Pareto Analysis: is a supply chain term that helps recognize problems and prioritize solutions based in importance. Pareto analysis is also commonly referred to as the 80/20 rule, meaning that 80% of the problem or topic of issue is caused by 20% of the inputs. It is an easy way to analyze many different aspects of business functions to solve problems, save money, and decision making.
Table of Contents
1. Broader Explanation
2. Historic Development
4. Further Analyses
5. Examples from Industry
- 1. Broader Explanation
Pareto Analysis is a tool that is often applied to decide on which parts of the problem or idea are most justified to spend attention and resources on. Pareto Analysis can be applied across many aspects of a business including sales, logistics, government policy, economy aspects, profits and much more. The main objective is to find the top 20% (most spend, most common customers, greatest impact of an outcome, and more) and then allocate the resources to fix or improve the top 20% or problems. It is generally true for most business organizations that 80% of sales come from 20% of all customers; therefore it is important to help keep the top 20% of those customers satisfied and it will lead to sustainable profits.
The diagram shown below represents suppliers A-G. Suppliers A,B and C account for 80% of the total spend. If a business wants to lower costs by lowering costs with their suppliers then it the business needs to allocate most of their time and resources on suppliers A,B and C and less with the rest of the suppliers.
- 2. History
Pareto Analysis dates further back than many other of the concepts that are relevant in the supply chain world today. The creator of the concept was Vilfred Pareto who lived in Italy during the late nineteenth century. Pareto was an Italian engineer, economist, political scientist, and philosopher. Pareto is known for many concepts but most notably the Pareto principal; he conceived this due to his observations that demonstrated that 80% of the land in Italy was owned by 20% of the population. The concept of Pareto analysis was not formally researched much again until the mid twentieth century where many scholars, most notably Guru Joseph Juran who applied the Pareto principals to industries as well as businesses. Many of these same principals are still applied today all across business structures.
- 3. Categorization
As previously stated there are many uses for Pareto analysis. Below are many of the categorizations of uses for Pareto Analysis
- Logistics and Transportation Management: One important use of Pareto Analysis is in logistics and transportation management. There are always problems with transportation of inventory. These problems are likely to be costly with regards to late shipments, damaged shipments, as well as reverse logistics. Likely most of those problems are caused by 20% of the inventory. It is important to analyze the inventory that is causing the most problems and it will in turn help the entire business performance for logistical purposes. Also, some deliveries take longer than others; resulting in more fuel consumption and more costs. It is important to analyze the top 20% of longest delivery nodes and optimize those routes based on many different constraint inputs. Therefore, it will have a more plausible delivery routes that does not require the optimization of all nodes (often times optimizing all nodes can be costly and not possible due to too many nodes because it can be impossible to manage every node or delivery).
- Customer and Supplier Management: it can be hard to monitor the relationships with all of the customers and/or suppliers. Therefore, if a Pareto analysis can be done to find out which parties represent the top 20% and focus most of the resources on the top 20% then it will result in better relationships with the top customers as well as suppliers.
- Continuous Improvement: one of the functions of Pareto Analysis is to focus on improvement of many aspects of a business. It works by finding the main inputs of a problem or process. That will help to prioritize innovation and time on those specific problem causing inputs to improve the process or problem.
- 4. Further Analyses
There are many advantages as well as disadvantages of Pareto Analysis. The main advantages that Pareto Analysis presents are easy to understand as well as present. Many managers prefer to see an analysis that is easy to represent and understand and this is a strong tool for that. Pareto Analysis also provides a great instrument to find cost savings that would have not been noticed before because it can provide insight on where to focus resources on a cost savings. There are also advantages of Pareto Analysis that effect service levels. If an analysis is done to determine the most purchased items then Pareto Analysis can help to improve on inventory management. Reductions in stock-outs as well as back orders will result in an improved service level. Consequently there are negative attributes of Pareto Analysis. To begin, Pareto analysis does not always provide insight on what specific problems are causing wastes or need improvement. Often, Pareto Analysis can be very general and lead decisions to not be as focused as needed. There is also the negative aspect that Pareto Analysis usually only focuses on quantitative data and ignores the qualitative data (unless qualitative data can be measured). That measurement can result in misguided representations of what is really going on. Pareto Analysis also does little to observe much of the statistical data including mean, standard deviation, modes and more. That inability to test statistical data through Pareto Analysis will not demonstrate the entire problems that can be occurring.
- Industry Examples
- Clothing Industry: Many retail companies note that 80% of their sales come from 20% of their specific types of clothing
- Auto Industry: throughout all of the auto industry the large profits are made from a automakers SUV lines. SUV’s usually account for around 20% of all of their products.
- Technology: in fixing problems with software, Pareto Analysis can be applied. This is demonstrated through a Microsoft example where 80% of the errors as well as crashes were ellininated by fixing the top 20% of most reported bugs.
- Rooney, Paula (October 3, 2002), Microsoft’s CEO: 80–20 Rule Applies To Bugs, Not Just Features, ChannelWeb