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Pareto Analysis Definition
Joseph M. Juran, the quality guru first expounded the Pareto Principle in the 1940s, and named it after Vilfredo Pareto, an Italian economist who observed that 80 percent of total income went to 20 percent of the population. Pareto’s later surveys indicated that the Pareto principle 80/20 rule apply to most things in life. For instance:
- 20 percent of the work yields 80 percent results
- 80 percent of profits derive from 20 percent of products
- 80 percent of customer complaints center on 20 percent of products or services.
- 80 percent of schedule overruns stem from 20 percent of causes
The converse is also true in these cases
The figures 80 and 20 are illustrative, and the Pareto principle mainly highlights that the results need not remain directly proportional to the efforts put in.
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Using the Pareto Analysis to Pinpoint Problems
Pareto Analysis finds use in quality control applications and in guiding project teams. It helps in prioritizing work, and identify and execute problems or tasks that yield maximum results.
Using Pareto analysis to pinpoint problems is a six-step approach
- Identify the problems, listing all the problems that require resolution
- Identify the root cause of each problem using techniques such as root cause analysis, brainstorming, 5 Whys or any other method
- Score the problems based on the nature of the problem. The most common scoring measurements are frequency, quantity, cost and time. For instance, if the problems relate to costs, the scoring is based on money, whereas if the problems relate to customer satisfaction, the scoring bases on the number of complaints eliminated. One important scoring consideration is to determine the period for which the scoring applies
- Group the problems together by root cause
- Add the scores for each group
- Take relevant action. The group that has the maximum score ranks top on priority, for resolving such tasks help achieve the maximum cost benefits or the maximum results.
Pareto analysis can be represented on an Excel sheet, or in a graph by arranging the list of problems in descending order of scores, adding a cumulative percentage, and plotting the problems in "x-axis" and the cumulative percentage on the "y-axis."
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An example of a consultant approached to turn around an imaginary retail shop beset with many problems illustrates the application of Pareto principle.
Assume the shop has the following problems. The score assigned to the list is the estimated value of business lost due to the specific problem, in a month.
- Lack of reliable supply of stock: $1000
- Staff lacks training in soft skills to interact with customer well: $300
- Lack of integrated accounting and inventory system, with much of the work done manually: $5250
- poor housekeeping and display: $350
- Lack of adequate number of staff to handle peak hour rush: $150
- failure to replenish packing materials for delivery on time: $125
- no backup power generator: $220
- high level of staff absenteeism: $375
- high rate of product returns $100
- high levels of dead stock: $450
The first task in Pareto Analysis is identifying the root cause of each problem. The consultant may observe, brainstorm, and study the shop records to reach the following conclusions regarding the root cause:
- the root cause for lack of reliable supply is poor inventory management
- the reason for staff not interacting with customers well is weak HR intervention
- a poor accounting system is the root cause for lack of integration between accounts and inventory
- weak HR intervention is the major raeson why staff neglect housekeeping duties
- weak HR intervention leads to failure to determine optimal staffing levels
- poor inventory management leads to packaging and delivery issues
- poor facility management results in no backup power generator
- high level of staff absenteeism is owing to weak HR interventions
- the root cause for missing stock is the poor accounting system that lacks bar-coding or other tracking mechanism and fails to properly account for the items sold
- high levels of dead stock again traces to poor inventory management
The next step in Pareto Analysis is to group the problem based on their root cause. Such a grouping produces the following results:
- Poor Inventory management: Points 1, 6 and 10: $1000 + $125 + $450 = $1575
- Weak HR Intervention: Points 2,4,5,8,9: $300 + $350 +$150 + $375 = $1175
- Poor Accounting System: Point 3 and 9: $5250+$100 = $5350
- Poor Facility Management: Point 7: $220
Although weak HR intervention is the cause for maximum number of issues, application of the pareto principle 80/20 rule highlight the need to get the accounting system perfect first, as this root cause leads to maximum loss. The two problems related to this root cause cause more loss than all the other eight issues combined.
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ASQ. "Pareto Charts." Retrieved from http://asq.org/learn-about-quality/cause-analysis-tools/overview/pareto.html on 07 February 2011.
Image Credit: Wikimedia Commons