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3 tips on using Pareto for Supply Chain

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The Pareto Principle is a tried and tested management technique that aids you in decision making by using
the 80/20 principle. What’s the 80/20 principle? It is an idea that a limited number of activities/causes can
generate 80% of the value/issues
Some examples –
 20% of your customers generate 80% of the revenue
 20% of your products cause 80% of the customer complaints
 20% of your sales force generate 80% of the sales
 20% of a bill of materials will account for 80% of the total part cost
Used correctly this technique helps you focus – with laser like precision on the facts that matter – Pareto can
be used almost everywhere and anywhere and Supply Chain professionals can really benefit from its
application.
The principle behind how you use Pareto is fairly simple – in our example we’re investigating late deliveries
by our suppliers – we have 600 suppliers and we have their annual deliveries, their late deliveries and we’ve
calculated a percentage late figure – we’ve created a table of the results formatted as below .
Supplier Total Late % late Cumulative
Name Deliveries Deliveries % late
ABC Inc 1000 200 20% 3.6%
Carrying out Pareto Analysis
First gather you data and summarise (as in the above example)
 Sort your table in descending order of the issue your investigating (in our example by number of Late
Deliveries)
 Add a Cumulative % column for your issue
 On your table/list draw a line at 80%
 The Items in your list which add up to the 80% are typically the primary causes the ones between
the 80-100% are the less important causes.
3 Key uses of Pareto Principle in Supply Chain
Here’s our three top three tips where to use Pareto
1/ Improving your supplier delivery schedule adherence
As in our example above – Pareto is an excellent tool when analysing supplier performance and deciding on
your management strategy – which suppliers to focus on and what route causes to eradicate.
2/ Applying appropriate inventory management controls through ABC Analysis
Applying Pareto principles and methods to your parts when conducting ABC analysis. All parts are not equal
– you don’t manage 5 cent screws the same way as a $50,000 part different ordering and inventory
management techniques. ABC is used as a method to segment your parts/inventory allowing you to
manage each appropriately. Click here for more on ABC analysis
3/ Cost Savings initiatives
Using Pareto techniques to analyse cost drivers within your organization can help you focus on the key
contributory factors such as Suppliers, Parts or Bill of material elements allowing you to focus your
improvement activities on the parts that matter.
These are just 3 examples of how you can use Pareto in the supply chain – if you have your own thoughts
please contribute in the comments section below.

Logistics and freight management are a fast paced world. There are a lot of
factors in your supply chain to consider in order for it to stay optimized and
healthy? So how does one keep up with all the tasks so there are tangible
returns on investments from the activities around these complex industries?
Often, The Pareto Principle is used as a way to get complex projects done. It’s
often called the “80/20” rule. Here is another great guest blog post from Chuck
Intrieri, whom you can connect with on LinkedIn.

Understanding the Pareto Principle (The 80/20 Rule)

Originally, the Pareto Principle referred to the observation that 80% of Italy’s
wealth belonged to only 20% of the population.

More generally, the Pareto Principle is the observation (not law) that most
things in life are not distributed evenly. It can mean all of the following
things:

 20% of the input creates 80% of the result

 20% of the workers produce 80% of the result
 20% of the customers create 80% of the revenue
 20% of the bugs cause 80% of the crashes
 20% of the features cause 80% of the usage
 And on and on…

But be careful when using this idea! First, there’s a common misconception
that the numbers 20 and 80 must add to 100 — they don’t!

20% of the workers could create 10% of the result. Or 50%. Or 80%. Or 99%,
or even 100%. Think about it — in a group of 100 workers, 20 could do all the
work while the other 80 goof off. In that case, 20% of the workers did 100% of
the work. Remember that the 80/20 rule is a rough guide about typical
distributions.
Also recognize that the numbers don’t have to be “20%” and “80%” exactly.
The key point is that most things in life (effort, reward, and output) are not
distributed evenly – some contribute more than others.

Life Isn’t Fair

What does it mean when we say “things aren’t distributed evenly”? The key
point is that each unit of work (or time) doesn’t contribute the same amount.

In a perfect world, every employee would contribute the same amount, every
bug would be equally important, every feature would be equally loved by
users. Planning would be so easy.

But that isn’t always the case:

The 80/20 rule observes that most things have an unequal distribution. Out of
5 things, perhaps 1 will be a good thing. That good thing/idea/person will
result in majority of the impact of the group (the green line). We’d like life to be
like the red line, where every piece contributes equally, but that doesn’t
always happen.
Of course, this ratio can change. It could be 80/20, 90/10, or 90/20
(remember, the numbers don’t have to add to 100!).

The key point is that most things are not 1/1, where each unit of “input” (effort,
time, labor) contributes exactly the same amount of output.

So Why Is This Useful?

The Pareto Principle helps you realize that the majority of results come from a
minority of inputs. Knowing this, if…

20% of workers contribute 80% of results: Focus on rewarding these

employees.
20% of bugs contribute 80% of crashes: Focus on fixing these bugs first.
20% of customers contribute 80% of revenue: Focus on satisfying these
customers.

The examples go on. The point is to realize that you can often focus your
effort on the 20% that makes a difference, instead of the 80% that doesn’t add
much.

In economics terms, there is diminishing marginal benefit. This is related to

the law of diminishing returns: each additional hour of effort, each extra
worker is adding less “oomph” to the final result. By the end, you are spending
lots of time on the minor details.

The point is to put in the amount of effort needed to get the most bang for your
buck — it’s usually in the first 20% (or 10%, or 30% — the exact amount can
vary). In the planning stage, it may be better to get 5 fast prototypes rather
than 1 polished product.

Concluding Thoughts

This may not be the best strategy in every case. The point of the Pareto
principle is to recognize that most things in life are not distributed evenly.
Make decisions on allocating time, resources and effort based on this:

 Instead of 1 hour on a rough draft for an article you may write, spend 10
minutes on 6 outlines for a paper / blog article and pick the best topic.
 Instead of investing 3 hours on a website, spend 30 minutes and create
6 different template layouts.
  Rather than spending 3 hours to read 3 articles in detail (which may not
be relevant to you), spend 5 minutes glancing through 12 articles (1
hour) and then spend an hour each on the two best ones (2 hours).

These techniques may or may not make sense – the point is to realize you
have the option to focus on the important 20%.

Lastly, don’t think the Pareto Principle means only do 80% of the work
needed. It may be true that 80% of a bridge is built in the first 20% of the time,
but you still need the rest of the bridge in order for it to work. It may be true
that 80% of the Mona Lisa was painted in the first 20% of the time, but it
wouldn’t be the masterpiece it is without all the details. The Pareto Principle
is an observation, not a law of nature.

When you are seeking top quality, you need all 100%. When you are trying to
optimize your bang for the buck, focusing on the critical 20% is a time-saver.
See what activities generate the most results and give them your appropriate
attention.

Simple Example: I use this principle every day. It sets all my priorities, so I’m
not “spinning my wheels” knowing what to do next. When I scan my e-mails, I
only look for those 20% that are 80% of all e-mails I receive, and concentrate
on those e-mails first.

This 80/20 principle can be used by any one for anything in any type of
business or personal endeavor.
ADAM ROBINSON
Adam Robinson oversees the overall marketing strategy for Cerasis including
website development, social media and content marketing, trade show
marketing, email campaigns, and webinar marketing. Mr. Robinson works with
the business development department to create messaging that attracts the right
decision makers, gaining inbound leads and increasing brand awareness all
while shortening sales cycles, the time it takes to gain sales appointments and
set proper sales and execution expectations.

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80-20 Rule
What is '80-20 Rule'
The 80-20 rule is a business rule of thumb that states that 80% of outcomes can
be attributed to 20% of all causes for a given event. In business, the 80-20 rule is
often used to point out that 80% of a company's revenue is generated by 20% of
its total customers. Therefore, the rule is used to help managers identify and
determine which operating factors are most important and should receive the
most attention based on an efficient use of resources.

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BREAKING DOWN '80-20 Rule'

The 80-20 rule is also known as the Pareto principle, the principle of factor
sparsity and the law of the vital few. At its core, the 80-20 rule is a statistical
distribution of data that says that 80% of a specific event can be explained by
20% of the total observations.

The 80-20 rule is frequently used in business, but it has been applied to a wide
variety of subjects, such as wealth distribution, personal finance, spending
habits, and even infidelity in personal relationships.

80-20 History
The 80-20 rule was first used in macroeconomics to describe the distribution of
wealth in Italy in the early 20th century. It was introduced in 1906 by Italian
economist Vilfredo Pareto, best known for the concepts of Pareto efficiency or
Pareto optimality. Pareto noticed that 20% of the pea pods in his garden were
responsible for 80% of the peas. Pareto then expanded this principle to
macroeconomics by showing that 80% of the wealth in Italy was owned by 20%
of the population.

Joseph Juran, a prominent figure in the study of management techniques and

principles, expanded the 80-20 rule to apply to business production methods. In
the 1940s, Juran applied the 80-20 rule specifically to quality control for business
production by showing that 20% of defects in production were responsible for
80% of problems. He coined this phenomenon "the vital few and the trivial
many."

Because 80% of the consequences stemmed from 20% of the causes, focusing
on the critical 20% of causes allowed for more effective quality control and a
better use of resources. Juran set forth these principles in his "Quality Control
Handbook." The first edition was published in 1951, and the publication is now
considered a classic in management theory. After World War II, Juran was invited
to Japan to give a series of lectures on quality control, which are cited as having
had a major impact on Japan's post-war economy.

Modern Uses
That 80-20 rule has since been expanded to more general uses in business. For
example, a company may find that 80% of its sales come from 20% of its
customers. A company can increase its sales by focusing on the 20% of
customers who bring in the majority of the revenue. Also, 20% of a company’s
employees may be responsible for 80% of the output. The company can then
focus on rewarding the most productive employees.

The 80-20 rule is meant to express a philosophy about identifying inputs. It is not
a hard-and-fast mathematical law, even though it is often interpreted that way.

It's just coincidence that 80% and 20% happen to equal 100% in the 80-20 rule.
Inputs and outputs represent different units, so the percentage of inputs and
outputs does not have to equal 100%. One might observe that, for a given
phenomenon, 74% of the output comes from 35% of the inputs. This is entirely
plausible and valid, even though 35% plus 74% equals 109%. The underlying
principle suggests that certain inputs should be focused on more than others.

There are many misinterpretations of the 80-20 rule. Some result from the
coincidental 100% sum. Some result from a logical fallacy, namely that if 20% of
inputs are most important, then the other 80% must be unimportant.

The actual implied application of the 80-20 rule is to focus on identifying the
inputs with the most potential productivity and pursuing those causes first. For
example, a student should try to identify which parts of a textbook are going to
create the most benefit for an upcoming exam and focus on those first. That
doesn't imply that the student should ignore the other parts of the textbook.

Practical Application of the 80-20 Rule

As it applies to business management, the 80-20 rule holds that 20% of the time
spent in a certain area of a business creates 80% of that business's results. This
ratio can help businesses become more efficient. By identifying and focusing
more time on the most important areas, businesses can achieve higher growth
and better results.

If a company can identify its highest-spending customers, for instance, it can

effectively market to them to retain existing customers and acquire similar
consumers. Therefore, companies should dissect their revenues and understand
who makes up their top 20% of customers.
From there, it's been found that the top 4% of a customer base accounts for 64%
of total sales, meaning that the more granular a company can get in its analysis,
the more accurate the understanding of its customers becomes. This allows
companies to launch targeted marketing campaigns aimed at resonating with the
most impactful consumers.

Managers must make decisions about how to allocate scarce resources – time,
finances, labor and capital equipment, among others. The 80-20 rule suggests
that it's important for managers to understand which inputs produce the greatest
results.

As mentioned, the 80-20 rule doesn't mean the exact 80% and 20% proportions
are necessarily constant in every case. If the manager of a financial advisory firm
knows that 70% of the firm's revenue comes from 10% of its clients, then the firm
should focus its efforts on those clients first and foremost. That is the most
efficient use of resources. It's a matter of opportunity cost, in other words.

The studied causes and effects don't have to be revenue producers. For
instance, a manager might know that 80% of his department's computer crashes
come from just a handful of bugs; so, he should focus the IT department on fixing
those bugs first.

However, the 80-20 rule is like the proverbial half full or half empty glass. That is,
the rule works both ways, depending on the manager’s focus.

Applying the rule to a company’s product line tells a manager that 80% of the
company’s sales volume is attributable to only 20% of the products in the product
line. If those products are stored in a warehouse as inventory, then that superstar
20% of the product line should occupy 80% of the warehouse space.

Using the 80-20 rule to evaluate employees, it suggests that 80% of a company’s
production is the result of the efforts of only 20% of its employees. But it could
also show the manager that 80% of all human resource problems are caused by
just 20% of the employees.

Regarding a company’s revenue, the rule would indicate that 80% of the revenue
comes from 20% of the company's customers. Conversely, the rule could also tell
managers that 80% of customer complaints come from 20% of the customers.
The rule will not tell managers whether the revenue-generating customers are
the same as the complaining customers. But since both are only 20% of the
customer list, this narrowed focus makes it easier to target those customers who
are truly influential, which is the real lesson of the 80-20 rule.

The Historical Validity of the 80-20 Rule

While there is a lack of scientifically stringent statistical analysis either proving or
disproving the validity of the 80-20 rule, numerous internal business analyses,
and much anecdotal evidence exists to support the rule as being essentially
valid, if not numerically accurate.

The basic assumption that underlies this rule is that things are typically
distributed unevenly in life. As it relates to business performance, the 80-20 rule
proposes that 80% of revenues come from 20% of customers. Regarding
investing, the rule suggests 80% of all profits come from 20% of investments. In
broad economic theory, the rule refers to the fact that a small percentage of the
population owns a large percentage of an economy's financial assets.

For example, the 80-20 rule in economics refers to the fact that 80% of a
country's wealth is usually controlled by 20% of its population, although this can
sometimes be explained by the Gini index. In June 2016, Nigeria was found to
have roughly this distribution of wealth within its country's borders. The minimum
annual income needed to sustain a living in Nigeria was $1,000, yet more than
74% of the population lived below this poverty level. This distribution came after
the country's population grew by 12% while its GDP rose by 54% from 2010 to
2014. However, the allocation of the increased wealth was not even, and it
exacerbated the income inequality, thus adding to the Pareto principle.

Six Sigma and other business management strategies have incorporated the
principle into their designs for increased business efficiency. Analysis of
performance results of salespeople across a wide spectrum of businesses also
supports the 80-20 rule.

The principle appears valid simply from a basic logical analysis. Obviously, not all
efforts in any endeavor will be equally effective. It is logical to deduce that, from
all the different efforts made toward achieving the desired end, less than half of
them will eventually be responsible for more than half of the total results.

Read more: 80-20 Rule [Link]

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PARETO ANALYSIS
Pareto analysis is a statistical technique in decision making that is used for the selection of a
limited number of tasks that produce significant overall effect. It is one of the most commonly
used, and easy to implement method. Pareto analysis is a relatively simple methodology that is
used when trying to determine which tasks or factors in an organization will have the most
impact (Cervone, 2009). It ranks the data/factors in the descending order from the highest
frequency of occurrences to the lowest frequency of occurrences. The total frequency is summed
to 100 percent. The “vital few” items occupy a substantial amount (80 percent) of cumulative
percentage of occurrences and the “useful many” occupy only the remaining 20 percent of
occurrences, which is also known as the 80-20 rule developed by the Italian Economist Vilfredo
Pareto (Karuppusami and Gandhinathan, 2006).
The results of a Pareto analysis are typically represented through a Pareto cart. The chart
represents the various factors under consideration in ranked order. The presentation of this chart
is in the form of a bar graph in descending order and helps to predict easily which factors are
vital few by providing a clear indicator through superimposing a line graph that cuts an 80
percent cumulative percentage and also helps in determining those factors which have least
amount of benefits and vice-versa. Joseph Juran extended this concept and found it to be
applicable in a broad array of aspects in everyday life (Cervone, 2009). For example it can be
applied in a number of contents such as searching for books on-line in digital library catalog,
determining which tasks in a project will have the most impact, assessing major causes of
customer complaints from products or services, identifying those products or services that
account 80 percent of the profit and many more.

(PDF) Pareto analysis of total quality management factors critical to success for service
industries. Available from:
[Link]
ment_factors_critical_to_success_for_service_industries [accessed Oct 18 2018].