Pareto’s law, sometimes known as Pareto’s principle, was originally applied to economics by Vilfredo Pareto, an Italian economist who lived in the 19th century. Also known as the 80/20 rule, as it is used today, it states that 80% of results stem from 20% of causative influences. As applied to business and economics, it implies that a majority of profits come from a small minority of customers. Pareto also held that this idea could be applied to other situations as well.
Application of this principle affects the way many modern companies do business. A fundamental result of following Pareto’s law is that the best customers get the most attention and best service and that the remainder are relatively unimportant. Of course, the principle does not dictate that these less valuable customers be ignored but simply that they receive a minimum of attention compared to the most important customers.
While the popular usage of the principle has become known as the 80/20 rule, the original law was expressed as a mathematical equation that Pareto developed to describe the way control of wealth is distributed. He postulated that this equation, log N = log A + m log x could be applied to any economic system to show the relative distribution of wealth. The variables N and x represent those with more wealth and influence and those with lesser wealth and influence, respectively. A and m are constants that depend on the particular system. Numerous studies of his work and applications of his equation have proven that it is historically very accurate.
Over time, in an effort to find a simpler way to describe Pareto’s law, economists began to refer to it as the 80/20 principle as this was the ratio that seemed to bear out his postulation. Of course, the 80/20 distribution was not necessarily a definitive value for the ratio but rather a generalization to illustrate his point.
Today, Pareto’s law is applied as a general principle in many ways that deviate from his original theory about the distribution of wealth. The general principle of small groups producing large results in economics has broadened to the belief that the 80/20 principle of proportional distribution has examples in almost any system, including socioeconomic, ecological, and other scientific settings. For example, many studies have shown that a majority of crimes are committed by a small group of criminals. In software and computer systems, a small number of bugs cause most of the crashes and other problems. When analyzing crop losses, it is normal for a few pests out of many to be the cause of most of the damage.