Mental Model: 80/20 Rule

 

The 80/20 Rule:

The 80/20 rule asserts that approximately 80% of the effects generated by any large system are caused by 20% of the variables in that system. [2]

The rule is not an exact ratio, it is only a general pattern that tends to occur. For example:

In the U.S. book business, the proportions are more like 97/20 (i.e., 97 percent of book sales are made by 20 percent of the authors); it’s even worse if you focus on literary nonfiction (twenty books of close to eight thousand represent half the sales). [1]

Some examples...

1. Mark Cuban and Shark Tank

The following is a quote from Mark Cuban, the immensely successful businessman and investor. In this quote, he is referring to the companies that he has invested in from the show Shark Tank:

Out of the 71, I would say ten or 11 are netting a minimum of half-a-million dollars a year, doing $8 million to $15 or in some cases, $20-plus million revenue. I would say about 30 percent of my companies have returned all of my investment and then some. To me, the more important thing is the ’80/20 Rule.’ So if I have the 20 percent that I think can really take off, that’s what I really care about. [3]

2. The Original 80/20 Observation

Vilfredo Pareto observed at the end of the 19th century that about 80% of wealth in Italy was concentrated into about 20% of the population. [4]

3. In Business:

It applies in business, as rough approximations:

Approximately 80% of process defects arise from no more than 20% of the process issues.

Approximately 20% of the sales force is likely to produce 80% of the company’s revenues.

Approximately 80% of sales are likely to come from 20% of the product/service range. The law applies in the finance team’s work:

Approximately 80% of purchase invoices will be for small amounts (e.g., under $2,000).

Approximately 80% of the time spent by the finance team is not adding much value.

About 80% of the chart of account’s codes are not worthwhile having.

About 80% of all month-end reporting is adding little or no value.

About 80% of the total debt will reside with about 20% of the customers. [5]

4. In Design

The 80/20 rule is useful for focusing resources and, in turn, realizing greater efficiencies in design. For example, if the critical 20 percent of a product's features are used 80 percent of the time, design and testing resources should focus primarily on those features. The remaining 80 percent of the features should be reevaluated to verify their value in the design. Similarly, when redesigning systems to make them more efficient, focusing on aspects of the system beyond the critical 20 percent quickly yields diminishing returns; improvements beyond the critical 20 percent will result in less substantial gains that are often offset by the introduction of errors or new problems into the system. [2]

5. Some Random Observations

80 percent of a product's usage involves 20 percent of its features.

80 percent of a town's traffic is on 20 percent of its roads.

80 percent of a company's revenue comes from 20 percent of its products.

80 percent of innovation comes from 20 percent of the people.

80 percent of progress comes from 20 percent of the effort.

80 percent of errors are caused by 20 percent of the components. [2]

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Sources

[1] The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb

[2] Universal Principles of Design, Revised and Updated: 125 Ways to Enhance Usability, Influence Perception, Increase Appeal, Make Better Design Decisions, and Teach Through Design by William Lidwell

[3] http://www.inquisitr.com/2518169/is-mark-cuban-a-successful-shark-tank-investor-hell-tell-you-the-stats/#wdJUFaSP2CglZS4t.99

[4] Supply Chain Engineering by Marc Goetschalckx

[5] Pareto's 80/20 Rule for Corporate Accountants by David Parmenter

Founder: Vilfredo Pareto

Notes: Also known as 'Pareto’s Principle', 'Juran’s Principle', and 'Vital Few & Trivial Many Rule'.

Categorisation: economics → wealth distribution

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