In statistics, Pareto charts are used to highlight the biggest factors in a data set, and help you to isolate the most common problems or issues. The idea behind a Pareto chart is that the few most significant defects make up most of the overall problem. By addressing these defects, you can create a more effective and efficient system.
In this article, we will show you how to create a Pareto chart, and also touch on specific use cases for Pareto charts.
A Pareto chart or sorted histogram chart is a statistical representation that contains a bar chart and a line graph. The bars are arranged in descending order and represent a specific defect or problem while the line graph accounts for the cumulative sum of the variables or defects.
It gets its name from the Pareto principle formulated by Italian economist, Vilfredo Pareto. The Pareto principle is the origin of the 80:20 rule which roughly translates to 20% of your input accounting for 80% of your outcome. We will delve into this in detail as the article proceeds.
With a Pareto chart, you can calculate descriptive statistics using a set of variables. In addition, it is often used as a cost analysis tool that helps organizations to determine the feasibility of a business idea.
The primary idea behind a Pareto chart is that a handful of significant defects are responsible for the overall problem in a specific context. So, the purpose of this chart is to highlight these causal factors so that the researcher or organization can resolve them and improve output.
To better understand how a Pareto chart works, let’s get familiar with the Pareto principle formulated by Vilfredo Pareto.
The Pareto Principle attempts to explain the imbalanced causal relationship between variables in different contexts. It states that for many outcomes, 80% of consequences come from 20% of all causes or inputs. This is why it is known as the 80/20 rule.
Initially used to explain the lopsided land ownership in ancient Italy and wealth distribution, the Pareto principle now applies to several scenarios including HR, education, and marketing. For instance, it suggests that you only need 20% of strategic efforts/inputs to achieve 80% of your goals. Other similar assertions that follow the Pareto Principle include:
Of course, these are simply assertions that are not backed by proof or scientific formula. In itself, the Pareto Principle is more of an observation than a full-fledged scientific theory, which means it doesn’t apply to every scenario.
Human resources managers can use the Pareto Principle to develop more strategic workplace policies and create a more efficient workplace. You can leverage this rule to improve growth, employee engagement, and communication in your organization.
In the workplace, the Pareto principle means that 80% of the responsibility and work are shouldered by only 20% of your employees. On the other hand, it also means that a small number of employees are responsible for 80% of the challenges and drawbacks you will face as an organization.
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Here’s how you can apply the 80/20 rule to your employees:
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Teachers can apply the Pareto Principle to improve classroom engagement and the overall behavior of students. Based on this rule, we can deduce that 20% of what teachers do in the classroom accounts for 80% of student performance. This means that teachers should focus on a handful of important goals to help them achieve maximum output and have a substantial impact on their students.
Here’s how you can leverage the Pareto Principle for classroom engagements:
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In marketing, the Pareto Principle suggests that 80% of your sale would come from 20% of your customers. As a marketer, your role is to identify the subset that makes up this “20%” and invest in your relationship with them. Alternatively, you could say that 20% of what you do represents 80% of that particular activity’s outcome.
Here’s how you can apply this rule to your marketing and sales activities:
In some way, a histogram and Pareto Chart are quite similar. They are both statistical representations that account for the frequency of occurrences. However, they have fundamental differences, and we’ll discuss them in this section of the article.
A histogram is a type of bar chart that uses the height of the bar to convey the frequency of an event occurring. On the other hand, a Pareto Chart combines bar charts and line graphs to account for the order of impact of an event.
In a Pareto Chart, the bars are arranged in descending order, so that the variable with the highest impact appears first. Also, the bars are not joined together, as is obtainable in a histogram.
On the flip side, all the bar graphs in a histogram are conjoined. Also, they are placed sporadically to show the frequency of different variables.
A Pareto Chart uses a line graph to represent the cumulative percentage of the visual representations. This means the line graph always rises from left to right as the bar graph falls from left to right. There’s no line graph in a Histogram.
Building a Pareto Chart from scratch may appear complex, especially if this is your first time. To make it easy for you, we’ve curated five (5) simple steps for creating and reading Pareto Charts. Let’s get into them.
Step 1: Discover the Causes
First, outline the causal factors you want to represent on the chart. These causal factors could be positive or negative depending on the context of an event. For example, in marketing, positive causal factors could be revenue-generation, churn rate, or other customer lifetime value metrics
Step 2: Create a Frequency Table
Create a frequency table to account for the occurrence of different variables at different points in time. Your frequency table can have a cumulative frequency column.
Step 3: Convert the Numbers to Percentages
Convert the variables to percentages. This is because percentages are intuitively easier to understand than regular numbers.
Step 4: Arrange All the Numbers in Descending Order
Arrange the variables in descending order; that is, from the highest variable to the lowest.
Step 5: Plot the Line Graph and Bar Chart
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.
When interpreting a Pareto Chart, the most important things you should focus on are the individual values and cumulative values.
The bar charts show the individual values of the different variables. Each bar is plotted on the X-axis and in descending order. These bars represent the most important factors and give the user a chance to understand their individual values.
Next, you should read the line graph for cumulative values. Typically, the line graph crosses each bar at the top. From the several touchpoints, the researcher can separate the primary causal variables from the rest of the data represented on the chart.
Pareto charts have several applications in marketing, education, and human resources management. For example, organizations can use this chart to reconcile the company’s revenue growth with specific time periods. They also come in handy when you want to analyze large volumes of data in an organization.
Let’s consider how Pareto charts work in some real-life scenarios.
1. Population Control
Countries can use Pareto charts to analyze population growth over a period. It can help with the identification of cities with the highest population acceleration ratio, plus their impact on the overall data.
2. Data Analysis
When analyzing data about the causal factors of a problem, you can use Pareto charts to plot out the frequency of each variable, and identify any significant variables.
3. Project Management
Pareto charts are an important tool in project management, especially Six Sigma. Project managers depend on these charts for quality management, and to figure out the most significant problem in a process.
Other common use cases for Pareto charts include:
4. When there are many problems or causes and you want to focus on the most significant
5. When you’re analyzing broad causes and their specific components
6. Quality assurance teams use Pareto charts to discover the most significant defects that have a far-reaching impact on output.
Pareto charts play an active role in different fields and spheres of knowledge. Its influence comes from the several benefits associated with interpreting your data using these charts. Let’s get through a few advantages of Pareto charts.
Should you use a Pareto chart in all statistical presentations? No. The following are a few limitations of Pareto analysis:
When you have a good understanding of the Pareto chart and how it works, you can leverage its principle to improve your workforce, optimize your marketing campaign, and improve teaching and learning. In-depth knowledge of Pareto charts means you can identify the root causes of major challenges in your organization and resolve them strategically.
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