The 80-20 rule, also known as the Pareto Principle, states that 80% of all outcomes result from 20% of all causes. In business, this means seeking the most productive inputs that will generate the highest outcomes/returns. There are a number of practical applications for the 80-20 rule in diverse areas such as the distribution of wealth in economics, quality production control, business sales, and growth.
Key Takeaways
- The 80-20 rule, also known as the Pareto Principle, states that 80% of all outcomes (output) derive from 20% of all causes (inputs).
- The Pareto Principle was created by economist Vilfredo Pareto in Italy in 1906.
- The rule has far-reaching applications, including in quality production, the distribution of wealth, business, investing, and project management.
- In business, the principle asserts that 80% of a company's revenues should come from 20% of its customers.
Origins of the Pareto Principle
The 80-20 rule was invented by Vilfredo Pareto in Italy in 1906. According to legend,Pareto, an economist, noticed20% of the pea pods in his garden provided80% of the peas. He then determined20% of the population in Italy owned 80% of the land. The use of the80-20 rulehas since expanded beyond the alleged humble beginnings in Pareto’s garden.
Dr. Joseph Juran applied the 80-20 rule to quality control in the 1940s. He found that 80% of problems with products were caused by 20% of the production defects. By focusing on and reducing that20% of production defects, overall quality could be increased. Juran became an important figure in Japan after lecturing there extensively on quality control issues. His main phrase was, "thevital few andthe trivial many."
Managers at companies should identify the factors that are the most important to the company's success and give those factors the most attention.
The 80-20 Rule in Business and Investments
The 80-20 rule has found applications in business management. For business sales, 20% of a company’s repeat customers should be responsible for 80% of the sales. Also, 20% of the employees are responsible for 80% of the results.
For project management, the first 20% of the effort put in on a project should yield 80% of the project’s results. Thus, the 80-20 rule can help managers and business owners focus 80% of their time on the 20% of the business yieldingthe greatest results.
In investing, the80-20 rulegenerally holds that 20% of the holdings in a portfolio are responsible for 80% of the portfolio’s growth. On the flip side, 20% of a portfolio’s holdings could be responsible for 80% of itslosses.
Another method is to attempt to focus a portfolio on the 20% of stocks in the broader market that comprises 80% of the market’s returns; however, due to the uncertainty of future returns, both of these methods are difficult to put into practice. Stocks are inherentlyrisky assetsdue to the unpredictability of future performance.
One method for using the80-20rule in portfolio construction is to place 80% of the portfolio assets in a lessvolatileinvestment, such as Treasury bonds or index funds while placing the other 20% in growth stocks. The 80% in the lower-risk investment will collect a reasonable return, while the 20% in the higher-risk assets will hopefully achieve greater growth.
What Is an Example of the 80-20 Rule?
An example of the 80-20 rule is 80% of a company's revenues coming from 20% of its customers or 20% of a portfolio's most risky assets generating 80% of its returns.
How Do You Set Goals With the 80-20 Rule?
To set goals with the 80-20 rule, you primarily establish that 20% of your efforts/tasks will result in 80% of your results. For example, at work, 20% of the effort you put into your job will result in 80% of your tasks being completed/successful.
What Is the 80-20 Rule for CEOs?
CEOs can use the 80-20 rule by determining the 20% of tasks that need to be prioritized and done themself while delegating 80% of the tasks to their subordinates. This allows a CEO to effectively manage their responsibilities and be productive.
The Bottom Line
The 80-20 rule (Pareto Principle) has many applications that allow companies and investors to make the most efficient decisions. For example, a company would look to 20% of its customers generating 80% of its revenues. The same thought process can be applied to risk and reward in an investment portfolio. Overall, the application of the 80-20 rule helps to maximize efficiency.
As an expert in the field, I can confidently affirm that the 80-20 rule, also known as the Pareto Principle, is a foundational concept with profound implications across various disciplines, including economics, business, quality control, and project management. This principle asserts that 80% of outcomes result from 20% of causes, and its origins trace back to the work of economist Vilfredo Pareto in 1906.
One compelling illustration of the 80-20 rule is found in Pareto's observation in his garden, where he noticed that 20% of the pea pods produced 80% of the peas. This simple yet impactful observation expanded to broader applications, such as the distribution of wealth in Italy, where 20% of the population owned 80% of the land. This rule has since been embraced and extended beyond its humble beginnings, becoming a versatile tool in diverse fields.
Dr. Joseph Juran further advanced the application of the 80-20 rule in quality control during the 1940s. He discovered that 80% of product problems stemmed from 20% of production defects. By focusing on addressing this critical 20%, overall product quality could be significantly improved. Juran's emphasis on "the vital few and the trivial many" has resonated in various industries, particularly in Japan, where he played a key role in shaping quality control practices.
In the realm of business, the 80-20 rule has practical applications in sales, employee productivity, and project management. For instance, it suggests that 20% of a company's customers should contribute to 80% of its sales, and similarly, 20% of employees may be responsible for 80% of the results. Project managers can leverage this principle by recognizing that the initial 20% effort on a project often yields 80% of the project's outcomes, guiding them to allocate resources more efficiently.
In the context of investments, the 80-20 rule is relevant to portfolio management. It posits that 20% of holdings may drive 80% of the portfolio's growth, or conversely, 20% of holdings might be accountable for 80% of losses. A strategic approach involves placing 80% of portfolio assets in lower-risk investments, such as Treasury bonds or index funds, and allocating the remaining 20% to higher-risk assets, aiming for greater growth.
Setting goals with the 80-20 rule involves recognizing that a minority of efforts, approximately 20%, will lead to the majority, or 80%, of the desired results. This principle is applicable to CEOs as well, guiding them to prioritize the 20% of tasks critical to their role while delegating the remaining 80% to subordinates for effective management.
In conclusion, the 80-20 rule is a powerful tool that transcends its origins in a garden in Italy. Its applications in business, economics, and project management underscore its enduring relevance and effectiveness in optimizing outcomes and resource allocation. The 80-20 rule is not just a principle; it's a strategic framework that empowers decision-makers to achieve maximum efficiency in their endeavors.
