How to apply the Pareto Principle in business and help it grow to its full potential
Focusing on the details of the business is vitally important, but it is wise also to focus on the details that matter and to try understand the power of the Pareto principle.
Sometimes referred to as the Pareto efficiency, the 80-20 rule, the law of the vital few or the principle of factor sparsity, Pareto states that for many events, roughly 80% of the effects come from 20% of the causes. Business management thinker Joseph M. Juran proposed the principle, naming it after Italian economist Vilfredo Pareto, who observed in 1906 that 80% of the land in Italy was owned by 20% of the population.
(He developed the principle by observing that 20% of the pea pods in his garden contained 80% of the peas.) Day in and day out, business people barely give it a thought, overlook its significance and only rarely apply this ‘universal’ cardinal to improve their business efficiency, productivity and profitability.
The fallacy of averages
Every day in business the talk is of the average sales per day being so much, or the average revenue per customer being that. Others often talk about the average returns of the stock market, or the average number of days in a delivery cycle. But averages mean nothing. Imagine a plane flying from a to b and the average terrain is 3000 feet, calculated from a low of 0 feet above sea level and a mountain peak of 6000 feet. You can just imagine if the pilot decides to plot his flight plan based on an average of 3000 feet. Or, imagine a person with no swimming skills trying to cross a lake just because someone said that the average depth is 3 feet. Averages are fallacies in real life, and also in business.
A focus on the fallacy of ‘average sales’ can mask poor performance and star achievers
Trying to understand the business by discussing averages will provide little insight if the average revenue derived from a few customers is exponentially bigger than the rest. In the telecommunications industry, we focus long and hard on the average revenue per customer, the average minutes of use, the average orders per channel, or the average customer care service levels. These averages are useless and baseless.
They reveal nothing about the business because the average revenue might be inflated as a result of having a few large customers, versus the rest of the base. Imagine building capacity for a mobile phone network, factory, hotel, or a restaurant based on averages. A restaurant that has excellent food falls down if the service is very poor during peak times. In most companies, 80% of the incremental sales (new sales) are generated through about 20% of the sales folks. Still, most training investments are spread across the entire sales force. Just imagine the returns if a company could hone that to the next 5th or 10th percentile; imagine the tremendous results that could be achieved, and the savings to be made when we focus on the details
Try saying to an employee that the average bonus payout is $X when he or she probably received one-fifth of that $X. The average is as close to the bottom, as it is to the top. As the famous US stand-up comedian George Carlin once said, “Just think of how stupid the average person is, and then realise half of them are even stupider!” Focusing on the averages really mean nothing.
Trying to solve all major issues at one time without focusing on a few critical ones is often costly and non-attainable and almost always futile and leads to failure.”john lincoln, author
Pareto, laser focus and the ‘64-4’ law
If a result, problem, outcome or anything has 80% of effects coming from 20% of causes, it follows that the 80% of that top 80% of effects come from 20% of that top 20% of causes, and so on (80% of 80% is 64%; 20% of 20% is 4% – so there is a ‘64/4’ law to explore here). Often, just by knowing that 4% of customers, revenues, problems or issues could be much more worth your attention than all the others put together, is good enough to make a difference to business. It does not always have to add up to 100 (80/20), it could be 70/40 in that 70% of a company’s revenue comes from 40% of its customers. The key is to focus on what matters. Trying to solve all major issues at one time without focusing on a few critical ones is often costly and non-attainable and almost always futile and leads to failure.
The application of the Pareto principles doesn’t have to be restricted to business but rather can be applied to everyday living. Imagine if you are trying to save money or if something or someone annoys you, or that you feel ‘good’ only on certain occasions. Just focusing on the few issues or attributes or behaviors that matter can help address, alleviate or enhance the experience or relationship, or whatever it is that you are trying to do. The Pareto Principle is a ‘power law’ relationship, a special kind of mathematical relationship between two quantities. When the frequency of an event varies as a power of some attribute of that event (eg its size), the frequency is said to follow a power law. The distribution of a wide variety of natural and man-made phenomena follow a power law, including frequencies of words in most languages, frequencies of family names, sizes of craters on the moon and of solar flares, the sizes of power outages, earthquakes, and wars, the popularity of books and music, and many other quantities.
Stay focused: Life is too short
We need to thank Mr Pareto for a universal principle that can be applied in our everyday life. It might seem too obvious or easy, but most folks ignore this principle day in and day out. Just observe this at work where people in Finance, Sales, HR, Technology, Operations and Marketing will all be preaching about the average of this and that. Take note and decide if it makes sense. Force the discussions around the stuff that really matters.
JohnLincoln.one –The business growth hacker