The Pareto principle (also known as the 80/20 rule, the law of the vital few and the principle of factor sparsity) states that, for many outcomes, roughly 80% of consequences come from 20% of causes (the "vital few").
In 1941, management consultant Joseph M. Juran developed the concept in the context of quality control and improvement after reading the works of Italian sociologist and economist Vilfredo Pareto, who wrote in 1906 about the 80/20 connection while teaching at the University of Lausanne. Volume 1 Volume 2 In his first work, Cours d'économie politique, Pareto showed that approximately 80% of the land in the Kingdom of Italy was owned by 20% of the population. The Pareto principle is only tangentially related to the Pareto efficiency.
Mathematically, the 80/20 rule is associated with a power law distribution (also known as a Pareto distribution) of wealth in a population. In many natural phenomena certain features are distributed according to power law statistics. It is an adage of business management that "80% of sales come from 20% of clients."
The term 80/20 is only a shorthand for the general principle at work. In individual cases, the distribution could be nearer to 90/5 or 70/40. Note that there is no need for the two numbers to add up to the number 100, as they are measures of different things. The Pareto principle is an illustration of a "power law" relationship, which also occurs in phenomena such as and earthquakes. Benoit Mandelbrot offered an explanation for this pattern in the field of economics and social science based on income dynamics in population. According to his reasoning, above a certain minimum income threshold, the probability of an individual's income increasing or decreasing by a fixed proportion (e.g., doubling) remains constant across all income levels. As a consequence, the ratio of individuals earning a given income x to those earning half that amount x/2 remains the same, regardless of the absolute value of x. This scale-invariant property is a defining feature of power-law distributions. Because it is self-similar over a wide range of magnitudes, it produces outcomes completely different from Normal or Gaussian distribution phenomena. The occurrence probability of rare extreme (or catastrophic) events showing power-law distribution may be of several orders of magnitude greater than that associated with other usual models, such as, e.g., Gaussian or exponential. This fact explains the frequent breakdowns of sophisticated financial instruments, which are modeled on the assumption that a Gaussian relationship is appropriate to something like stock price movements.
Pareto analysis is a creative way of looking at causes of problems because it helps stimulate thinking and organize thoughts. However, it can be limited by its exclusion of possibly important problems which may be small initially, but will grow with time. It should be combined with other analytical tools such as failure mode and effects analysis and fault tree analysis for example.
This technique helps to identify the top portion of causes that need to be addressed to resolve the majority of problems. Once the predominant causes are identified, then tools like the Ishikawa diagram (also called Fish-bone Analysis) can be used to identify the root causes of the problems. While it is common to refer to pareto as "80/20" rule, under the assumption that, in all situations, 20% of causes determine 80% of problems, this ratio is merely a convenient rule of thumb and is not, nor should it be considered, an immutable law of nature.
The application of the Pareto analysis in risk management allows management to focus on those risks that have the most impact on the project.David Litten, Project Risk and Risk Management, Retrieved May 16, 2010
Steps to identify the important causes using 80/20 rule:
A chart that demonstrated the effect appeared in the 1992 United Nations Development Program Report, which showed that the richest 20% of the world's population receives 82.7% of the world's income. However, among nations, the Gini index shows that wealth distributions vary substantially around this norm.
+ Distribution of world GDP, 1989 | |
Richest 20% | 82.70% |
Second 20% | 11.75% |
Third 20% | 2.30% |
Fourth 20% | 1.85% |
Poorest 20% | 1.40% |
The principle also holds within the tails of the distribution. The physicist Victor Yakovenko of the University of Maryland, College Park and AC Silva analyzed income data from the US Internal Revenue Service from 1983 to 2001 and found that the income distribution of the richest 1–3% of the population also follows Pareto's principle.
In Talent: How to Identify Entrepreneurs, economist Tyler Cowen and entrepreneur Daniel Gross suggest that the Pareto Principle can be applied to the role of the 20% most talented individuals in generating the majority of economic growth.Paris Aéroport, Paris Vous Aime Magazine, No 13, avril-may-juin 2023, p. 71 According to the New York Times in 1988, many video rental shops reported that 80% of revenue came from 20% of videotapes (although rarely rented classics such as Gone with the Wind must be stocked to appear to have a good selection).
Aside from ensuring efficient accident prevention practices, the Pareto principle also ensures hazards are addressed in an economical order, because the technique ensures the utilized resources are best used to prevent the most accidents.
The remarkable success of statistically based searches for root causes is based upon a combination of an empirical principle and mathematical logic. The empirical principle is usually known as the Pareto principle. Juran, Joseph M., Frank M. Gryna, and Richard S. Bingham. Quality control handbook. Vol. 3. New York: McGraw-Hill, 1974. With regard to variation causality, this principle states that there is a non-random distribution of the slopes of the numerous (theoretically infinite) terms in the general equation.
All of the terms are independent of each other by definition. Interdependent factors appear as multiplication terms. The Pareto principle states that the effect of the dominant term is very much greater than the second-largest effect term, which in turn is very much greater than the third, and so on. Shainin, Richard D. “Strategies for Technical Problem Solving.” 1992, Quality Engineering, 5:3, 433-448 There is no explanation for this phenomenon; that is why we refer to it as an empirical principle.
The mathematical logic is known as the square-root-of-the-sum-of-the-squares axiom. This states that the variation caused by the steepest slope must be squared, and then the result added to the square of the variation caused by the second-steepest slope, and so on. The total observed variation is then the square root of the total sum of the variation caused by individual slopes squared. This derives from the probability density function for multiple variables or the multivariate distribution (we are treating each term as an independent variable).
The combination of the Pareto principle and the square-root-of-the-sum-of-the-squares axiom means that the strongest term in the general equation totally dominates the observed variation of effect. Thus, the strongest term will dominate the data collected for hypothesis testing.
In the systems science discipline, Joshua M. Epstein and Robert Axtell created an agent-based simulation model called Sugarscape, from a decentralized modeling approach, based on individual behavior rules defined for each agent in the economy. Wealth distribution and Pareto's 80/20 principle emerged in their results, which suggests the principle is a collective consequence of these individual rules.
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