.
It is the discipline of organising the data that is central to the success of using Pareto Analysis. Once calculated and displayed graphically, it becomes a selling tool to the improvement team and management, raising the question why the team is focusing its energies on certain aspects of the problem.