Tuesday, May 22, 2020

How useful is the Pareto Principle?

The Pareto Principle is often quoted as a way to save time and effort and thus lower pressure. In theory, it’s a great idea. And, if you look back at the past, it can seem quite easy to identify the 20% of situations, actions, or even people that generated 80% of the returns. But is it quite as simple as it appears? The Coyote investigates.

The Pareto Principle states that 80% of the results from any series of actions are caused by 20% of the actions themselves. In other words, most of the results we get because of a minority of our actions. The rest are either wasted or produce little of value. This sounds like a useful observation. However, before you decide the Pareto Principle is true and can be used to guide your actions, I want to ask some important questions.
  1. Can you identify which actions make up the useful 20%? And can you do so in advance? We have to live forwards in time, so to be useful a principle has to be predictive.

  2. Going forward, will this useful 20% still contain more or less the same actions? If it doesn’t, repeating them won’t produce any benefit.

Identifying the “magic 20%”

Let’s take the first question. It’s easy to feel intuitively that most results arise from a small group of actions. The Pareto Principle feels immediately valid. It also feels like a practical tool. Identify the “magic 20%” of actions and you can more or less dispense with the other 80% without much impact on your results. What a marvelous saving of time and effort.

Of course, this only works if these conditions hold true:
  1. You can reliably distinguish the 20% of actions that produce that disproportionate amount of benefits.

  2. These actions or behaviors remain the same for long enough to produce enough benefits to make a difference. If they change more rapidly, not only will repeating them be useless, it might even prove harmful. History contains many instances of people clinging on to actions that used to be helpful, long after they have ceased to be anything of the kind.

  3. The beneficial 80% of results come from single, identifiable actions—or at least small, obviously-linked groups of them.
Is all of this this true? Can you distinguish, reliably, which 20% of actions matter? Don’t some results rely on the interaction of large numbers of events, choices, actions and decisions? Can we know which count and which don’t? What if we dropped some, only to find later that they were essential in some way? Maybe they only produce good results in combination? Cutting seemingly unnecessary actions because they don’t obviously fit into the “magic 20%” might turn out to be a poor idea.

What about change?

How long will the beneficial actions remain valid? Change can come quickly and unexpectedly. Sticking with what used to work might become a liability in a fast-changing world. And can you be certain that is it always the same 20% of actions that count?

The Pareto Principle is perhaps most often applied to sales. Suppose you could reliably identify the 20% of sales calls that produced 80% of the orders you took this week. How much might the success of those calls rely on the market intelligence, knowledge and simple practice you gained by making the other 80%? Could you miss out all the rest, or even a significant number of them? That would include new customers being encouraged to place larger orders, most prospects and those former customers who might be won back from a competitor.

Suppose that this week, 20% of your calls do produce 80% of your sales. Pareto rules! Next week, you need to sell just as much. Will you visit the same 20% of customers and receive the same orders? Surely that’s unlikely. They only just placed an order. Most, maybe all, need to use up that order before buying again. Fine. You just need to find another 20%. But how? Everyone else was in the “unproductive” 80% last week. Why should that change?

What’s going on? My guess is that:
  1. The Pareto Principle distinguishes groups you can only find after the event, once you can see what worked and what didn’t.

  2. The 80:20 proportion only works over quite long periods. Take any shorter period and it’s much less likely to be correct. 80% of sales might come from 20% of customers over a year or more, but not over a month or a quarter.

  3. The membership of the “magic 20%” of people, behaviors, or actions shifts. Wait long enough and just about everyone will sometime be part of that 20% group.
If my reasoning is sound, the Principle is almost worthless as a guide to future action, which is how it’s most often used. There may be some actions or people (20% again? Who knows?) that figure so rarely in the “magic group” they could be removed without loss. There may be some regular members of that group that could be identified and given more focus and investment. Either way, what’s needed is time, careful observation and recording over many occasions, good records, and much patience and reflection. None of these are actions or qualities much associated with today’s frenetic organizational pace.

I’m not saying Pareto is wrong. I don’t know. I’m not sure anyone has ever done the lengthy and extensive research needed to find out. I’m merely suggesting it’s not the universally applicable principle, or the simple course of action, or the practical guide to decisions that we’ve been asked to believe it is.

To sum up

I think the Pareto Principle has great intuitive attractiveness—which says little about whether or not it works, nor how it works (if it does). However, these questions remain unresolved for me:
  1. How do you know which 20% is producing the results? Can you ever find out at a time when the knowledge might be useful? I suspect you can usually only find the answer—if there is one—after the event. And if that’s so, it leads me to a second question.

  2. Is it always the same 20%? If it’s not (and I suspect it isn’t), maybe the whole 100% will be in that magic 20% group sometime. And if that’s true, the Principle applies only to a specific time period (if it applies at all).

  3. Are the beneficial results caused by either single actions, or small, readily identifiable groups of actions? If they come from complex patterns of linked causes and effects, it may be impossible, in practical terms, to identify the “magic 20%” under any circumstances.
If any of these concerns are valid, the whole idea becomes fairly worthless as a guide to future action or allocating resources (which is how people try to use it). Maybe its real use lies in encouraging exploration. Looking for the “magic 20%” might well throw up all kinds of useful data and insights, whether or not you ever find exactly what you were looking for at the start.

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Finally an honest look at the oft-used and misused Pareto Principle.

Here's what I discovered after reviewing the business financials of the past 10 years:

1. About 80% of my revenues did, in fact, come from 20 % of clients.

2. That was over a 10-year period.

3. My short term cash flow was actually being paid by the smaller (80%) clients who paid faster. Therefore, the bills were being paid on time as a result of the 80%.

4. There was no pattern of predictability (using hindsight) to the trends. Too many factors influence life, and business life, to divine with any degree of certainty how to plan using the 80/20 rule. It is helpful to understand, after the fact, the impact of the rule.

5. For some strange reason, the more steadily I worked and did the right things over the past 30 years, the more profitable the business. Any time I deviated from my original business purpose, it had a negative effect.

6. Being a focused tortoise keeps you going successfully 80% of the time. The other 20% probably has little or nothing to do with anything over which you have control.
Thanks for a great comment, Steve.

I also noticed this posting from Grigor, who has also taken a careful and analytical view of Pareto.

His basic finding, backed up with some interesting reasoning, is this: "It is obvious that Pareto principle is not always valid and that it is much more trickier than it looks."

Keep reading, my friend.

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