Sep 242011

The Pareto Principle For Entrepreneurs

The Pareto Principle For Entrepreneurs

Most people in the business world have heard of the Pareto Principle, also known as the “80/20 Rule”.  For those who haven’t and for those who may have forgotten, first a little refresher, then we’re going to talk about how to use it to your advantage as an entrepreneur.

The Pareto Principle, suggested by management consultant Joseph Juran and named after Italian economist Vilfredo Pareto, refers to the concept that in many “systems,” roughly eighty percent of the output comes from roughly twenty percent of the inputs. Or, as it’s described in Wikipedia, “for many events, roughly 80% of the effects come from 20% of the causes”.  In other words, there’s the twenty percent that really matters, then there’s the rest.

Back in the first decade of the 1900’s, Pareto observed that eighty percent of the land in Italy was owned by twenty percent of the population.  If you take a look around in your world, you’re likely to find many “80/20” realities.  I know I do in mine.  For example, in many groups to which I belong, twenty percent of the members are very active and generate roughly eighty percent of the activity of the group, and the other eighty percent, well, they don’t do much.  It’s not necessarily a negative, but once you’ve seen this phenomenon enough times, it does help you to set your expectations better and look for more “20-percenters”.

You may also note the presence of Pareto in your own efforts in your business and personal life.  Do you ever get the sense that a minority of the actions you take, say roughly twenty percent, have the biggest impact in moving you in the direction of your goals?  Chances are that you are not imagining it; once again you’re seeing the Pareto Principle at work.

Also, note that it’s the Pareto Principle, not the Pareto “Rule”.  It is not “written in stone” and it’s not exact; it’s an approximation or “rule of thumb” that can be quite useful in understanding what you’re observing and determining where to focus your efforts.  It’s worth noting too that you will see much more extreme examples in certain situations, where rather than being 80/20, it will be 90/10, or even more lopsided.  Again, it’s a principle, not a rule.

I think the greatest use of the Pareto Principle for an entrepreneur is in helping to determine where to focus your efforts and expend your resources.  You can try to convert the “80 percenters,” or you can work more closely with the “20 percenters” and make them even more productive, profitable, etc.  Let me explain.

In business, applying Pareto, you may find that, for example:

  • 80% of your revenues come from 20% of your products
  • 80% of product returns come from 20% of customers
  • 80% of profits come from 20% of customers
  • 80% of machine breakdowns come from 20% of processes
  • 80% of your revenues come from 20% of your salespeople
  • 80% of your revenues can be traced to 20% of your “ad spend”
  • 80% of your sick days come from 20% of your employees
  • 80% of your worker’s compensation claims come from 20% of your employees
  • 80% of your return comes from 20% of your investments
  • 80% of your computer’s memory is used by 20% of its processes
  • 80% of your new business leads come from 20% of your referral sources
  • 80% of your viable new product ideas come from 20% of your R&D team
  • Etc.

This list could go on and on, but you get the idea.  Sure, you may find none of these 80/20 phenomena, or you may find all of them.  In any case, the point is, be on the lookout for Pareto in your business and personal life.  In some cases, when you find it, there may not be much more use for it than, “oh, that’s interesting”.  In other cases, it may be very useful, as it may be instructive in helping you determine where to allocate more or less resources, such as time, human capital, and financial capital.  “Pareto” is out there; the question is: can you find ways to use the Principle to your advantage?

I look forward to your thoughts and questions.  Please leave a comment (“response”) below or in the upper right corner of this post.

Paul Morin


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