The Pareto Principle: 80-20 Rule

How perfect do your solutions need to be be? If very perfect, you are in for a world of hurt. If you are willing to settle for very good or excellent instead of perfect then life will be easier AND far more productive.

The Pareto principle

The Pareto principle was named after Italian economist Vilfredo Pareto who first identified the idea in 1896. It was an observational thing at that time. It was developed for our purposes by Romanian engineer and management consultant, Joseph Juran.

It says that 80% of the outcome result from 20% of the inputs. Those are approximations. it is an idea not a guarantee.

Observationally, as Pareto found it , about 80% of the land is owned by roughly 20% of the people. From a management perspective, as Juran thought about it, why do 80% of the sales come from 20% of the customers?

Observation of it is one thing, organizing around it is quite another.

The Pareto Principle is a “Power Law”

All that means is there is something that happens with two variables instead of one. In this case effort expended or inputs, and the observable result. Power law distributions tend to look like this.

Generalized Pareto Distribution – Matlab and Simulink

The idea is the bars represent the effect of adding another unit of input represented horizontally. Each additional input returns less value than any before it.

In the real world it is very complicated because we usually don’t just input one thing and we don’t know which inputs matter and how they interact.

Despite guessing a lot and doing a lot of A/B testing, the idea is worth thinking about.

Here’s why it matters.

Your resources of time, skill, and money are limited. If you use them one way, you cannot then also use them for something else. That forces you to make judgement calls.

You will find that resource allocation is fundamental to success in business, investing, and even relationships.

You would eventually, by trial and error, figure out a good mix of outcome and input. The Pareto Principle gives you a way to think about it before you start. It will help you with priorities.

Application

Lets suppose you have 100 units of time, skill and money. If you use the, they are gone. Suppose you have 3 projects to use them on.

How do you allocate and why? That question addresses a key point, how solved do you want the problem or opportunity? The idea is if a problem only needs to be 80% solved, you won’t use many of your resources. (just 20%) If you want a much higher level of solved, things get more difficult.

Being a power law, at step two, you will cure 80% of the remaining problem with 20% of the resources. That’s assuming the second step is no harder than the first. Not usually the case. As you perfect answers, each incremental gain tends to be more difficult than the early ones. Set that aside for now. So you can get 96% solved for 40% of your resources and 99.2% for 60%, and so on. You use all your resources before you get to 100% solved, and you will have done nothing else.

That’s where the judgement comes in. For 20% of the resource, is 80% solved a very good solution? 96% an excellent solution for 40% ?  and eventually 99.97%, a near-perfect solution, but using 100% of your resources?

Only decision makers who have unlimited resources fall into the near-perfect solution trap. Maybe governments. They tend to notice tiny incongruities and work to fix them. Perfect is very expensive.

You as resource allocator must make value judgments about how solved the problem must be. Make that an important early step in your assessment. You also must learn which resources matter. It is easy enough to fall into the trap of having and using resources that require 8 units of input to get another 2 units of output.

Your decisions eventually address a strategic question. Is one problem solved at 99.997% solved better than five problems solved at 80%? If no, you are on your way to understanding resource allocation.

You learn by doing

A point in favour of very good answers (80%) as the first step.

If you target 80% in the beginning and use what you learn getting there to help your next step of 20 units of input, you won’t come to the same place as a person who committed 40 units in the beginning to get 96%. You should have a better answer by the time you commit 40 units in two steps.

Here in the real world.

The Pareto principle is not a guarantee. It is a way for you to think about resource allocation. Do you need high perfection answers to every problem. When you do not know the problem completely and you don’t know what works for sure, perfection is not so smart. Pareto can help you choose paths to evolve answers.

The resource mix matters. If you have lots of time and very little money, your approach will be different from those who have lots of money and not much time.

Understanding the problem and how it is solvable is very important.

The Pareto Principle works in both directions.

You can get 80% of the 80% with 20% of the 20% input. So, the 64-4 rule. There is no need to add to 100.

The interesting one is is the 80% of 64% for 20% of 4% place, or 50.4% of the value for 0.8% of the input. That is about as close to something for nothing as you can get.

Do you think you can get a 50% good answer for 1% of the input? I hope not. Theory and practice differ. The problem is you can’t tell what the 1% input is that gets the answer. Is it advertising , or customer care, or price, or quality, or delivery, or guarantees? No one knows and it is not the same for every customer, and it is not the same in every place. What is important is not that you can pick the right 1% exactly, but that you think about what that 1% might be and always address it. If 50% of your result might depend on 1% of the inputs, you better be sure you input that 1%.

The takeaway

  1. You get better answers when you know a little more about the problem you are trying to solve.
  2. You can’t do everything to perfection. In fact, you cannot do anything to perfection for a finite commitment of resources.  New thinking frees you from the burden of perfect answers. This is not a test on number facts in Grade 1. 50/50 meant something then. Perfection in real life is a dumb goal, unless you do quality control in a nuclear power plant. Look for evolving very goods answers to the problems that matter.
  3. Think about what resources you must apply and what is in your resource inventory. Know what resources add the most value. Know approximately how. You might run out of one aspect before others. How does that change your solution set?
  4. You must learn from the very good answers, so you can, over time, make them better and less costly to solve. Make revisiting solved problems a thing in your management program.
  5. Think about the other side of this. 80% of life’s complications come from about 20% of the factors. Life will get easier if you work on those first. That frees time and probably money too. I had an executive in a business with 4,000 employees tell me he could eliminate 50% of his day-to-day problems if he could fire 40 people of his choosing. The 50% – 1% example.

Add this level of meaning to your decision making.


I help people have more retirement income and larger, more liquid estates.

Call in Canada 705-927-4770, or email don@moneyfyi.com 

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