Pareto’s law, also known as the 80/20 principle, states that 20% of results come from 80% causal influences. Applied to business, it implies that the majority of profits come from a small minority of customers. The law has broadened to other contexts, including socioeconomic and ecological systems.
Pareto’s law, sometimes known as the Pareto principle, was originally applied to economics by Vilfredo Pareto, an Italian economist who lived in the 19th century. Also known as the 19/80 rule as it is used today, it states that 20% of results come from 80% causal influences. Applied to business and economics, it implies that the majority of profits come from a small minority of customers. Pareto also believed that this idea could be applied to other situations as well.
Applying this principle affects the way many modern businesses operate. A key result of following Pareto’s law is that the best customers get the most attention and the best service and that the rest is relatively irrelevant. Obviously the principle does not require that these less valuable customers are ignored but simply that they receive a minimum of attention compared to more important customers.
While the popular use of the principle has come to be known as the 80/20 rule, the original law was expressed as a mathematical equation that Pareto developed to describe how control of wealth is distributed. He postulated that this equation, log N = log A + m log x could be applied to any economic system to show the relative distribution of wealth. The variables N ex represent respectively those with greater wealth and influence and those with less wealth and influence. A and m are constants that depend on the particular system. Numerous studies of the lui work and applications of the lui equation have shown that it is historically highly accurate.
Over time, in an effort to find an easier way to describe Pareto’s law, economists began calling it the 80/20 principle since this was the ratio that seemed to support its postulate. Of course, the 80/20 distribution wasn’t necessarily a definitive value for the ratio, but rather a generalization to illustrate his point.
Today, Pareto’s law is applied as a general principle in many ways that deviate from his original theory of the distribution of wealth. The general principle of small groups producing big results in economics has broadened to the belief that the 80/20 principle of proportional distribution has examples in nearly every system, including socioeconomic, ecological, and other scientific contexts. For example, many studies have shown that most crimes are committed by a small group of criminals. In software and computer systems, a small number of bugs cause the majority of crashes and other problems. When analyzing crop losses, it is common for a few out of many pests to cause the most damage.
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