50minutes - Paretos Principle: Expand your business with the 80/20 rule

In the forties, Joseph Juran observed that a minority of faults caused the majority of problems in the production line. Quickly recognising the 80/20 ratio (80% of problems are caused by 20% of faults), he attributed this theory to Vilfredo Pareto in the early twentieth century. Joseph Juran, during his research on quality management, showed that causes can be separated into two groups: those which are vital (in this case, 20% of faults) and those which are secondary, representing the remaining 80%. By isolating the most problematic faults (those that cause 80% of problems) Joseph Juran could focus on these further and significantly reduce the problems in the production line.

Good to know

Joseph Jurans principle was originally called the vital few and trivial many. Despite the considerable contribution of the economist, the Paretos principle name is still remembered more, probably because it sounds better than the name given by Joseph Juran.

Today, Paretos principle has many applications in business and in areas of personal management and research efficiency. Applications in business are mainly used for customer management and human resources. For example, 20% of employees produce 80% of the work. But it is also used in business strategies, knowing that 20% of products generate 80% of profits. In this book we will discuss in depth the application of this principle to the corporate sector. The following points present the many different uses in a clear and succinct way to help you understand Paretos principle.

As we have already mentioned, one of the most important applications of Paretos principle is the customer management of a company. Many studies show that 20% of customers are responsible for 80% of sales. These customers are the most important to the company. It is therefore better to make them loyal customers in order to ensure maximum retention, particularly through relationship marketing.

Useful information

Relationship marketing is a tool that lets you create and maintain a relationship between a brand and its customers by awarding gifts or discounts, or through invitations or advice. The goal is to develop a long-term relationship with customers, as retention costs are lower compared to the costs of attracting new customers.

Another application of Paretos principle is managing customer relations: 20% of customers are the source of 80% of complaints. If the 20% of customers used in the above example are the same as this 20%, the company will have no difficulty meeting their demands since it is already focusing on retention. Unfortunately, this is hardly ever the case: the 20% of important customers are rarely the same as the 20% responsible for 80% of complaints. In this case, it is more difficult for the company to clearly identify each customer category and assign them most of the attention. The company must then decide on its priority and choose between revenue and complaints management (generating customer satisfaction).

A second application, used by Joseph Juran, is that of control and quality management in a production line. If 20% of faults cause 80% of the problems, the company can concentrate its efforts on addressing the faults in question in order to improve quality. Other similar applications are also valid:

• 20% of machine set-up time can solve 80% of problems;
• 20% of the production line is responsible for 80% of the final product.

• Personal management tool: 20% of the work produces 80% of the results.
• Risk management tool: 20% of the risks cause 80% of the consequences.
• Logistics management tool: 20% of products generate 80% of storage costs.
• Stock management tool: 20% of the total number of products represents 80% of the total value of the stock.
• Sales management tool: 20% of products generate 80% of profits, etc.

What if Paretos principle was always used in business today? Should we get as close to the 80/20 ratio as possible to survive?

Take the example already studied: A company, after studying its customers, finds that only 10% of its customers contribute to 90% of its turnover. This situation is quite worrying as its capital of key customers is low. If the company were to lose just a few of them, its revenue would fall drastically. In this case, moving away from the standard 80/20 could be fatal for the company. There are two possible solutions: