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Outlier’s Path

The Pareto Principle

Vilfredo Pareto was an Italian polymath who discovered the Pareto principle and helped develop microeconomics. He was the first to observe that Italian land ownership follows a Pareto distribution, also known as the power-law distribution, with 80% of the land belonging to 20% of the population. This Pareto principle was extended further to state that for many outcomes, roughly 80% of the consequences come from 20% of the causes, otherwise called the 80/20 rule. The principle suggests that a small number of inputs will contribute to the vast majority of outputs. If that’s the case, we can identify and prioritize the critical areas to focus. For example, if you look at customer service complaints, 80% of them are the result of a handful of issues. This heuristic has been broadly applied to many problems across various industries.

While heuristics are mental shortcuts that ease our cognitive load and serve as general approximations, they are not necessarily optimal. Therefore, before or after we apply heuristics (by thinking fast), remember to think slow. For example, check the following when applying the 80/20 rule:

  1. Pareto stated that his numbers were rough approximations. Depending on the problem, the numbers are not necessarily 80/20. The numbers in entrepreneurship and venture capital are closer to 90/10. In many areas of biology, the numbers are 70/30.
  2. The theory that 20 out of our 100 To Dos can result in 80% of the total impact is compelling, but we still don’t know a priori which 20 items they are. We still must think critically to determine which 20 have the most impact.
  3. Make sure we’ve applied the Pareto principle properly. A common misconception is that with 20% of the effort, we can achieve 80% of the result. The Pareto principle speaks to inputs and outputs, not effort. We still want to put 110% of our effort into the input areas we’ve determined will have the most impact.
  4. The Pareto principle would make us believe that we should look for and focus only on first-order issues at the expense of second-order problems. Generally, we can agree, but at logical extremes, this breaks. At times, the sum of all the second-order issues becomes a first-order issue.
  5. Finally, for the fans of the 80/20 rule, is 80% really good enough? It may be for a first approximation, but in a world of six-sigma (99.997% reliability), we may need to go far beyond 80% impact.

The Pareto principle is a valuable concept, and the 80/20 is an excellent heuristic. However, as with all heuristics, use it with caution and as a first approximation. Remember to think critically to achieve a more comprehensive understanding of the problem we are trying to solve.