Pareto analysis explained: How to use the 80/20 rule

You’ve probably heard the saying “less is more.” Did you know that it’s based on fact?

It might sound too good to be true, but a basic statistical tool called Pareto analysis that shows how less is more could be the key for organizations like yours to unlock their goals. This principle can effectively measure impact to help your organization prioritize decisions.

Companies use this analysis to detect weaknesses and opportunities to help them achieve their business goals.

Read on to find out more.

Understanding the Pareto principle

Pareto analysis is based on something called the Pareto principle, also known as the 80/20 rule. The Pareto principle states that 80 percent of impacts result from just 20 percent of causes.

Therefore, most issues an organization faces are produced by a fraction of that organization’s actions (or “causes”). The issues with the greatest impact can now become an organization’s highest priority.

For example, according to the Pareto principle, 80 percent of an organization’s Yelp reviews are shared by 20 percent of their customers. With that in mind, the organization can focus on improving the experiences of the twenty percent of customers who are leaving reviews. This then helps to boost their overall score on Yelp, maintain customer loyalty, and attract new customers.

You might be wondering about the history behind the Pareto principle. In 1906, Italian economist Vilfredo Pareto observed that the top 20 percent of a country’s population comprises 80 percent of that country’s wealth.

Nearly 40 years after his discovery, Romanian-American business theorist Joseph Juran dubbed Pareto’s 80-20 rule “Pareto’s Principle of Unequal Distribution.” Juran then applied Pareto’s principle to business, determining that a small investment can yield a much greater outcome.

What Is a Pareto analysis?

Pareto analysis is a statistical technique based on the 80-20 rule that enables organizations to identify, target, and measure the impact of their top-priority problems. This way, they can better decide how to allocate their resources to address those problems and grow.

Organizations that use Pareto analysis have a better shot at achieving their goals and finding success—it’s that simple.

Companies across a wide range of industries rely on Pareto analysis. For example:

• Sales companies base advertising strategy on the fact that 80 percent of their sales are made by 20 percent of their products;
• Nonprofit organizations, on the other hand, use Pareto analysis to determine which of their causes to prioritize and which of their donors they should appeal to;
• And manufacturing companies commonly use Pareto analysis in quality control.

Pareto analysis ranks an organization’s weaknesses according to their impact on the organization’s overall success. (The higher a problem scores, the greater its impact.) With that knowledge in hand, companies and organizations can effectively target and resolve the underlying causes of their most significant problems.

This works best with other root causes analysis tools, as a Pareto analysis can’t find the root causes by itself — it simply helps prioritize which ones you should focus on first.

For example, imagine you’re running a retail store with a customer satisfaction issue. You can analyze your customer complaints using a Pareto analysis to determine your biggest problems and their causes.

Once you identify the causes affecting your poor performance by grouping them together—hypothetically, too few employees and a lack of training—you can improve your customer experience by hiring more employees and giving staff more training.

Instead of trying to address each individual issue, you can simply address the two largest causes.

Doing so will help an organization maximize its existing resources and ensure long-term sustainability. Struggling organizations would do well to conduct a Pareto analysis if they feel overwhelmed by the problems that they face.

Specifically, Pareto analysis is useful when employers want to review employee performance. Labor is a primary resource for any organization; as a resource-maximizing tool, Pareto analysis serves employers well when dealing with management and payroll decisions.

How to conduct a Pareto analysis

There are several ways to conduct a Pareto analysis. Let’s dive into the basic steps that your organization can follow to take full advantage of this awesome tool.

1. Identify the problem(s)
This is pretty straightforward: Figure out what’s getting in the way of your organization’s success. It might be one issue or several.

2. Determine the cause or causes of the problem
Once you acknowledge problems to focus on, identify all of the possible factors that are creating those problems for your organization.

3. Rate the problems by priority, based on the level of negative impact
Take your list of problems, decide which ones have the greatest negative effect on your organization, and score them accordingly.

4. Sort the problems into groups
After you score each problem based on its organizational impact, categorize the problems according to their causes.

5. Build an improvement plan prioritizing the highest impact problems and the highest impact solutions
Design a course of action that will help your organization focus on addressing their most significant problems. Make sure the plan is designed to help your organization achieve sustainable, effective solutions.

6. Take action on the plan, starting from top-priority items, and re-evaluate
Implement the plan, acting on make-or-break problems first. It’s natural for the plan to evolve as your organization alters their priorities, problems grow or shrink, or new problems arise.

Pareto analysis example

Suzy is the HR manager at a medium-sized technology company. She has noticed that employee turnover is high and that the company is struggling to attract and retain top talent.

Suzy decides to use the Pareto analysis and the 80/20 rule to identify and prioritize the company’s most significant obstacles regarding employee retention and talent management.

She starts by listing the company’s challenges (see the Problem rows in the table below). Then, Suzy identifies the root causes behind each challenge (see the Cause rows). Finally, Suzy scores each challenge by the number of employee complaints or departures that each has received (see the Score rows).

Using the Chart

Using the Pareto chart, Suzy groups challenges together by cause and adds up the scores for each group. She finds that the following root causes are the main obstacles affecting employee retention and talent management:

1. Insufficient training and development programs (items 1) — 50 complaints.
2. Lack of market research about the appropriate salary and benefits for certain roles (items 2) — 20 complaints.
3. Lack of recognition and appreciation for employees (item 3) — 10 complaints.

As a result, Suzy determines that improving employee training and development programs should be her top priority. She plans to offer skill certification courses and professional development meetings for interested employees to foster career growth.

Suzy also recognizes the importance of investing in market research about the appropriate salary and benefits for specific roles and implementing a more effective system of employee recognition and appreciation. However, she understands that focusing on these challenges first may not provide the company with the biggest payoff in retaining current employees.

Using the Pareto analysis and the 80/20 rule, Suzy can efficiently identify and prioritize the company’s most significant obstacles in employee retention and talent management. This allows her to focus her efforts where they are needed most and address the root causes that will benefit the company most.

Steps to create and read Pareto charts

A Pareto chart is a bar graph. The length of the bars represents time or money, and the bars are arranged with the longest on the left and the shortest on the right, illustrating which issues are more significant.

Pareto charts come in handy when an organization needs to:

• Analyze data about the frequency of problems that they face;
• Pinpoint which of their problems is most pressing;
• Understand the specific causes of their broader problems;
• Or share their data with a wider audience.

While there are Microsoft Excel templates that can help, it’s helpful to know how to create a Pareto chart yourself to fully understand the process. Here are eight quick steps for creating and reading a Pareto chart.

1. Develop a standard measure to compare the list of problems
This standard measure could include how often a problem occurs (number of complaints, complications, errors, etc.); how long it takes (total minutes elapsed, total billable hours, etc.); or how many resources it consumes (cost).

2. Set a timeframe for gathering data
It’s important to make sure that your timeframe is long enough to allow for proper data collection and the randomization of data.

3. Measure each item and add the amounts to get the total of all items
One option here is to tally the problem according to the standard unit of measure you decided on in step one. Then, add up the tallies for the grand total.

4. Convert the amount of each item to percentages to determine their contribution to the grand total
Divide the sum of the item by the grand total and then multiply that by 100.

5. Organize the items from highest to lowest percentage
List the items in decreasing order of the measurement unit that you chose in step one. For example, if you selected cost as your standard, you could list items from the most expensive to the least expensive.

6. In that order, add the items to the horizontal axis of the graph
Arrange the x-axis items with the highest-measuring to the left and the lowest to the right.

7. List the measured amounts on the left vertical axis (frequency, time, cost…) and the cumulative percentages on the right vertical axis (adding up to 100 percent)
There are two y-axes in a Pareto chart. Label the left y-axis of the Pareto diagram with the standard measure from step one and the right side with percentages increasing from zero to 100.

8. Draw the bars for each item and add the line graph for the cumulative percentages
Your final product should look like a bar chart with a line chart showing the cumulative total percentage on top of it.

Key benefits and disadvantages of the Pareto analysis

Pareto analysis can help organizations identify and begin to address the root causes of problems or obstacles on their path to sustainable success. However, the statistical technique has its limits — namely, that it does not instruct organizations on how to solve their problems.

The importance of conducting an HR Pareto analysis

The Pareto principle, or the 80/20 rule, is a powerful tool for individuals and businesses looking to optimize their resources and efforts. By identifying the 20 percent of factors contributing to 80 percent of the outcomes, we can make informed decisions on where to focus our attention, time, and resources. This can significantly improve productivity, profitability, and overall success.

In the workplace, Pareto analysis can be used to analyze employee performance and identify areas for improvement. Businesses can make informed management and payroll decisions based on the collected data, leading to more efficient use of resources and a more productive workforce.

The Pareto principle reminds us of the importance of prioritizing decisions and identifying opportunities for improvement. By focusing on the 20 percent that produces 80 percent of the results, we can achieve greater efficiency, productivity, and success in our personal and professional lives.

Sources

Pareto Chart | UNC

What Is Pareto Analysis? How to Create a Pareto Chart and Example | Investopedia

Pareto Analysis in Quality Improvement | Wake Tech