Pareto Principle: Determining Key Drivers

In 1906, Italian economist Vilfredo Pareto created a mathematical formula to describe the unequal distribution of wealth in Italy, observing that twenty percent of the people had eighty percent of the wealth.  The principle does not just apply to economics. In fact, the pattern occurs in almost every natural and social system. Pareto himself showed that in his garden, 80 percent of the peas came from 20 percent of his pea pods.

This law or principle came to be known as the Pareto principle, the 80/20 Rule or the Principle of Factor Sparsity. This law states that, for many events, roughly 80 percent of the outputs come from 20 percent of the inputs.

The 80/20 rule is one of the great truths of management consulting and, by extension, of business. You will find that 80 percent of your sales will come from 20 percent of your sales force, 80 percent of your profits will come from 20 percent of your clients or 20 percent of someone’s job will take up 80 percent of his time.

I’ve always been impressed by this rule’s power as a problem-solving rule of thumb. When a client asks the question “How do I boost my profits?” the first thing you should do is take a step back and ask the question “Where do your profits come from?” The answer to this is not always obvious, even to people who have been in their particular line of work for years.

In any Ballard team meeting where problem solving is on the agenda, someone will use the inelegant phrase “key drivers,” as in, “Joe, I think these are the key drivers of this issue.” In other words, there may be 50 different factors affecting the sales of our widgets – weather, consumer confidence, raw material prices – but the three most important ones are X, Y, and Z. We’ll ignore the rest.

Focusing on the key drivers means drilling down to the core of the problem, rather than picking the whole problem apart piece by piece, layer by layer. Then, you can apply thorough, fact-based analysis where it will do the most good and avoid going down blind alleys.

In our consulting, we find that understanding these 80/20 ratios is crucial for maximizing performance.

So look for the products or services that generate the most profit (the 20 percent) and drop the rest (the 80 percent) that only provide marginal benefits. Spend your time working on the parts of the business that you can improve significantly with your core skills and leave the tasks that are outside your best 20 percent to other people. Work hardest on projects that work hardest for you. Reward the best employees well, cull the worst. Drop the bad clients and focus on upselling and improving service to the best clients.

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