Pareto analysis is a statistical technique used to rank the causes or effects of a problem in order of importance. The technique is based on observations made by the Italian economist Vilfredo Pareto in the 19th century. Pareto noticed that the distribution of income in Italy was unequal, with 80% of the total income belonging to only 20% of the population. This observation is known as the “80/20 rule” and has been observed to apply in many different fields.
Pareto analysis can be used to identify, prioritize, and solve the causes or effects of a problem.
Its basic principle is based on the 80/20 rule, which states that in many cases a small amount causes a large impact. So, typically 80 percent of a business’s revenue comes from 20 percent of its customers. This analysis helps businesses make effective decisions by enabling them to focus on what matters most.
How is Pareto Analysis Applied in Theory?
- Define the problem.
- List the causes of the problem.
- Determine the frequency and importance of the causes.
- Rank the causes in order of importance.
- Improve processes by addressing the top causes in order of importance.
How is Pareto Analysis Performed?
- Data Collection: The first step for Pareto Analysis is to collect business data. Key performance indicators such as revenue, customer satisfaction, product sales are analyzed.
- Ranking the Data: The collected data is sorted from those with the largest impact to those with the smallest impact.
- Applying the Pareto Principle: Sorted data is analyzed according to the 80/20 rule. It is determined which factors are within 20 percent.
- Focus and Improvement: Based on the results of the Pareto Analysis, the business management primarily focuses on the most effective areas. Improvements are made in these areas.
Advantages and Disadvantages of Pareto Analysis
Advantages
- Effective Resource Utilization: Companies can increase productivity by using their resources in the most effective way.
- Strategic Planning: Pareto Analysis clarifies the areas that companies should focus on in their strategic planning processes.
- Improved Decision Making: Company management can make more informed and effective decisions based on Pareto Analysis results.
Disadvantages
- Risk of Generalization: The fact that the 80/20 rule tends to generalize means that not every situation follows this ratio. Every industry and business is different and sometimes the proportions of important factors can differ.
- Variability: Pareto Analysis evaluates a specific snapshot and does not take variability into account. When we have ever-changing dynamics in the business world, there is a risk that the analysis loses its validity over time.
- Lack of Immersion in Detail: Analysis provides an overview and may neglect a detailed examination. In some cases, the results of the analysis may require a detailed review for a more comprehensive understanding.
- Ignoring Relevant Factors: By focusing on certain factors, Pareto Analysis may ignore other important factors. This can cause companies to overlook other potential problems or opportunities.
- Neglecting Emotional and Social Factors: Because the analysis is often based on quantitative data, it can neglect emotional and social factors. The impact of emotional factors on issues such as customer satisfaction may be overlooked.
- Focus on the Past: Pareto Analysis is often based on historical data. There is a risk that the past does not reflect the future well enough.
- Risk of Complicating the Management Process: Pareto Analysis can complicate the management process and decisions made based on the results of the analysis can unnecessarily complicate business processes.
In conclusion, Pareto analysis is an effective method for identifying the causes or effects of a problem and solving the problem by focusing on them. This technique can be used to efficiently utilize limited resources.
