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Pareto’s Law: The 80/20 Principle

by Jason Dean 


Vilfredo_Pareto Very few people have ever heard of Vilfredo Pareto, but most of us are familiar with his eponymous Law, more commonly known as the 80/20 Rule. It states that 80% of consequences flow from 20% of causes — in other words, 80% of good stuff comes from 20% of sources (people, activities, etc.); and 80% of bad stuff comes from the worst 20% of sources.

For example: If you run a business or you’re a salesperson, you might find that 80% of your sales come from 20% of your customers. Is it smart, then, to treat all customers equally? Pareto’s Law says no — you should focus on your top 20% of customers and keep them happy.

Conversely, what if 80% of your problems come from 20% of your customers — and they’re not the same 20% that give you most of your sales? Pareto would say you should ditch those customers. At the very least, abandon efforts to maintain them and refuse to spend more time on them than they’re worth. What’s the worst that could happen? They could defect to a competitor, but instead of it being his gain, it will actually be his loss!

These concepts also apply to non-business people. Do 20% of your household tasks cause you 80% of your frustration? Consider outsourcing them. If you really despise cleaning your kitchen or even doing the laundry, find someone else to do it for you. Chances are they will work for less than your hourly rate, but even if they charge more, you might derive enough satisfaction from the relationship to make it worth your while. After all, people often pay others more than they personally earn to do things they can’t do (i.e. doctors, lawyers) — why not pay them to do things you simply don’t want to do? It can be money well spent. Instead of paying $25 to go to the movies, stay home, watch an old DVD, pop your own popcorn, and pay someone $25 to clean your house while you spend time with your family!

Personal finance is about more than just socking away money in your 401(k) or saving a few dollars here and there. Ultimately, it’s about rationally allocating your resources to maximize individual utility. In laymen’s terms, this means that while money cannot necessarily buy happiness, it sometimes can if you spend it wisely. Instead of always striving for the biggest house, the fanciest car, or the newest model of iPod, consider spending your money to buy the one resource that’s always in limited supply — time. Then spend that time the way you most enjoy it, whether that’s with your family, writing a novel, or hunting sharks in the middle of the Pacific, that’s up to you.

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Comments

2 Responses to “Pareto’s Law: The 80/20 Principle”

  1. Tod means Fox | The 80/20 Principle and Software Development on September 3rd, 2007 11:09 am

    [...] great demonstration of how the 80/20 Principle (aka Pareto’s Law) works can be seen through examining source code. Clearly, a small minority of code in an [...]

  2. Using Pareto Principle to Improve Personal Finance | Moolanomy on November 27th, 2007 8:01 am

    [...] Pareto’s Law: The 80/20 Principle @ Smart Money Daily [...]

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