The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.

Understanding the Pareto Analysis

The Pareto Analysis was named after Italian economist Vilfredo Pareto, who noted that 80% of the total income earned in Italy went to 20% of the population. In a modern business context, the principle is evident in a variety of settings.

For example:

• 20% of a product range accounts for 80% of profits.
• 80% of customer complaints relate to 20% of products or services.
• 20% of the workforce accounts for 80% of company revenue.
• 80% of meeting decisions come in 20% of the total meeting time.

Conducting a Pareto Analysis

Although the applications of a Pareto Analysis are vast, certain principles will apply to most situations.

Following is a six-step process that businesses can use.

1. Identify the problems

Start by writing a list of the problems that need resolving.

2. Identify root causes

Then, identify the fundamental cause of each problem. Note that there could be multiple causes of a single problem.

3. Score the problems

In step 3, it is time to score each problem. The scoring method being utilized will depend on the industry and the nature of the problem itself. For example, a business trying to increase profits might score each problem based on how much it is costing them. 

Indeed, cost is a common problem in business. But problems can also be scored based on duration or the number of times they occur in a specified period.

4. Group problems

Group the problems according to the root cause. Perhaps a group is focused on customer satisfaction, while another on quality control.

5. Tally the scores

Now, add the scores for each group. The group with the highest score is the top priority, as it is part of the 20% of factors causing 80% of the problems. Sometimes, two or even three groups may be causing the majority of problems.

6. Action

Lastly, allocate resources to the problems with the highest scores and thus the most potential to impact on profits, customers, or sales.

Advantages of the Pareto Analysis

• Efficiency. The analysis allows businesses to quickly and accurately identify factors that are contributing to a significant proportion of their problems.
• Problem-solving ability. Many workplace problems are intangible in the sense that personnel does not agree on their scope or even on their definition. The Pareto Analysis allows people to come to a consensus on the main problems facing an organization. This also increases morale and cohesiveness in the process.
• Improved decision making. A company that can quantify its main problems is better able to make decisions to counteract them. Quantifiable problems are also better prepared for so that they have less chance of recurring in the future.

Key takeaways

• Fundamentally, the Pareto Analysis is a statistical technique that identifies a limited number of factors that produce a significant overall effect.
• The Pareto Analysis has a vast range of applications in business settings, allowing organizations to target problems that erode profits or budget expenditure.
• The Pareto Analysis is an efficient technique that brings personnel together to quantify and then work to address tangible problems.

Connected resources:

• Financial Ratios
• Balance Sheet
• Business Analysis
• Gross Margins
• Decision-Making

Additional resources:

• Business Models
• Business Strategy
• Digital Business Models
• Distribution Channels
• Go-To-Market Strategy
• Marketing Strategy
• Network Effects
• Platform Business Models
• Revenue Models

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