What Is the 80-20 Rule?
The 80-20 rule, also known as the Pareto Principle, is a familiar saying that asserts that 80% of outcomes (or outputs) result from 20% of all causes (or inputs) for any given event.
In business, a goal of the 80-20 rule is to identify inputs that are potentially the most productive and make them the priority. For instance, once managers identify factors that are critical to their company's success, they should give those factors the most focus.
Although the 80-20 rule is frequently used in business and economics, you can apply the concept to any field. Wealth distribution, personal finance, spending habits, and even infidelity in personal relationships can all be the subject of the 80-20 rule.
- The 80-20 rule maintains that 80% of outcomes comes from 20% of causes.
- The 80-20 rule prioritizes the 20% of factors that will produce the best results.
- A principle of the 80-20 rule is to identify an entity's best assets and use them efficiently to create maximum value.
- This rule is a precept, not a hard-and-fast mathematical law.
- People sometimes mistakenly conclude that if 20% of factors should get priority, then the other 80% can be ignored.
The Pareto Principle (80-20 Rule)
How Does the 80-20 Rule Work?
You may think of the 80-20 rule as simple cause and effect: 80% of outcomes (outputs) come from 20% of causes (inputs). The rule is often used to point out that 80% of a company's revenue is generated by 20% of its customers.
Viewed in this way, it might be advantageous for a company to focus on the 20% of clients that are responsible for 80% of revenues and market specifically to them. By doing so, the company may retain those clients, and acquire new clients with similar characteristics. However, there's a more fundamental meaning to the 80-20 rule.
At its core, the 80-20 rule is about identifying an entity's best assets and using them efficiently to create maximum value. For example, a student should try to identify which parts of a textbook will create the most benefit for an upcoming exam and focus on those first. This does not imply, however, that the student should ignore the other parts of the textbook.
People may not realize that the 80-20 rule is a precept, not a hard-and-fast mathematical law. Furthermore, it is isn't necessary that the percentages equal 100%. Inputs and outputs simply represent different units. The percentages of these units don't have to add up to 100%. It's the concept behind the rule that matters.
There's another way in which the 80-20 rule is misinterpreted. Namely, that if 20% of inputs are most important, then the other 80% must not be important. This is a logical fallacy. The 80% can be important, even if the decision is made to prioritize the 20%.
Business managers from all industries use the 80-20 rule to help narrow their focus and identify those issues that cause the most problems in their departments and organizations.
80-20 Rule Background
The 80-20 rule is also known as the Pareto principle and is applied in Pareto analysis. It was first used in macroeconomics to describe the distribution of wealth in Italy in the early 20th century. It was introduced in 1906 by Italian economist Vilfredo Pareto, who is best known for the concepts of Pareto efficiency.
Pareto noticed that 20% of the pea pods in his garden were responsible for 80% of the peas. Pareto expanded this principle to macroeconomics by showing that 80% of the wealth in Italy was owned by 20% of the population.
In the 1940s, Dr. Joseph Juran, a prominent figure in the field of operations management, applied the 80-20 rule to quality control for business production.
He demonstrated that 80% of product defects were caused by 20% of the problems in production methods. By focusing on and reducing the 20% of production problems, a business could increase the overall quality of its products. Juran referred to this phenomenon as "the vital few and the trivial many."
Benefits of the 80-20 Rule
Although there is little scientific analysis that either proves or disproves the 80-20 rule's validity, there is much anecdotal evidence that supports the rule as being essentially valid, if not numerically accurate.
Performance results of salespeople in a wide range of businesses have demonstrated success by incorporating the 80-20 rule. In addition, external consultants who use Six Sigma and other management strategies have incorporated the 80-20 principle in their practices with good results.
Example of the 80-20 Rule
A Harvard graduate student, Carla, was working on an assignment for her digital communications class. The project was to create a blog and monitor its success during the course of a semester.
Carla designed, created, and launched the site. Midway through the term, the professor conducted an evaluation of the blogs. Carla's blog, though it had achieved some visibility, generated the least amount of traffic compared with her classmates' blogs.
Define the Problem
Carla happened upon an article about the 80-20 rule. It said that you can use this concept in any field. So, Carla began to think about how she might apply the 80-20 rule to her blog project. She thought, "I used a great deal of my time, technical ability, and writing expertise to build this blog. Yet, for all of this expended energy, I am getting very little traffic to the site."
She now understood that even if a piece of content is spectacular, it is worth virtually nothing if no one reads it. Carla deduced that perhaps her marketing of the blog was a greater problem than the blog itself.
Apply the 80-20 Rule
To apply the 80-20 rule, Carla decided to assign her 80% to all that went into creating the blog, including its content. Her 20% would be represented by a selection of the blog's visitors.
Using web analytics, Carla focused closely on the blog's traffic. She asked herself:
- Which sources comprise the top 20% of traffic to my blog?
- Who are the top 20% of my audience that I wish to reach?
- What are the characteristics of this audience as a group?
- Can I afford to invest more money and effort into satisfying my top 20% readers?
- In terms of content, which blog posts constitute the top 20% of my best-performing topics?
- Can I improve upon those topics, and get even more traction from my content than I'm getting now?
Carla analyzed the answers to these questions, and edited her blog accordingly:
- She adjusted the blog's design and persona to align with her top 20% target audience (a strategy common in micromarketing).
- She rewrote some content to meet her target reader's needs more fully.
Significantly, although her analysis did confirm that the blog's biggest problem was its marketing, Carla did not ignore its content. She remembered the common fallacy cited in the article—if 20% of inputs are most important, then the other 80% must be unimportant—and did not want to make that mistake. She knew it was necessary to address aspects of the content, as well.
By applying the 80-20 rule to her blog project, Carla came to understand her audience better and therefore targeted her top 20% of readers more purposefully. She reworked the blog's structure and content based on what she learned, and traffic to her site rose by more than 220%.
What's the 80-20 Rule?
The 80-20 rule is a principle that states 80% of all outcomes are derived from 20% of causes. It's used to determine the factors (typically, in a business situation) that are most responsible for success and then focus on them to improve results. The rule can be applied to circumstances beyond the realm of business, too.
What Does the 80-20 Rule Mean?
At its heart, the 80-20 rule simply underscores the importance of exerting your energy on those aspects of your business—or life, sports activity, musical performance, blog, etc.—that get you the best results. However, it does not mean people should then ignore the areas that are less successful. It's about prioritizing focus and tasks, and then solving problems that reveal themselves due to that focus.
How Do I Use the 80-20 Rule to Invest?
When building a portfolio, you could consider investing in 20% of the stocks in the S&P 500 that have contributed 80% of the market’s returns. Or you might create an 80-20 allocation: 80% of investments could be lower risk index funds while 20% might could be growth funds. Of course, past performance doesn't necessarily correlate with future results. So, be sure to monitor your portfolio's performance to see how well the results match your intent and your goals.