The Pareto Principle

Written by

Sergio Caredda

Posted on

October 1, 2024

Edited on

October 1, 2024

Application of the Pareto Principle to Organisation Design

The Pareto Principle can be a powerful tool for designing more effective organisations by helping to identify key drivers of success and focusing resources on the most impactful areas. Here’s how it can be applied:

1. Focusing on Key Activities and Processes

In most organisations, a small number of activities or processes drive the majority of value creation or outcomes. By applying the Pareto Principle, organisations can identify these critical activities and ensure that they receive the majority of resources, attention, and improvement efforts. This aligns organisational design to prioritise high-impact activities and reduce or optimize less critical processes.

Example: In a manufacturing company, it might be discovered that 20% of production lines account for 80% of defects. Applying the 80/20 rule, the organization would focus its improvement efforts on those lines, significantly reducing defects without spreading resources too thin across all production processes.

2. Prioritising Customer Segments or Product Lines

Often, a small proportion of customers (typically the top 20%) contribute to the majority (80%) of sales or profits. In organisational design, this insight can help structure sales, marketing, and customer support teams to better serve these high-value segments. Similarly, a small number of product lines may drive most of the company’s profits, and efforts can be concentrated on these key products.

Example: A retail company might discover that 20% of its customers generate 80% of its revenue. As a result, it could design its customer service department, loyalty programs, and marketing efforts around these top customers to maximise profitability and customer satisfaction.

3. Talent Management and Team Structure

In many organisations, a minority of employees drive a majority of performance and results. Recognising this, organisations can apply the Pareto Principle to focus on identifying, developing, and retaining these high-performing individuals. This could influence the design of teams, leadership development programs, and incentive structures.

Example: A software development company might find that 20% of its engineers are responsible for 80% of the code or the most innovative contributions. Recognising this, the company can design mentoring programs, performance incentives, and career development opportunities to ensure these high-impact individuals are nurtured and retained.

4. Simplifying Organisational Structure

In complex organisations, the Pareto Principle can guide simplification efforts by helping to identify the key functions, processes, or units that are essential to success. By focusing on the most impactful areas, an organisation can streamline its structure, reduce unnecessary bureaucracy, and allocate resources more effectively.

Example: A large corporation undergoing restructuring may find that a small number of business units (e.g., 20%) are responsible for most of its revenue and growth. The organisation can then redesign its structure to prioritise those units, consolidate or eliminate underperforming units, and simplify management layers to increase agility.

5. Project and Initiative Prioritisation:

When managing a portfolio of projects or initiatives, organisations can use the Pareto Principle to identify which projects deliver the most significant value relative to the effort invested. This can help in prioritising resources, focusing on high-impact initiatives, and avoiding the trap of spreading efforts too thinly across many low-impact projects.

Example: A non-profit organisation working on multiple programs might realise that 20% of its initiatives account for 80% of its social impact. By reallocating resources to these key programs and potentially dropping or scaling back less impactful initiatives, the non-profit can amplify its overall effectiveness.

6. Decision-Making and Governance:

The Pareto Principle can help improve decision-making processes by identifying the critical decisions that have the most impact on the organisation’s performance. This allows organisations to structure decision-making hierarchies and governance models to ensure that high-impact decisions receive the most attention and are made by the right people.

Example: A company might discover that a small number of strategic decisions, such as product pricing, market entry, or key partnerships, drive most of its business outcomes. The organisation can design its decision-making process to ensure that these key decisions are made quickly, by senior leaders, and based on comprehensive analysis.

Challenges in Applying the Pareto Principle

While the Pareto Principle provides a useful lens for prioritisation and focus, there are several challenges in its application:

1. Identifying the Correct 20%

It can be challenging to accurately identify the 20% of causes, activities, or individuals that are driving the majority of results. This requires good data analysis, a deep understanding of the organisation, and sometimes, trial and error. Also, we should not get fixated on the percentage: the 20/80 rule is clearly a “rule of thumb” that identifies a proportion, not a mathematical rule.

2. Risk of Oversimplification

Over-reliance on the Pareto Principle can lead to the neglect of the “other 80%” that, while individually less impactful, may collectively play a crucial role in the organisation’s success. It’s essential to find a balance and recognise that less critical elements still contribute to overall functioning. Juran himself refused in the last part of his research the wording of “trivial many” to use the “useful many”, exactly to support the risk of oversimplifying.

3. Dynamic Environments

The key drivers of an organisation’s success can change over time as markets, technologies, and internal factors evolve. The 20% that drives the 80% of results today may not be the same in the future. Regularly revisiting and reassessing which activities, customers, or teams are most impactful is crucial.

4. Long Tail Effect

The Pareto Principles has often been used to “cut the tail” on a number of organisationally relevant phenomena to establish priorities especially around investments. New technologies have however reverted one principle that is often associated to Pareto’s Principle, with is that of incremental costs. Serving 100 markets is more expensive than serving only the top 20, especially if these deliver 80% of the results. For Amazon, though, providing its platform also to an immense queue of niche products, is adding costs only at a fraction of the initial investments. Yet, Amazon has grasped the value of having a “Long tail” of products becoming the go to market for basically anything in many markets.

Balancing Pareto’s Principle and Long Tail Effects

The concept of the Long Tail was popularised by Chris Anderson in his 2004 article in Wired magazine, and later in his book The Long Tail: Why the Future of Business is Selling Less of More (2006). The Long Tail describes a phenomenon where a large number of niche products or services, when aggregated, can collectively make up a market share comparable to or even larger than that of the “hits” or bestsellers.

In contrast to the Pareto Principle the Long Tail focuses on the “tail” of the distribution: the 80% of products, customers, or opportunities that individually contribute little but collectively represent a significant portion of the market.

Fig.2: Pareto Principle vs. Long Tail

Anderson noted that digitalisation, lower production costs, and unlimited shelf space in e-commerce allow for the sale of a much broader range of products than was possible in the traditional retail environment. This shift enables businesses to profit from a diverse range of niche products that previously would have been economically unviable to sell.

As OD professionals we need be consistently analysing the situation where Pareto Principle can apply, or where instead we should focus on the Long Tail concept.

Here are some key differences and implications in four main areas.

1. Strategy and Product Offering

Pareto Principle	Long Tail
- Focus on Vital Few Products - Focus on High spending customers - Focus on Key Markets	- Broad range of products through diversified product portfolio - Broad range of niche markets
Implications for Design	Implications for Design
- Product & Market Specialisation - Need for structures that deliver efficiencies	- Focus on Flexibility and Responsiveness - Need of structures that support experimentation, decentralised decision-making and customisation.

2. Customer Relationship and Marketing

Pareto Principle	Long Tail
- Focus on Key Accounts and Profitable Customers	- Focus on Personalisation and Segmentation - Marketing requires targeting and tailoring
Implications for Design	Implications for Design
- Focused teams dedicated to large accounts - Focus on seniority of roles and cross-sectional knowledge able to answer requirements of larger clients.	- Focus on Data and Analytics to increase offerings across customers. - Cross-functional teams, data driven decision making. - More scalable model.

3. Supply Chain and Inventory Management

Pareto Principle	Long Tail
- Inventory optimised to keep stock of bestsellers. - Reduction of inventory of low cost items.	- Focus on large number of low-volume items. - Focus on technology to enable just-in-time production, drop-shipping and digital delivery.
Implications for Design	Implications for Design
- Focus on cost optimisation, where possible also exploring centralisation models. - Focus on reducing per item cost	- Flexible and scalable Supply Chain organisation, focused on handling high variety of products. - Solutions like distributed warehousing might be explored - Ancillary costs need to be optimised.

4. Innovation and Product Development

Pareto Principle	Long Tail
- R&D and Product Development focused on large scale innovation projects or “marginal innovation” first. - Low appetite for cannibalisation risks.	- Need of a continuous pipeline of small innovation both of existing products and new ones.
Implications for Design	Implications for Design
- Support for strong investments in large scale R&D projects - Centralisation of R&D effort, not just in ideation but also in testing pre-release.	- Openness to decentralised and modular approaches to Product Development - Exploration of User-generated content and open innovation models.

5. Organisational Culture and Leadership

Pareto Principle	Long Tail
- Performance driven culture, focused on maximising returns.	- Focus on diversity, creativity, tailoring, risk-taking. - Support for bottom-up innovation.
Implications for Design	Implications for Design
- Traditional top-down models work well in this frameworks.	- Distributed leadership and autonomy based models are required to grasp the best results here.

How can the model coexist?

Can the two models coexist? Yes for sure. There are multiple examples of companies exploiting both a prioritisation model and a “long tail” effect. Apple is a good example: it focused on a limited range of products, tailored at high-end customers, and ruthlessly prunes its product lines of categories it deems dilutive of focus. At the same time, it created a number of platforms to exploit the Long Tail effects, starting from the iTunes Store, to the iOS App Store and so on.

With the arrival of new technologies, and specific market characteristics, we need to be very careful in adapting prioritisation models (such as Pareto) and Long Tail effects. What to choose often depends from the consistency and congruence considerations across multiple organisational elements, particularly around Business Model and Strategy.

An interesting aspect to notice is that way to rarely companies are able to apply the Pareto Principle consistently. Yes, you will probably find many companies deciding to focus on few products categories or customer segments. But do they apply the same “prioritisation” effort also on internal process efforts? An area where the Pareto Principle can be applied pretty well is internal bureaucracy. Yet bureaucrats are “magicians” in hiding some of the inefficiencies of their (improductive) long tails, behind curtains of compliance or simple bad process design.

The “Laws of Organisation Design” Collection. This article belongs to a series focused on the different principles and laws that govern organisational behaviours, decision-making and group work, and that should be taken into account in organisation design projects.

The Laws of Organisation Design

Law of Requisite Variety
Law of Alignment

Conclusion

The Pareto Principle can be a valuable tool in organisation design by guiding leaders to focus on the 20% of activities, resources, or customers that drive the majority of outcomes. Whether applied to prioritising key processes, aligning teams, or improving decision-making, the principle encourages organisations to concentrate their efforts where they will have the greatest impact. However, careful analysis is required to identify the correct high-impact areas, and care must be taken not to oversimplify or ignore the remaining elements that contribute to the organisation’s overall success. Particularly, in many organisations we need to account for the coexistence of Long Tail Effects, and we need to ensure we can balance well the effects and impacts on prioritisation efforts with finding growth opportunities exploiting scale effects that is today enabled by technology.