A business is all about making choices! Some of them can help a business grow super-duper fast, and some of them make a business sink. Hence, an entrepreneur must have good decision-making skills. Every day we tend to get confused about many things, and in the end, we have to make a perfect choice. But making business decisions can be tricky, which is why entrepreneurs use some statistical and mathematical rules to make better decisions. One of those rules is the Pareto Analysis.
Now, without further introduction, let’s dive into a detailed explanation.
WHAT’S IN IT
- What is Pareto Analysis
- How to make a Pareto chart
- Graphical representation of Pareto Analysis
- When to use Pareto Analysis
What is Pareto Analysis?
Pareto Analysis is a statistical technique to choose the best possible answer to a problem from several probable answers.
Predominantly, it’s known as the 80/20 rule because it’s based on the idea that 80% of the outcome has resulted from 20% of the work.
During the second world war, Austrian-American business consultant Joseph Juran, for the first time suggested the term ‘Pareto Analysis’, though it’s named after the Italian socio-economist Vilfredo Pareto, who in the 1890s observed that 80% of Italy’s gross wealth used to come from 20% of its land.
Pareto’s Principle is a universal rule. Let’s see some of its most prominent examples,
- In B2B, 80% of the profit is generated with the help of 20% of its customers.
- In offices and factories, 80% of the work is done by 20% of the employees.
- 80% of the crimes are committed by 20% of the criminals.
Pareto’s 80/20 rule is not as accurate as the laws of Physics, but it’s based on observation and till today it is observed that 80% of the events are caused by 20% of the causes.
How to make a Pareto Chart?
There are a few different ways to implement the Pareto Analysis, and they are based on the same basic rule. This is used when we are trying to find the best possible pattern that can give the greatest impact. According to Mind Tools, there are 6 steps to conduct a Pareto Analysis,
- Identify the problems- Make a list of the problems you have to resolve.
- Identify the causes- Find and list the causes behind every single problem.
- Score the problems- Based on the need to resolve the issues, give them a point. Suppose you have listed down 3 problems,
- Grey hair
- Hair fall
- Split end
Now, here the biggest problem is hair fall. So we will give it 3 points. The second biggest problem is the Split end. Let’s give it 2 points and finally give Grey hair 1 point.
- Group all the problems- Make a group of your problems based on the problems behind them.
- Add points- Give points to the cause groups. The group with the top score signifies the highest priority, and the one with the lowest score signifies the lowest priority.
- Actions- Start fighting the top priority problem first.
Graphical representation of Pareto Analysis
Let’s understand how to present the Pareto Analysis in Graphical Form. First, divide the score of every individual problem by the total score of all the problems and then calculate the percentage by multiplying by 100.
Now, draw a chart with one horizontal axis and two vertical axes. Put 0 to the total problem score from bottom to the top along the left axis. On the other hand, put 0 % to 100% from bottom to top along the right vertical axis.
Draw vertical bar diagrams. The problem with the highest percentage score must be placed on the extreme left and the problem with the lowest percentage score must be placed on the extreme right.
The length of each bar must relate to the value on the left axis and the total percentage on the right axis. Now let’s start accumulating these. Start making a curve from the first bar. The curve starts to rise quickly, but then it starts tapering off because the percentages of a problem bar get smaller.
It’s time to apply the Pareto principle to the graph. Determine the point on the right axis where it will be marked as 80%. Now start to draw a straight line from that 80% mark towards the curve horizontally and then draw the line downwards from the point where it meets the curve.
The whole diagram is now divided into two parts, one is Vital Few, and the other is Trivial Many or Useful Many. The problem bars which are in the Vital Few sections signify the problems which we must give most of the priorities to resolve.
When to use Pareto Analysis?
Earlier we have seen some of its examples. Whether you are optimizing code, trying to improve the workflow, or trying to do quality improvements Pareto’s chart can be helpful everywhere.
Beginning of Quality Improvement Process
Pareto Analysis is utilized toward the beginning of a round of quality improvement to make sense of what business issues are liable for the most objections or misfortunes and commit improvement assets to those.
For instance, pioneers at one organization accepted that most of the client grievances included defective products. When they saw the grievance information in a Pareto Analysis, it indicated that a lot more individuals complained about delivery delays. Maybe the authorities of the company were more cautious in resolving problems due to the defective products. however, more clients were influenced by transportation delays, and the organization’s priority was better committed to take care of that issue.
Later in Quality Improvement Process
Even after facing the basic challenges like the one we discussed in the previous point, big companies face many other big issues that require their attention to get resolved.
On the previous point, we mentioned that the company identified that the biggest problem was shipping delays. Now shipping delays can be caused by many reasons, like distance to be traveled, unavailability of the good supply chain, lack of infrastructure, etc.
Again the company has to use the Pareto Analysis to understand the biggest cause resulting in the shipping delay.
Other than the Quality Improvement process
The Pareto Analysis is implemented to resolve a lot of other issues as well. Like, suppose you are a student, and you are not scoring good marks. You can also use the Pareto Analysis to identify why you are not scoring good marks.
The Pareto Analysis is not as accurate as of the Laws of Force or Laws of Attraction, or any other kind of Physics laws. But it’s still better than making big decisions based on gut feelings. Almost a century after its origin, it is still relevant. Widely known as the 80/20 law it helps executives in taking risky decisions and point out the top priority errors to make their services and products better.
Also You can read our blog on Prospect Theory- An analysis of decision under Risk and Uncertainty