What is the Pareto Principle?
Vilfredo Pareto stated, almost 100 years ago that, for lots of different events or phenomenon, 20% of the Input yield 80% of the Outcome.
- A statement that seems to be completely counter-intuitive.
However, these percentages can be observed in lots of situations:
- Companies: 20% of workers add 80% company value.
- Programming: 20% of errors cause 80% issues.
- Blogging: 20% of Posts generate 80% of traffic.
Of course, there are thousands of exceptions, and the percentages may be different in each situation studied.
However, the basic principle is solid as a rock:
- A minority tend to be more decisive than the majority.
Think about this: A Few brilliant scientists, thinkers, writers… have modeled our world much more than the rest of the society together.
Maybe, the most important scientist of all times: Sir Isaac Newton.
And even among them, just a few ultra-geniuses created the ground on which others have risen:
- Isaac Newton.
- William Shakespeare.
- Albert Einstein.
- W.A. Mozart.
What if we told you that this principle could be also applied to Religion?
There are approximately 4.200 religions all around the world.
- However, just Christianity (33%) Islam (24.1%) and Hinduism (15%) represent 72% of World’s religious population.
Nature works that way.
Pareto realized this phenomenon while developing his, also very famous, Pareto Analysis.
What is a Pareto Analysis?
Pareto analysis chart.
A Pareto Analysis is an easy and useful way of classifying the variables involved in something.
- Usually a Process,a Work or an Event.
With this analysis it is easy to appreciate which variables or “components” are affecting more the outcome, which is the biggest sub-group or what could be neglected if you had to focus on just few things.
It consists on listing the sub-parts that constitute a whole, ordering them from largest to smallest in “weight” or influence, adding the accumulated % contributed by each sub-part.
It is much easier than it seems.
We’ll give you an example:
Premier league Turnover - Pareto analysis example
In this analysis, you can appreciate the Premier league’s turnovers per team (left axis in million pounds) and which percentage each one of them represents (right axis, in accumulated %).
The blue line represents each team’s turnover (left axis), while the red one represents the % of TOTAL Turnover accumulated (right axis).
In this particular case, we don’t see a very “rigid” 80/20 rule. That is true.
However, 25% of the teams (5 of them) are making 50% of the overall Premier league Turnover.
* Price’s Law, which we’ll explain later, predicts that the square root of the members of a company or group is responsible for the 50% of the results.
- Here, we observe almost a perfect example: 5 (almost the square root of 20) make 50% of the total turnover.
Why is Pareto Principle or 80/20 Rule important?
Although this “rule” is usually regarded as a mere curiosity, it can be one of the most important things a Business should always consider.
If you focus on the important, on that “20%”, you’ll reach your goals in a much more efficient way.
Have you ever seen a documentary about Warren Buffett or Bill Gates?
- We encourage you to do so.
They are the entire day from meeting to meeting all around the world.
When you see their schedules, you may think:
- “How is that possible?”
- “How can they be so productive?”
They are not just geniuses (which they are); they focus on the most important issues, and delegate the rest in other people.
This principle is what you’ll find behind lots of Success stories.
And even in those Success stories, where very intelligent people focused on just one thing, 20% of their work built 80% of their reputation:
Steven Spielberg - 80/20 example of success
He is one of the best Movie Directors ever.
His career is something nobody could easily explain.
He has directed 32 Movies and produced many others.
Which movies you think are his “most Iconic” ones?
We would say:
- Close encounters of the Third Kind.
- Jurassic Park.
- Save Private Ryan.
- Schindler’s List.
Maybe, you could take one movie out, put some other instead…
But more or less, this would be the amount of movies that made him be one of the best Movie Directors ever: 6.
He has directed 32 big Movie films (we are just counting Movie films, not Television programs).
6 movies represent exactly 20% of the total amount of Movies directed by him.
But… How can you use this Principle in your Project or Business?
How do you Use the Pareto Rule?
Focusing on the most important, the 20%, you’ll gain efficiency and also, you’ll move faster.
Now, we’ll propose some recommendations for you to “squeeze” this Principle:
1. Identify your 20% with Data Analysis
It is easy to say: “focus on the main thing”, but: What does it mean? How can you do it?
These things are easy to state but difficult to do.
Generally speaking, nobody knows what the important 20% is, until a few years after becoming successful.
The only way to approach this 20% successfully is by analyzing the data.
Analyzing the data carefully, developing a proper Pareto Analysis is vital for identifying your 20% “space”.
Let’s see this with a helpful example:
Blogging - 80/20 Pareto principle rule example
Imagine that you have a Blog site, where you write about anything you like.
You started this site as a Hobby for sharing your experiences and thoughts but one day you realized that you could be full-time dedicated if you were able to monetize it properly.
Your Blog is receiving 22.775 page views per month, but you are not sure which Topics your users like the most.
- So far, you have been Posting not even thinking about Topics.
Since you have heard about 80/20 Pareto principle rule, you want to focus on the best Topics, so you don’t spend much time in your “weak” ones.
You decide to group all your Posts in 7 Topics:
- Personal issues.
- News and Economy.
- Travel Experiences.
Next, you sum up all the page views you receive per month in each Topic:
- Politics: 150.
- Friendship: 1.500.
- Personal issues: 5.500.
- News and Economy: 500.
- Travel Experiences: 11.750.
- Sports: 875.
You then order them according to their “weight” and develop a Pareto Analysis:
- “Travel Experiences” is your “Star”.
- Together with “Personal Issues“, they represent 76% of your Traffic.
You then decide to focus on those Topics.
In fact, you Posted about Politics and Sports just because you wanted to improve your numbers and it seems that it has been a “waste of time”.
- You should have continued posting about Travel experiences and Personal Issues.
This example shows how, sometimes, finding your “20%”, your “golden nugget” is not that difficult.
You just have to:
- Establish a purpose, a goal.
- Classify all the activities involved in reaching that Goal.
- Measure their impact.
- Order that impact.
- Study the results.
- Get your Conclusions.
Now you can develop the proper strategy that allows you to reach that goal.
2. Become a Niche Master
Once you know which is the activity or activities that give the better outcome, it is time for you to focus on them.
- You have already found a Niche, so focus on it.
You may think that you’ll be missing customers, users…
Forget about that: some of the most successful and stable companies in the world focus on one thing.
- When they start diversifying their activity in excess, they usually end up with problems.
- Normally, big companies have to diversify their activity since the market they once dominated no longer exists, or has changed drastically.
By mastering your niche, you’ll move forward much faster.
Tesla - 80/20 rule example
Although we could have chosen many other Niche examples, we think Tesla’s is a good one.
Elon Musk is focusing just on Electric cars. Nothing else.
It is true that Tesla has serious economic problems; poor Cash Flow in particular.
- However, they have been able to convince banks and investors while raising funds.
They have come a long way fast, because they focused on few things:
- Few models.
- Self-driving system.
That is why the have the best car battery in the market and also the best self-driving system (so far).
While other car companies have lots of different models, engines, designs… Tesla focuses on few products, directing all their efforts towards the Electric Niche.
Only time will say whether their strategy has been successful or not.
This example shows how, no matter the sector you’re in: you’ll always be able to success if you focus exclusively on a niche.
3. Identify 20% of professionals that add value
- You have found the important 20%.
- You have developed a proper Data Analysis and a Pareto Study.
- You ended up with the “gold nugget” you should focus on.
Moreover, you have chosen a particular Niche that better fits that 20% you’re good at.
This 80/20 Pareto principle rule is endless.
You could apply it at:
- The product you are selling: 20% of your products or services will represent 80% of your income.
- Your clients: 20% of your Clients will represent 80% of your revenues.
However, there is a very interesting application of this rule/principle:
20% of the people working at a certain company create 80% of its value.
Think about it.
If you “discount” all the work that could be easily done by other people at a certain company (“expandable” or “easily-to-replace” jobs) you’d end up with few important people that is creating most of the company value:
- Top Designers.
- Top Engineers.
- Top Managers.
- Top Investors.
- etc, etc.
It is a bit “sad” to think this way, but there is lot of people developing “administrative” tasks whose job position could be easily replaced by other person in hours.
We don’t say that those job positions are not important, of course not.
- Without those people, the company would not exist.
We just say that, the “core Business”, what really defines a company, its “raison d’être” relies on fewer people than you would imagine.
Berkshire Hathaway - 80/20 Pareto principle example
Just mentioning this example, we’re sure that you’ll immediately agree with what we just said.
Berkshire Hathaway: the most successful private holding in the world.
Main “numbers” according to Wikipedia:
- Total Assets: US$ 710 Billion.
- Revenues: US$ 200 Billion.
- Net income: US$ 4 Billion.
Which employees are creating that much value?
Warren Buffett, the legend.
He is the 20%.
This is an “extreme” example, we know.
However, in every Business, you’ll find that there are very few people that really push the projects forward.
You have to find that 20% of good professionals adding value.
You have to find your “Warren Buffetts”.
If you think this rule is a bit “hard” judging people’s contributions in companies, there is other one that you have to know:
- The Price’s law, also known as the Square root rule.
Price's Square Root Law
This is a variation of the Pareto’s principle.
- Its “essence” is exactly the same: few components (in this case, people) are much more important than the rest.
What this principle says?
According to Price’s law, the square root of the number of people in a company (or project) does half of the work.
If you think about it, it predicts an exponential inefficiency trend since, the higher the company is, the fewer people would represent 50% of the work.
Although it is difficult to contrast both Rules (Pareto and Price’s) since they point different percentages, let’s compare them with numbers:
Price's Law vs Pareto Distribution - Examples
A company with of 4 employees:
- Pareto principle: 1 person (technically 0.8) does 80% of the work.
- Price’s Law: 2 people – 50% – do 50% of the work.
- That doesn’t mean that each one of the others represent 25%.
- Maybe, one works much more than the other.
A company with of 25 employees:
- Pareto principle: 5 people do 80% of the work.
- Price’s Law: 5 people – 20% – do 50% of the work.
A company with of 100 employees:
- Pareto principle: 20 people do 80% of the work.
- Price’s Law: 10 people – 10% – do 50% of the work.
A company with 900 employees:
- Pareto principle: 180 people do 80% of the work.
- Price’s Law: 30 people – 3.3% – do 50% of the work.
You can appreciate how Price’s Law implies a decrease in employees’ efficiency as the company gets bigger.
Let’s see what these “Laws” would predict at Top companies:
Facebook: 39.651 employees.
- Pareto principle: 7.930 people do 80% of the work.
- Price’s Law: 199 people – 0.5% – do 50% of the work.
Microsoft: 144.000 employees.
- Pareto principle: 28.800 people do 80% of the work.
- Price’s Law: 379 people – 0.26% – do 50% of the work.
McDonalds: 375.000 employees.
- Pareto principle: 75.000 people do 80% of the work.
- Price’s Law: 612 people – 0.16% – do 50% of the work.
Walmart: 2.2 million employees.
- Pareto principle: 440.000 people do 80% of the work.
- Price’s Law: 1.483 people – 0.067% – do 50% of the work.
You may be thinking: “this makes no sense”.
How is it possible that among 2.2 million employees Walmart has, just 1.483 do 50% of the work?
If you think about it, it makes sense:
- Top managers, specialists, people designing a company’s strategy, marketing “gurus”…
These are the people really adding value to the company and proportionally, they are few people.
Think about U.S.A, for example:
- It is a 327 million people country.
How many people really run the country?
If we use Price’s law we could estimate that: 18.000 people create half of the country’s value.
Isn’t that accurate?
Think about this: How many really important, influential and powerful people are in the country?
- 18.000 seem a fair estimation.
All these rules, laws and principles are not rigid, or 100% accurate all the time, of course.
However, what you must never forget is that normally, few important things or persons are what make the real difference.
And the first step for succeeding at anything is to discover what or who they are.
Pareto principle, also known as 80/20 rule, states that, on average, 20% of the Inputs (sub-parts, components, etc) are responsible for the 80% of the outcome.
Based on the same principle, Price’s Law states that the square root of the number of people working at a company does 50% of the work.
This implies that usually, few things tend to be much more important than all the rest put together.
You can take advantage of this Rule by:
- Identifying your 20%’s by doing Data Analysis: find where you really outstand and generate value.
- Becoming a Niche master: focusing and improving even more at that 20%.
- Apply this rule to the people surrounding you: find who is really adding value to you.