# Pareto Analysis: Definition, How to Create a Pareto Chart, and Example

![Pareto Analysis](https://www.investopedia.com/thmb/KIJnD7w9ww2mwOoFKj5025dE1LI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/pareto-analysis.asp-final-607d7b07847744e2a9d6ea9039672529.png)

*Businesses use Pareto analysis to make informed decisions about where to allocate resources and efforts. — Julie Bang / Investopedia*

> **Definition**
>
> Pareto analysis is a decision-making tool that is based on the 80-20 principle, which states that 80% of outcomes stem from 20% of inputs.

## What Is Pareto Analysis?

Pareto analysis is based on the 80/20 rule, which states that 80% of any outcome, good or bad, can be traced to 20% of its causes. Pareto analysis can be used as a decision-making tool. A project or a process can be improved or streamlined by focusing attention on the steps that have the greatest impact on the end result.

Pareto analysis will typically show that a disproportionate improvement can be achieved by ranking the causes of a problem and then concentrating on solutions that will have the largest impact.

It is a technique for gathering the facts that are necessary to set priorities.  

### Key Takeaways

*   Pareto analysis can be used to pinpoint the factors that are having an outsize impact on an organization, for better or worse.
*   As a decision-making technique, Pareto analysis helps clarify the actions that could have the greatest positive impact.
*   Each problem or benefit is given a numerical score based on the level of impact on the company; the higher the score, the greater its impact.

## Understanding Pareto Analysis

Pareto analysis is mainly used for business decision-making in business, but it has applications in other areas from [welfare economics](https://www.investopedia.com/terms/w/welfare_economics.asp) to quality control.

A Pareto analysis is most effective when each variable being tracked is graphically depicted. This depiction is called a Pareto chart.

Pareto analysis gets its name from Italian economist Vilfredo Pareto, who discovered in 1906 that 80% of the land in Italy was owned by just 20% of its people. He extended his research and determined that this disproportionate [wealth](https://www.investopedia.com/terms/w/wealth.asp) distribution existed throughout Europe.

The [80-20 rule](https://www.investopedia.com/terms/1/80-20-rule.asp) was originally defined as follows: The top 20% of a country’s population accounts for an estimated 80% of [the country’s wealth or total income](https://www.investopedia.com/terms/p/per-capita-gdp.asp).

Joseph Juran, a Romanian-American business theorist, discovered Pareto’s research in 1937, about 40 years after it was published. Juran proceeded to rename the 80-20 rule as “[Pareto’s Principle of Unequal Distribution](https://www.investopedia.com/terms/p/paretoprinciple.asp).”

Juran extended Pareto’s principle to the business world to understand whether the rule could be applied to problems faced by businesses.

Juran observed that most production defects were the result of a small number of defects. So, by extension, 80% of the problems are caused by 20% of the defects; Juran’s work implies that if you focus on fixing that 20%, you can have a big impact with minimal effort.

> **Important**
>
> Pareto analysis saves the most scarce resource, which is time. It allows problems to be addressed more efficiently.

Modern-day applications of Pareto analysis are used to determine which issues cause the most problems in an organization. Typically, Pareto analysis is employed by [business managers](https://www.investopedia.com/articles/02/062602.asp), whose approach may involve conducting a statistical analysis, such as a cause-and-effect analysis, to produce a list of potential problems and their outcomes.

A Pareto analysis might include:

*   Analyzing data to identify errors or defects.
*   Sharing information about errors or defects with high-priority stakeholders.
*   Prioritizing fixes that address the most consequential errors or defects.  
    

> **Fast Fact**
>
> Joseph Juran, a Romanian-American engineer and management consultant, coined the terms “vital few,” “useful many,” and “trivial many” to categorize the contributions to a project.

## Steps of Pareto Analysis

By applying the 80-20 rule, problems can be sorted based on whether they affect profits, customer complaints, technical issues, product defects, or delays and backlogs from missed deadlines.

Each of these issues is given a rating based on the amount of revenue or sales and time lost, or the number of complaints received.

Here is a basic breakdown of the steps of Pareto analysis:

1.  Identify the problem or problems.
2.  List or identify the cause of the issues or problems, noting that there could be multiple causes.
3.  Score the problems by assigning a number to each one that prioritizes the problem based on the level of negative impact on the company.
4.  Organize the problems into groups, such as [customer service](https://www.investopedia.com/terms/c/customer-service.asp) or system issues.
5.  Develop and implement an action plan, focusing on the higher-scored problems first, and solve the problems.

Not all problems will have a high score, and some smaller problems may not be worth pursuing immediately. By allocating resources to high-impact issues or higher scores, companies can solve problems more efficiently, targeting the issues that have a major impact on profits, sales, or customers.

## How to Create a Pareto Chart

A common part of Pareto analysis is to graphically depict the occurrence of each variable being tracked. This is a Pareto chart, and it organizes and displays information to show the relative importance of various problems or causes of problems.

It is similar to a vertical bar graph in that it puts items in order (from highest to lowest) relative to some measurable effect of interest: frequency, cost, or time. Here is the process of making a Pareto chart.

1.  Develop a list of problems to be compared.
2.  Develop a standard measure for comparing the items—for example, how often it occurs: frequency (e.g., utilization, complications, errors); how long it takes (time); and how many resources it uses (cost).
3.  Choose a time frame for collecting the data.
4.  For each item, tally how often it occurred (or cost or total time). Then, add these amounts to determine the total for all items.
5.  Find the percent of each item in the total by taking the sum of the item, dividing it by the total, and multiplying by 100.
6.  List the items being compared in decreasing order of the measure of comparison; e.g., the most frequent to the least frequent. The cumulative percent for an item is the sum of that item’s percent of the total and that of all the other items that come before it in the ordering by rank.
7.  List the items on the horizontal axis of a graph from highest to lowest. Label the left vertical axis with the numbers (frequency, time, or cost).
8.  Label the right vertical axis with the cumulative percentages (the cumulative total should equal 100%).
10.  Draw in the bars for each item.
11.  Draw a line graph of the cumulative percentages. The first point on the line graph should line up with the top of the first bar.

The final step is analysis. You can analyze a Pareto chart by identifying those items that appear to account for most of the difficulty. In the example below, the Institute for Healthcare Improvement identified three vital types of errors discovered during surgical setup.  

![Pareto Example](https://www.investopedia.com/thmb/bU6Fjx4mNtyPubFzk306fFDGnNM=/1042x0/filters:no_upscale():max_bytes(150000):strip_icc()/ParetoExample2-e075b949a3af4751a329954498103d1b.JPG)

*Pareto Chart Example.*

## Advantages and Disadvantages of Pareto Analysis

### Advantages

The advantage of Pareto analysis is that it helps to identify and determine the root causes of defects or problems.

This should save time in addressing the defects and problems. In business, the most important resource is time.

With this technique, businesses can resolve defects or errors with the highest priority first, getting the maximum gain with the minimum effort.

Pareto charts can help determine the cumulative impact of a problem. Cumulative impact is the result of problems festering over time.

Pareto charts can sharpen problem-solving and decision-making. Problems are distilled into issues to be addressed.

### Disadvantages

The main disadvantage of Pareto analysis is that it does not provide solutions to issues. It only identifies the causes of problems.

It also uses past data. There’s no guarantee that it will be relevant in future scenarios.

A final disadvantage of Pareto charts is that they can only show qualitative data, not quantitative data. For example, Pareto charts cannot be used to calculate the mean, the standard deviation, or the average of the data, their variability, or changes in the measured attributes over time.

Advantages of Pareto Analysis

*   Helps to determine the root causes of defects or problems.
    
*   Identifies issues that can be addressed with the greatest impact.
    
*   Determines the cumulative impact of a problem.
    
*   Focuses attention on the most substantive actions to be taken.
    

Disadvantages of Pareto Analysis

*   Identifies problems, not solutions.
    
*   Focuses on past data.
    
*   Reveals only qualitative data that can be observed, not quantitative data.
    

## Example of Pareto Analysis

The Department of Ecology for the state of Washington performed a study to identify why oil spills happen. It gathered information on 209 oil spill incidents, including an internal peer review of the causes, and factored in input from responsible parties.

In total, the Department of Ecology identified dozens of causes for oil spills. It identified the primary causes as:

*   Inattention/distraction (38 times cited)
*   Procedural error (31)
*   Judgment (26)
*   Mechanical failure (23)
*   Structural failure (20)
*   Unknown causes (11)

The total number of explanations above (six) represents a little bit more than 20% of the total causes identified (29 total causal factors). However, these six causes cumulatively were responsible for 71% (149 of 209 cases) of the oil spills identified.

In this example of Pareto analysis, only a few data items are primarily responsible for most causes of oil spills.

![Pareto Example](https://www.investopedia.com/thmb/i-1Y8EeGa9OXFqtg2yVPRF8AvgQ=/1238x0/filters:no_upscale():max_bytes(150000):strip_icc()/ParetoExample-adaa218246474f08b52e509b49e9c3b6.JPG)

*Pareto Analysis (Washington State Department of Ecology, Oil Spills).*

## What Is Pareto Analysis Used for?

Pareto analysis is used to identify the root causes of problems or strengths in an organization, and their relative impact on the whole. It identifies the material issues worth resolving or the successful aspects worth preserving.

## How Is a Pareto Chart Different From a Standard Vertical Bar Graph?

A vertical bar graph visually displays data using bars rising from the bottom. The lengths of the bars are proportional to the quantities they represent. Vertical bar graphs are typically used when one axis cannot have a numerical scale.

A Pareto chart contains both bars and a line graph. Individual values are represented in descending order by bars, and the cumulative total is represented by the line. The bars are positioned in order of decreasing height, with the tallest bar on the left.

## What Is Pareto Efficiency?

[Pareto efficiency](https://www.investopedia.com/terms/p/pareto-efficiency.asp) is an optimal condition in which resources cannot be reallocated to provide more advantages for one individual without making at least one other individual worse off. Pareto efficiency implies that resources are [allocated](https://www.investopedia.com/terms/a/allocationalefficiency.asp) in the most [economically efficient](https://www.investopedia.com/terms/e/economic_efficiency.asp) manner. However, this state does not guarantee equality or fairness.

## The Bottom Line

When there are too many options to choose from or it is difficult to decide what is most important, a Pareto analysis can be a good next step. It attempts to identify the most crucial and impactful steps to take.

By leveraging Pareto analysis, a company can more efficiently and effectively approach its decision-making process.

> **Article Sources**
>
> 1.  Vilfredo Pareto, via Google Books. “[Cours d’Économie Politique: Nouvelle édition par G.-H. Bousquet et G. Busino](https://www.google.com/books/edition/Cours_d_%C3%A9conomie_politique/8VEZzwEACAAJ?hl=en)_.”_ Librairie Droz, 1964. 
>     
> 2.  National Center for Biotechnology Information. “[Joseph Juran: Overcoming Resistance to Organisational Change](https://www.ncbi.nlm.nih.gov/pmc/articles/PMC2565827/).”
>     
> 3.  Institute for Healthcare Improvement, via Upstate Medical University, University Hospital Nursing. “[QI Essentials Toolkit: Pareto Chart](https://www.upstate.edu/nursing/documents/qi_tool_paretochart.pdf).”
>     
> 4.  Washington State Department of Ecology, via Internet Archive Wayback Machine. “[Why Spills Happen](https://web.archive.org/web/20200929115017/https://ecology.wa.gov/Spills-Cleanup/Spills/Oil-spill-prevention/Why-spills-happen).”