What Is the Pareto Principle (80/20 Rule) in Business

In business, identifying where the positive and negative results stem from is vital for making data-driven decisions. This could be applied to any area, from operations to sales. 

For example, organic search may not be a top-priority marketing channel for a brand, but at the same time, it could be generating the majority of online purchases. Surprisingly, there’s an explanation for this phenomenon that can be found in the sphere of statistics – the Pareto Principle, also referred to as the 80/20 rule.

In the following sections, we explore what the 80/20 rule is, how it works, and why it matters for businesses. 

What is the Pareto principle? Understanding the 80/20 Rule in a Business Context

The 80/20 rule has many names – the law of the vital few, the principle of factor sparsity, and the most popular one – the Pareto principle. This statistical principle derives from the sociological findings of the Italian economist Vilfredo Pareto on wealth distribution in Italy. 

Pareto discovered that 80% of the country’s wealth was in the possession of 20% of its citizens. Later, inspired by these findings, Joseph M. Juran used this concept in the field of quality control and improvement.

In mathematics, the Pareto principle can be described by a power law distribution or Pareto distribution for a set of parameters, guided by power law statistics. 

In business, the 80/20 rule simply represents the fact that 80% of sales (consequences) derive from 20% of clients (causes). For instance, when looking at a company’s customer base, you can often discover that the top 20% of shoppers are responsible for 80% of revenue.

However, this principle can apply to many different areas of business – time management, resource allocation, product output, and more.

Applying the 80/20 Rule to Grow Your Business

The 80/20 rule can be applied to any niche or industry. However, it’s mostly popular in business and economics. 

But what are the areas where you can apply it and how?

As noted above, this principle suggests that 80% of results come from 20% of actions. In business, you can use this concept when determining productivity, quality control, and more.

Productivity

Whether we’re talking about general productivity in a business setting or product or service creation, the 80/20 rule can apply. It can be used to prioritise activities that must be completed during a day, week, or month in order to result in 80% of the impact for that period. 

To prioritise tasks, you’ll first need to understand which ones have the highest impact. Think about whether any of these activities require other employees or teams, whether there are any other ongoing processes preventing these activities from moving forward, or if there are any other obstacles.

As a result, the 80/20 rule can help you optimise sales and marketing, or allow you to focus on high-value customers to land more revenue.

Quality control

Another powerful way to use the Pareto principle is for quality control. In fact, the Pareto chart and the Pareto analysis are essential components in the Six Sigma quality control methodology. 

This methodology visualises information to help business owners understand which actions are higher priority than others. Throughout the process, Six Sigma minimises variations and enhances production. 

Making informed decisions

Last but not least, you can apply the 80/20 rule in business for improvements in decision making, as the Pareto principle can help you spot the solutions with the highest priority. 

First, uncover any existing problems and determine what’s causing these issues. You can do this with the help of other processes like the 5 Whys. This problem-solving technique is used to identify the root cause of an issue by repeatedly asking “Why?” five times after stating what the problem is. 

Next, make a list of these problems and categorise them into small clusters. You’ll also need to give value to each cluster based on the impact they have on the business as a whole. The easiest way to do this is via a simple numbering system, from one to ten. 

Finally, create an action plan that concentrates on the top 20% of the problems with the highest impact. Addressing these challenges can potentially help you achieve 80% of the results.

Advantages of Using the Pareto Principle

The Pareto principle offers a wide array of benefits for business owners. It allows a company to make a substantial impact with fewer efforts or amount of work. As a result, you can witness dramatic improvements in efficiency and a significant boost in gains.

Via the 80/20 rule, companies can identify top-performing marketing channels, identify sales targets that represent the biggest opportunities, determine which products or services drive the most revenue, and more.

Here are a few advantages of the 80/20 rule.

Better time management  

The Pareto principle will help you determine what tasks generate the biggest results. As a result, you’ll be able to prioritise your activities on a daily basis to concentrate on the ones that are yielding the most significant impact on your business.

Naturally, this can prevent wasting time, which can also have a positive effect on your bottom line.

Better leadership

With a thorough understanding of those 20% that are making the strongest impact, business leaders and managers can make positive adjustments to their leadership style. 

They can use the discovered information from a Pareto analysis to guide different teams more effectively to generate more sales, improve customer satisfaction, grow online traffic, or others. 

Better allocation of resources 

In a nutshell, the Pareto principle is a powerful tool to allocate resources more strategically to achieve better results. 

These resources could be used better to find out more about your competitors, optimise the hiring process at the company, or more. 

Disadvantages of Using the Pareto Principle

Despite the many advantages that the Pareto principle offers, it can also create several challenges. Although it’s based on statistical laws, it’s not entirely backed up by mathematical principles. 

In some cases, the 80.20 rule may not be applicable. In fact, it may turn out to be completely irrelevant as it’s a general principle rather than a natural law. 

Moreover, the Pareto principle takes into account previous performance and data to make predictions, but does not factor in future performance. This means that it can sometimes prove to be ineffective in taking into account current or future changes or trends.

Examples of How the Pareto Principle Works in Business Specifically

When it comes to business, the Pareto principle can be seen across several examples:

• Sales and revenue – oftentimes, 20% of customers generate 80% of a business’s revenue, as mentioned earlier. Discovering your high-value clients can help concentrate your efforts on retention, upselling, and outstanding customer service for this audience specifically.

• Customer complaints – a lot of companies uncover that 80% of customer complaints derive from 20% of business issues. Having the ability to identify these issues can help solve the problems that are causing the most damage, dramatically improving customer satisfaction and achieving good results.

• Marketing – in digital marketing, in a lot of cases, 20% of online campaigns or marketing channels bring in 80% of conversions. By analysing this data and performance, marketing departments can find the best-performing platforms and allocate most resources there while pausing ineffective efforts.

• Inventory management – even in inventory and stock management, retailers often find that 20% of products account for 80% of sales. This can help make informed decisions and even set up more strategic promotions to clear inventory. 

These are just a few examples of how the Pareto principle works in business in real life. Depending on your niche or type of business operations, you can find even more creative ways to use the 80/20 rule.

How myPOS Card Machines Can Help You Grow Your Business

Using the Pareto principle in business means concentrating on the tools and systems that will yield the greatest return with the least friction. One extra tool that can partner in this process is myPOS.

By offering smart, efficient payment solutions, myPOS can help streamline your business operations and improve customer satisfaction with no unnecessary complexity. For these purposes, you can take advantage of convenient card payments, instant access to funds, no monthly fees, a built-in top-up system, and more.

Our aim is to simplify how you get paid, access your money, and manage finances. Ultimately, that helps you focus more energy on 20% of actions that drive 80% of your business success. 

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