80-20 Rule Details

The 80/20 Rule, or Pareto Law, lends itself to just about any discipline. Also called Pareto Distribution or Pareto's Principle of Unequal Distribution, Vilfredo Pareto first described the law in 1896. His work was further developed by Joseph Moses Juran. This Romanian-American engineer and management consultant coined the phrase "the 80-20 rule."

The 80-20 rule helps us understand why there's an uneven distribution of "things," including wealth. This would explain an individual's unequal contribution to a whole. The fact that 80 and 20 equal 100% is a complete coincidence. The numbers are meant to demonstrate uneven distribution, not just that the two parts equal 100%. Your inputs and outputs (your 80 and 20) do not have to equal 100.

The formula states that N represents the number of people with wealth larger than the income limit x. A and α are constants. Therefore, the formula is:

N = A/xα. As a result, log(N) = log(A) − α log(x)

You plot these logarithms (log)—which are the number of times you need to raise a number to achieve a certain number—of the number of people who receive an income above definite amounts against the logarithms of the amount of these incomes.

Real-World Example of the 80/20 Rule

The Bracken Company was concerned because their productivity was down. They were always missing output goals, and the delays were costing the company orders. They hired a consultancy firm, Stark Stearns, which did an efficiency study on the company's data before and after the company missed its goals.

Stearns found that the main difference after the delays began was that staff shortages were higher after the lower productivity began. So they applied the 80/20 rule and found that roughly 80% of the absences were among 20% of the employees. The consultant met with management and human resources to address the situation. They considered:

  1. The number and percentage of employees who were absent on any shift.
  2. The attendance record of each employee and the reasons for their absences.
  3. The overall trend in the reasons for absences.
  4. Whether the company needed more employees for adequate coverage in every shift.
  5. The 20% of employees who were absent the most and their general work records. HR targeted these employees for special interviews. In these interviews, they asked employees what they could do to improve their attendance. The overall finding was that the company needed cross-trained per diem employees who could come in for the day.

After the company made the necessary changes, Stearns reassessed. They found that 20% of employees who had been absent the most were now attending more frequently. Some follow-up interviews indicated that the reason they came to work more often was that employees felt that management was listening to their needs. They also stated that work, in general, was less difficult as a result.

Significance of the 80-20 Rule

The 80/20 rule is important in a variety of ways and can benefit any entity that considers applying it. For example, a charity might find that 20% of its donors give 80% of the fundraising campaign's proceeds. So obviously, focusing on that 20% is an effective use of the organization's limited time and outreach.

Investors use the 80-20 rule when constructing a safe portfolio rather than a risky one. The general rule states that 80% of the assets are placed in less volatile areas such as index funds and treasury bonds. Investors put the remaining 20% towards a riskier area of potentially high growth stocks. This risky 20% can only do a controlled amount of damage, should the bottom fall out beneath those investments. Meanwhile, 80% will attract a moderate return.

The 80-20 rule can also help prioritize just about anything and help save money itself. Better use of both time, staff, finances, and other resources can all result from its application.