The 80-20 rule, also known as the Pareto Principle, is a guiding idea that asserts: 80% of outcomes result from 20% of all causes or inputs in any given event.
In business, the goal of the 80-20 rule is to identify the inputs that are the most productive and prioritize them. For example, once managers identify the critical success factors of their company, they should focus their efforts on those factors.
Although frequently applied in business and economics, the concept of the 80-20 rule can be applied to many fields such as wealth distribution, personal finance, spending habits, and even personal relationships.
Key Takeaways
- The 80-20 rule maintains that 80% of outcomes derive from 20% of causes.
- The rule prioritizes the 20% of factors that will produce the best results.
- The principle identifies an entity’s best assets and uses them efficiently to create maximum value.
- This rule is a general guideline, not a strict mathematical law.
- People sometimes wrongly assume that if certain factors should get priority, then the remaining factors can be ignored.
How Does the 80-20 Rule Work?
You may think of the 80-20 rule as a simple cause and effect: 80% of outcomes (outputs) come from 20% of causes (inputs). The rule often highlights that a large portion of a company’s revenue is generated by a small percentage of its customers.
Core Principle
At its core, the 80-20 rule is about identifying an entity’s best assets and using them efficiently to create maximum impact. For instance, a student should focus on the parts of a textbook that yield the greatest benefit for an upcoming exam.
Misinterpretations
It’s important to recognize that the 80-20 rule is a guiding concept, not an exact mathematical law. The percentages don’t necessarily have to add up to 100%. The concept emphasizes the importance of prioritization:
“The fallacy is assuming that if 20% of inputs are most important, the remaining 80% are unimportant. Both can be vital.”
Managers across industries use the 80-20 rule to focus on the issues causing the most problems in their departments.
Origin and History
The 80-20 rule, also known as the Pareto principle, was first applied in macroeconomics to describe wealth distribution in Italy in the early 20th century. Italian economist Vilfredo Pareto noticed that 20% of pea pods in his garden contained 80% of the peas. He applied this principle to economics by showing that 20% of the population held 80% of the wealth in Italy.
In the 1940s, Dr. Joseph Juran applied this principle to quality management in business, demonstrating that addressing the 20% of production problems could improve overall product quality. Juran called this the “vital few and trivial many.”
Benefits of the 80-20 Rule
While less scientific analysis either proves or disproves the 80-20 rule explicitly, there is significant anecdotal evidence supporting its validity. Many salespeople and consultants, especially those using Six Sigma and other management strategies, have successfully incorporated this rule to improving their practices.
Example of the 80-20 Rule: Carla’s Blog
A Harvard graduate student, Carla, was working on a project to create a blog for a digital communications class. Midway through the term, her blog generated minimal traffic.
Define the Problem
Carla discovered the 80-20 rule and decided to apply it to her blog project. She realized that despite her expended effort, her blog’s main problem might be its marketing rather than its content.
Apply the 80-20 Rule
To apply the 80-20 rule, Carla identified that 80% of her resources were committed to blog creation and content while the remaining 20% of effort should be focused on marketing:
- Top Traffic Sources: Analyze the top 20% of traffic sources.
- Audience Profile: Identify and cater to the top 20% of her audience.
- Top Performing Content: Focus on the best performing topics.
She adjusted her blog, thus realigning it to better serve the needs of her top audience segment.
Results
By applying the 80-20 rule, Carla learned to understand and target her audience more effectively, resulting in a 220% increase in traffic to her blog.
Final Thoughts
The 80-20 rule asserts that 80% of outcomes result from 20% of causes. Used for identifying factors most responsible for success, it can be applied to various areas beyond business. The rule emphasizes prioritization but stresses that all factors, whether or not prioritized, can hold importance.
Using the 80-20 Rule to Invest
When building a portfolio, you might consider focusing on the 20% of stocks that make up 80% of the market’s returns. One example could be creating an 80-20 allocation where 80% of investments are in lower-risk index funds while 20% are in growth funds. Remember, past performance does not guarantee future results, so monitor your portfolio’s performance regularly.
Related Terms: Pareto Efficiency, Productivity, Revenue, Marketing, Quality Control.
References
- Econlib. “Vilfredo Pareto”.
- Six Sigma Daily. “Remembering Joseph Juran and His Lasting Impact on Quality”.
