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The Pareto Principle

by | Feb 7, 2019

The Pareto Principle is also known as the 80/20 rule. It is named after Italian economist Vilfredo Pareto who noted that 20% of the pea pods in his garden provided 80% of the peas. At the time he was studying income and wealth and the discovery in his garden (according to legend) led him to note that 80% of the land in Italy was owned by 20% of the people. He further studied income distributions and likewise found a similar power law relationship that 80% of the income is made by 20% of the people.

The Pareto Principle is not a hard and fast rule, but rather an observation that often a small amount of inputs (like 20%) is responsible for the large majority of the output (the 80%).

This 80/20 concept has been found to have applicability in many areas of business and life. For example:

• In many companies, 20% of the clients/customers generate 80% of the revenues
• Often, 20% of salespeople are responsible for 80% of sales.
• 80% of production problems have been found to come from 20% of the production defects.
• 20% of the words in a language make up 80% of the words used.
• The richest 20% in a country typically own about 80% of the wealth.
• In healthcare, 20% of patients utilize about 80% of the resources.
• In a home or office, 20% of carpet/flooring receives 80% of the wear.
• People typically wear 20% of their clothes 80% of the time.

Note that the 80/20 aspect of the Pareto Principle only tells part of the story. As described by Nassim Taleb in The Black Swan, the 80/20 rule could “easily be called the 50/ 01 rule, that is, 50 percent of the work comes from 1 percent of the workers. This formulation makes the world look even more unfair, yet the two formulae are exactly the same. How? Well, if there is inequality, then those who constitute the 20 percent in the 80/ 20 rule also contribute unequally— only a few of them deliver the lion’s share of the results.”

Thus, if you have a business where 20% of the clients generate 80% of the revenue you might decide to jettison the 80% of the clients that generate only 20% of the revenue and keep only the 20% that are the biggest revenue generators. Taleb’s point is that now you probably have an 80/20 ratio again with 20% of the remaining clients generating 80% of the remaining revenues.

The concept of the Pareto Principle is related to Zipf’s Law (IFOD on Zipf’s Law), which also concerns power laws. Very interesting.

The Pareto Principle is sometimes referred to as the “trivial many vs. the vital few.” As you look at your business and life it is illuminating to think about your many trivial efforts vs. your vital few actions. In his best-selling book The 4-Hour Work Week, Tim Ferriss uses the Pareto Principle as the foundation of the entire system he recommends. He asks the following illuminating questions:

1. Which 20% of sources are causing 80% of my problems and unhappiness
2. Which 20% of sources are resulting in 80% of my desired outcomes and happiness?

These are great questions. Which of our inputs are producing most of our outputs? How do we maximize our focus on those inputs that really matter? How can we minimize the majority of the inputs that are less effective.

1. The 80/20 rule is well known. However, all the factors involving the 80/20 rule are not always disclosed. The most glaring being the 80/20 does not remain consistent. That is, the same 20 % are not the same period to period. I.E, the same 20% of stocks do not account for 80% of the gain year after year. The same 20% of people do not account for the best performance period to period. The key is figuring out what or who is going to be one of the top performers the next period. Why do most stock pickers miss the mark. They lack foresight and hind sight is a poor indicator of the next periods performance.

2. This is yet another great reason to take a nap every day! Luv2Nap

3. I follow this rule with my diet … 80% healthy eating … 20% whatever I feel like🤪

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