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.
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The 80-20 Rule (Pareto Principle)
The 80-20 rule, or the Pareto Principle, states that 80% of all outcomes or results are typically derived from 20% of the causes or inputs. This principle was named after Vilfredo Pareto, an Italian economist who observed this pattern in various contexts. For example, Pareto noticed that 20% of the pea pods in his garden produced 80% of the peas, and he also found that 20% of the population in Italy owned 80% of the land .
Origins of the Pareto Principle
Vilfredo Pareto first introduced the 80-20 rule in Italy in 1906. He noticed the unequal distribution of wealth and land ownership in his country, which led him to formulate this principle. Since then, the 80-20 rule has been applied in various fields beyond its humble beginnings in Pareto's garden.
Applications of the 80-20 Rule
The 80-20 rule has far-reaching applications in different areas, including:
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Economics: In the distribution of wealth, it is often observed that a small percentage of the population owns a large percentage of the wealth. This principle is also applicable to income distribution, where a small percentage of individuals or businesses earn a significant portion of the total income.
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Quality Production Control: The 80-20 rule has been applied in quality control to identify and address the most significant causes of defects or problems. By focusing on the 20% of production defects that contribute to 80% of the problems, overall quality can be improved .
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Business Sales: In business, the 80-20 rule suggests that 80% of a company's revenues should come from 20% of its customers. By identifying and focusing on the most valuable customers, businesses can optimize their sales strategies and allocate resources more effectively.
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Business Growth: The 80-20 rule can also be applied to business growth. It suggests that 20% of the efforts or inputs put into a business should yield 80% of the results. By identifying the key factors that contribute the most to a company's success, managers can prioritize their efforts and resources accordingly .
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Investments: The 80-20 rule can be applied to investment portfolios. It suggests that 20% of the holdings in a portfolio are responsible for 80% of the portfolio's growth. On the other hand, 20% of the holdings could also be responsible for 80% of the losses. This principle highlights the importance of diversification and risk management in investment strategies .
Setting Goals with the 80-20 Rule
To set goals using the 80-20 rule, you can establish that 20% of your efforts or tasks will result in 80% of your desired results. For example, in the workplace, you can identify the most important tasks or projects that will contribute the most to your overall success and prioritize them. By focusing on these key tasks, you can maximize your productivity and achieve desired outcomes .
CEOs and the 80-20 Rule
CEOs can also apply the 80-20 rule by determining the 20% of tasks that need to be prioritized and personally handling them, while delegating the remaining 80% of tasks to their subordinates. This approach allows CEOs to effectively manage their responsibilities and focus on the most critical aspects of their role .
In conclusion, the 80-20 rule, or the Pareto Principle, is a concept that highlights the unequal distribution of outcomes and causes in various contexts. It has practical applications in economics, quality production control, business sales, and growth. By understanding and applying this principle, individuals and businesses can optimize their efforts and resources to achieve maximum efficiency and desired results.
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