What is Pareto Analysis?

Pareto analysis is a way of making decisions regarding business operations. This technique relies on the statistical finding that, in quality management, a significant majority of the problems are caused by a few particular issues. This is known as the Pareto principle, also called the 80/20 rule.

The Pareto analysis method can be applied to just about any situation in business. Companies may find that 80 percent of complaints from customers come from a small selection of products or services, 20 percent of products or services account for a majority of the company's profit, or 20 percent of salesmen produce 80 percent of the company revenue. Once this analysis has been established, companies can apply the deeper principles of the Pareto analysis to determine what influences the 80/20 rule in their company.

The first step in the Pareto analysis is to create a table listing the important situations or causes in their business and the frequency of occurrence. This list may include causes from several areas in the business or may be completed on a departmental basis. Companies should probably separate out each department when creating a statistical table for the Pareto analysis method. The next step is to arrange the information by the importance of order for each situation or cause.

Companies should attach a numerical number to each situation or cause and its frequency of occurrence when arranging the information using according to the importance. A simple way to do this is by dividing the number of times a situation occurs by the total number of situations counted by the business. After this is complete, the information can be entered onto a basic percentage table with an X axis and Y axis. In statistics, this is commonly known as a right angle graph. Plot marks are entered at the specific percentage points on the graph to mark the frequency percentage of each situation or cause under examination by the Pareto analysis.

The plot marks are then connected by drawing a line to connect each mark on the table diagram. To complete the analysis, a line is drawn at the 80 percent point of the Y axis. The intersection of the plot mark curve and the 80 percent line of the Y axis is the separation point of the graph. Important business situations or causes are to the left of this intersection, while less important situations or causes are on the right.

The Pareto principle was named after Vilfredo Pareto, an Italian economist. He found that nearly 80 percent of the income in Italy was earned by about 20 percent of the country's population. This analysis method was then translated into observing what percentage of problems occurred from internal business processes or functions.