Pareto Principle

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What is the 'Pareto Principle'

The Pareto principle is a principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The principle states that 20% of the invested input is responsible for 80% of the results obtained. Put another way, 80% of consequences stem from 20% of the causes; this is also referred to as the "Pareto rule" or the "80/20 rule."!--break--This principle serves as a general reminder that the relationship between inputs and outputs is not balanced. For instance, the efforts of 20% of a corporation's staff could drive 80% of the firm's profits. In terms of personal time management, 80% of your work-related output could come from only 20% of your time at work. In Pareto's case, he used the rule to explain how 80% of the wealth is controlled by 20% of the country's population.

Example of the Pareto Principle in Real Life

The Pareto principle can be applied in a wide range of areas such as manufacturing, management and human resources. It has been adopted by a variety of coaching and customer relationship management (CRM) software programs. A financial advisory business commonly uses the Pareto principle to help manage its clients. The business is dependent on the advisor’s ability to provide excellent customer service, as its fees rely on its customer’s satisfaction. However, not every client provides the same amount of income to the advisor. If an advisory practice has 100 clients, according to the Pareto principle, 80% of the financial advisor’s revenue should come from the top 20 clients. These 20 clients have the highest amount of assets and the highest fees charged.

The Pareto principle seems simple but is hard to implement for the typical financial advisor. The principle suggests that since 20 clients are paying 80% of the total fees, they should receive at least 80% of the customer service. Advisors should spend most of their time cultivating the relationships of their top 20 clients. However, as human nature suggests, this does not happen. Most advisors tend to spread out their time and services without regard to a client’s status. If a client calls and has an issue, the advisor deals accordingly, regardless of how much income the client actually brings in to the advisor.

Advisory practices that have adopted the Pareto principle have seen improvement in time management, productivity and overall client satisfaction. The principle has also led to advisors focusing on replicating their top 20% of clients, knowing that adding a client of that size immediately affects the bottom line.

The Pareto principle can be applied to many businesses, especially those that are client-service based. It can also be applied on a personal level. Time management is the most common use for the Pareto principle, as most people tend to thinly spread out their time instead of focusing on the most important tasks.

BREAKING DOWN 'Pareto Principle'

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