Sunday, September 25, 2022
No menu items!

How to apply the Pareto principle for professional cost-benefit analysis

Must Read

Introduction

Pareto analysis is a statistical technique used in decision making to identify a limited set of tasks to achieve the most significant effect. We are based on the Pareto principle, which says that 20% of the work on a project accounts for 80% of the outputs.

This technique is also known as the 80/20 rule, the rarity factor principle, and the rule of the essential few and the trivial many.

In project management, cost-benefit analysis is used to evaluate costs and benefits in the project proposal and business case. It starts with a list, as many processes do.

The costs of the project and what the expected benefits will be after the successful implementation of the project. From this you can calculate cost benefit ratio (CBR), return on investment (ROI), internal rate of return (IRR), net present value (NPV) and payback period (PBP).

What is the Pareto principle?

In the 1940s, Armenian-American management consultant Joseph Juran developed the Pareto Principle. Juran named the principle after the Italian economist Vilfredo Pareto, who documented in 1906 that 80% of income goes to 20% of the population. He first noticed it in Italy, but later made surveys in other countries and observed the same distribution.

We can use the 80/20 rule in almost every situation:

  • 20% of system defects cause 80% of usage problems;
  • 20% of the sales force provides 80% of the sales;
  • 20% of products generate 80% of complaints;
  • 20% of the product portfolio accounts for 80% of the profit.

After looking at Pareto and Juran’s work, the UK’s NHS Institute for Innovation and Improvement observed the Pareto distribution in the following scenarios:

  • 20% of employees come up with 80% of innovations;
  • 20 efforts give 80% personal success;
  • 20% of provided services account for 80% of customer complaints;
  • 20% of the time in meetings is 80% of the decisions made.

The Pareto principle is widely used in quality management because it is the basis of the Pareto diagram, which is a critical tool in quality management and Six Sigma. The value benefit analysis provided by the Pareto principle is that it reminds project managers to focus on the 20% of things that matter, the 20% that matter. Only then should they focus on the remaining 80%.

We must remember that the 80/20 rule is mostly a rule of thumb and should not be taken as something exact. Roughly, this is presented by the performance distribution (Pareto distribution) for a set of parameters. In fact, many phenomena show such a distribution.

Pareto analysis

Pareto analysis is useful where there are many possible ways to compete for attention. The benefit of each activity is estimated and based on this we select a few of the most beneficial steps to achieve the maximum possible result.

Using a Pareto analysis, we can identify the root causes that need to be addressed to solve most problems. Then we need to use other tools to identify the root causes of these problems.

The problem with the Pareto technique is that we can limit the analysis by excluding possible significant problems that may be small at first but grow over time.

Steps of Pareto analysis

We would typically use the following approach to perform a Pareto analysis:

  1. Identify the problems;
  2. Identify the causes of these problems;
  3. Rank problems according to the degree of negative impact on society;
  4. Arrange them into groups;
  5. Create and implement action steps to solve problems, starting with those with higher scores first.

After the above steps, we notice that not all problems get high scores and some are not worth solving at first. By focusing on high-impact issues, a company can allocate the right resources to address issues that have the greatest negative impact on profits, growth, sales, customer satisfaction, and more.

Pareto analysis proves that we can achieve greater improvement by focusing on solutions with the most substantial impact. It is important to realize that technology does not give answers to problems, but only shows what are the root causes of most of society’s problems. The underlying assumption is that not all inputs have an equal or proportional impact on output.

Multilevel Pareto analysis

Pareto analysis helps us identify significant issues that a company needs to focus on in order to get the most benefits. What we can do then is take it a step further. By looking at the reasons for a particular problem, we can perform a second-level Pareto analysis of those reasons within a single problem and better understand where to focus the company’s resources.

Weighted variables in Pareto analysis

It is common to assign issue weights to highlight issues that management believes have a more significant impact on performance. We use weights to normalize the contribution of causes. We will then base a Pareto analysis and our Pareto chart on the weighted contributions.

Pareto chart

The principle of the Pareto chart is a type of chart representing individual values ​​in descending order as bars and the cumulative total as a line chart. We display the frequency of occurrence along the left vertical axis, and the right axis is the cumulative percentage of total occurrences.

We display the values ​​in descending order, so the cumulative line follows a concave function. The Pareto chart aims to highlight the most critical factors

from a usually large set of factors.

A diagram of the Pareto principle serves as a visual representation of the vital few versus the trivial many.

How to do a cost-benefit analysis

According to The Economist, the CBA has been around for a long time. In 1772, Benjamin Franklin wrote about its use. But the concept of CBA as we know it comes from Jules Dupuit, a French engineer who outlined the process in an 1848 paper.

Since then, the CBA process has evolved considerably. Let’s go through this checklist to see how to do a cost-benefit analysis:

  • What are the goals and objectives of the project?

Create a business case for your project and outline its goals and objectives.

  • What are the alternatives?

Before you know if a project is right, you need to compare it to similar past projects to see which path is best. You can quickly review their success metrics such as ROI, Internal Rate of Return, Payback Period, and Benefit-Cost Ratio.

  • Who are the stakeholders?

List all stakeholders in the project. They are the ones affected by the costs and benefits. Describe who makes the decisions.

  • How will you measure costs and benefits?

You must decide on the metrics you will use to measure all costs and benefits. Some of these will have a dollar value, while others will need other metrics. Also, how will you report on these metrics?

This process can be greatly improved with project management software. Project Manager has one-click reporting that allows you to create eight different project reports. Get data on project status, variance and more. Reports can be easy

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Latest News

Nicotine Gum Vs. Pouch

To make an informed decision about whether nicotine gum or a nicotine pouch is suitable for you, it is...

More Articles Like This