Pareto Analysis

Updated on April 11, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Pareto Analysis?

Pareto principle analysis refers to the process conducted to ensure individuals or businesses make effective and productive decisions. It works on the 80/20 principle, which states that 80% of the problems are influenced by only 20% of causes or 80% of the benefits come from only 20% of the effort put in by different forces, be it manual or mechanical.

Pareto Analysis

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When the causes/reasons and problems/benefits are identified, making decisions to better the individual or business efficiency becomes easier. The 80/20 connection enables users to proceed with solutions ensuring maximum benefits. The technique finds relevance in various fields, including economics, human resources, business management, customer handling, quality control, etc.

Key Takeaways

  • Pareto analysis refers to the technique that helps individuals and businesses make effective decisions.
  • It works on the 80/20 rule, also known as the Pareto principle, which advocates that 80% of problems/productivity arise from only 20% of causes/efforts.
  • The major steps for an effective Pareto analysis include identifying problems, listing down root causes, giving scores to problems, grouping them together, adding up the scores, and taking necessary actions.
  • Though the analysis results in effective decision-making or problem-solving, the results are of no use if the scores assigned to problems are not relevant.

Pareto Principle Analysis Explained

Pareto analysis works on the Pareto principle, named after Italian economist Vilfredo Pareto. He introduced the 80/20 rule after discovering that 80% of the Italian land belonged to only 20% of the citizens. Later, he explored that the distribution of wealthWealthWealth refers to the overall value of assets, including tangible, intangible, and financial, accumulated by an individual, business, organization, or nation.read more across Europe followed the same pattern.

Gradually, it was observed that the 80-20 distribution was true in almost every sphere of social, political, and economic life. For example, 80% of a company’s productivity depends on only 20% workforce, or 80% of the website traffic is generated through only 20% of posts.

With the help of Pareto analysis, businesses get to identify the factors falling under the 80 and the 20 categories. In simple terms, this technique lets users separate a number of input factors that are likely to impose the greatest impact on the effect or outcome. So, if the outcome is positive, the individuals or businesses decide to continue with the factors. In contrast, the users remove those factors from their action plan if the effect appears to be negative.

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Steps of Pareto Analysis

To understand Pareto analysis meaning properly, it is important to explore the steps that help users identify the problem areas and their causes to frame relevant strategies to tackle the same. Here is a list of steps to prepare the Pareto chartPareto ChartA pareto chart is a graph which is a combination of a bar graph and a line graph, indicates the defect frequency and its cumulative impact. It helps in finding the defects to observe the best possible and overall improvement measure.read more and analyze the factors to consider before deciding on a plan of action.

#1 – Identify the Problems

The first step is to detect the problems. Individuals and businesses can conduct thorough research to understand what opinion the other individual or party has about it. While individuals can interact face to face with the other side to check how well they are performing as a single unit, businesses can have a proper feedback system to record the responses. Feedbacks help identify the problem areas, which becomes the foundation of the analysis as users know in what direction they need to proceed.

#2 – List the Causes

When people are aware of the problems, it becomes easier to identify the causes and list them down for further handling. There might be multiple reasons causing the same issues. It is recommended to take note of all of them.

#3 – Score the Problems

The next step is to rank the problems. Depending on the feedback obtained from end-users, be it clients, customers, or team members, users can assign a score to every problem. For example, the scores can be given based on the number of complaints received or the cost of items if that’s the factor affecting sales, etc.

Pareto Analysis Steps

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#4 – Group the Problems

Based on the root causes of the issues, individuals and businesses can group the problems. This means the issues having the same or similar reasons could be grouped under one label. For example, if the root cause for multiple issues is the lack of information available with customer support personnel, those issues can be listed under a single group.

#5 – Add up Scores

The next step is to add up the scores. Again, the problems with the highest scores should be the top priority. This helps individuals and businesses prioritize the issues to proceed with resolving them one by one.

#6 – Take Action

When people create the Pareto analysis chart, and the problems and their causes and ranking are clearly noticeable, it helps users understand how to tackle the issues in a sequence. Hence, they can frame necessary actions to ensure dealing with things effectively. If the factors positively influence the results, the users can improve them, while the input factors harming the business or individual identity should be removed immediately.

Examples

Let us consider the following Pareto analysis examples to understand the steps mentioned above more clearly:

Example #1 – Prioritizing Problems

Prioritizing the problems is one of the most crucial steps to understand in the context of Pareto analysis. For example, suppose a business wants to assign a score to the problems per the number of complaints received. Here is how it does it:

Pareto steps example

Based on the common root causes, it further adds up the scores as shown below:

steps

Example #2 – Taking Required Action

Considering the above example, the first focus should be to organize relevant training sessions for the personnel handling customer queries. Hence, the company has to prepare a module that would resolve all eight problems together to reduce the number of complaints from 57 to zero.

The next focus would be to increase the number of staff members and handle 34 complaints at one go. Then, consecutively, the third emphasis would be on improving the setup and making sure customers do not suffer from the same problems ever again.

Advantages & Disadvantages

Conducting Pareto analysis has its own set of pros and cons. While it is the best way to identify the problems and their root causes for better problem solving and decision making, it cannot offer solutions. Hence, it can be a guide but not a problem solver for users.

Pros & Cons

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The users document the procedures used while conducting this analysis for improving the input factors and other conditions. This, in turn, acts as a ready reference for individuals and businesses, thereby helping them make effective decisions in the future.

The documentation, however, may turn obsolete with the changing times. In short, the past procedures might not efficiently work for future problems. In addition, scoring problems is a complicated process. If one fails to assign a proper score to the issues, Pareto analysis might turn ineffective.

Frequently Asked Questions (FAQs)

What is Pareto analysis?

Pareto analysis is a tool that utilizes the Pareto principle or 80/20 rule to help individuals and businesses make effective decisions. First, it lets them identify the problem areas and root causes associated with the products or services. Then, once the issues and their causes are known, they prioritize them and implement solutions to tackle them.

What are Pareto analysis charts used for?

Pareto charts are used for interpreting scores of the identified problems. These are bar graphs or line graphs that move in descending order for a graphical representation of the scores assigned to the problems. The scores are based on various parameters, like the number of complaints received. These scores are then added up to check which issues need immediate attention. The problem with the highest score on the chart is the one that becomes users’ top priority.

How to interpret Pareto analysis?

Interpreting Pareto analysis is a complicated affair as one needs to assign scores to the problems carefully. Once the individual scores are added up, the issues are prioritized, with the one with the highest score to be tackled first.

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