Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > Performance Management Checklists > Understanding Pareto’s Law

Performance Management Checklists

Understanding Pareto’s Law


Checklist Description

This checklist describes what Pareto’s Law is and how it is applied in business logistics. It is also known as the Pareto principle, or the 80–20 rule.

Back to top

Definition

Pareto’s Law is an inexact rule that, in a given situation, 80% of the effects come from 20% of the causes. Italian economist Vilfredo Pareto noted that 80% of Italian income went to 20% of the population. Pareto’s Law was named after him by business management specialist Joseph M. Juran, who spotted that the 80–20 rule was common across many areas of business. For example, 80% of sales generally come from 20% of one’s clients.

Pareto’s Law has many useful applications in business. A Pareto chart is a type of bar chart, used to illustrate the 80–20 assumption, in which the values plotted are in descending order with a line graph showing the cumulative totals of each category from left to right. Such charts are used to monitor, for example, logistics, procurement, stock control, or quality control.

Where there is a large enough data set, Pareto’s Law can be expressed as a mathematical formula. Here, k is a number between 50 and 100 and k% is (100 – k)% of the data set. The number k can be any value between 50 (where 50% of sales comes from 50% of a company’s customers) to almost 100 (where, for example, k = 98, or 98% of sales are to just 2% of clients). Most of the time, in most data sets, k seems to hover around the 80 mark.

Sometimes when logistics are examined, a Pareto calculation may show up a ratio of 80–15 or 80–25. There is no need to panic about this as there is no requirement for the figures to add up to 100. The two figures measure different data sets, such as amount of sales versus number of clients. So, for example, 80–15 would mean 80% of sales coming from 15% of your customers, the remaining 20% of sales being made to 85% of clients.

Back to top

Advantages

  • The 80–20 rule is a handy tool for making a quick assessment of almost any measurable logistic before going on to make a more in-depth calculation and assessment of the facts.

Back to top

Disadvantages

  • Pareto’s Law is only a rule of thumb application and therefore must never be used as a stand-alone means of calculation. The principle is often misused. For example, it would be inaccurate to assume that if a solution to a problem fits 80% of cases it must be the right solution. There is a clear implication, instead, that the solution should need just 20% of available resources to solve all cases.

Back to top

Dos and Don’ts

Do

  • Remember that Pareto’s Law is only a guide and rarely 100% accurate.

  • Carry out proper in-depth research to back up any findings produced by Pareto’s Law.

Don’t

  • Don’t make assumptions with Pareto’s Law and base important strategies or policies on basic findings.

Back to top

Further reading

Books:

  • Gen, Mitsuo, and Runwei Cheng. Genetic Algorithms & Engineering Optimization. Wiley Series in Engineering Design and Automation. New York: Wiley, 2000.
  • Rushton, A., J. Oxley, and P. Croucher. The Handbook of Logistics and Distribution Management. 2nd ed. London: Kogan Page, 2000.

Articles:

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share