Wednesday, April 1, 2015

A Second Look at the Pareto Principle

Vilfredo Pareto (1848 – 1923) was an Italian civil engineer who became more famous as an economist, political scientist and philosopher. He gave the world what we call the 'Pareto Principle'. At the University of Lausanne, Switzerland he published his first paper "Cours d'économie politique" in 1896. Studying income distribution of people, he found that 80% of the land in Italy was owned by 20% of the population. This was an important contribution, whose scope was not limited to economics alone, but spanned several areas.

The quality guru Joseph Juran popularized the Pareto Principle. In reliability engineering it is now known that 80% of the problems or pains come from 20% of the 'bad actors'. In problem solving, esp. with Lean Six Sigma projects, we have been preaching the mantra of Pareto for decades saying that the root cause(s) of the problem is (are) few, and usually can be found within 20% of the input factors that contribute to 80% of the effects [not strictly true, though]. So rather than trying to find a needle in a haystack a smart problem solver should rather focus on a limited area. In the business world, similarly, a common rule of thumb says that "80% of your sales come from 20% of your clients." 

Pareto Principle is often called the ‘80/20 Rule’. You can apply the 80/20 Rule to almost anything, from the science of management to the physical world. Project Managers know that 20 % of the work (the first 10% and the last 10%) consume 80 % of your time and resources. You probably can find out that 20 % of your stock is taking up 80 % of your warehouse space and that 80 % of your stock comes from 20 % of your suppliers. If you are a site manager, 20% of your staff will cause 80 % of your problems, but another 20 % of your staff will provide 80 % of your production. Similarly, don’t be surprised to know that 80 % of your sales revenue is probably coming from 20 % of your sales staff. Don’t be surprised either to find out that 60% of customer complaint comes from 20% of your customers.

It is not difficult to understand why those smart sales guys are interested in hooking up or earning the loyalty of their customers by providing preferential services - platinum or gold service as against bronze service – to their target clients. One would call such a customer service a highly discriminatory practice due to the fact that not all the customers are treated equally. The sad reality is you can see such discriminatory treatments in most service sectors today, even with the airlines industry.

Last Monday I was on a flight to Detroit from Philadelphia. I took a flight with Delta Airlines. Like all other airlines these days, Delta has a frequent flyer program. I don't fly Delta as often as I do using US Airways. Naturally, I was put in Zone 2 for boarding the plane. Those with the chairman's/platinum or better status than me - with hundreds of thousands of flown miles - were preferred over me in boarding the flight earlier. Because of the limited overhead luggage space available by the time I boarded the plane, I had to put one of the small carry-on bags underneath the passenger’s seat in front of me. It was an inconvenient flight with limited space for my feet to rest, but quite normal experience these days for most passengers who make up roughly 80% of the ‘discriminated’ bunch who are not in the preferred boarding categories, including Zone 1.

As can be seen, the Pareto Principle is responsible for popularizing the use of the term "elite" in social analysis. It was a Darwinian type finding – survival of the fittest. Society has never been a "social pyramid" with the proportion of rich to poor sloping gently – almost in a linear way - from one class to the next. “Instead it was more of a ‘social arrow’ – very fat on the bottom where the mass of men live,” notes mathematician Prof. Benoit Mandelbrot (known for his work with the fractals), “and very thin at the top where sit the wealthy elite. Nor was this effect by chance; the data did not remotely fit a bell curve, as one would expect if wealth were distributed randomly.”

Pareto’s work showed that in our society, a very small number of powerful elites – elite of the elite class - sit at the top of this ‘social pyramid’ who control almost everything – the lion share - while a vast majority – starving and unfed – stays in the bottom layer. Elites survive and help each other while others suffer. Thus, what was once 80% may actually become 99% later. Consider, for instance, the matter of wealth in our time. During the World Economic Forum in Davos, held in January, among some of the world's most influential political and business leaders, it was announced that the wealth of the 80 richest people in the world now equals that of the 3.5 billion people -- the poorest half of the world's population. The Oxfam report observed that while the wealth of the world’s 80 richest people doubled between 2009 and 2014, the wealth of the poorest half of the world’s population (3.5 billion people) was lower in 2014 than it was in 2009. In 2010, it took 388 billionaires to match the wealth of the bottom half of the earth’s population; by 2013, the figure had fallen to just 92 billionaires. It fell to 80 in 2014.

Oxfam also estimated that by next year, the wealth accumulated by the richest one percent of the world's population would exceed that of the other 99 percent.

Are you surprised, where we are heading? I am not. Whether we like to admit or not: the harsh fact is - growing inequality between the rich and the poor has been fueled by the capitalist system and a society that values material wealth above everything else. We have become a consumer society who does not mind buying things we don't need, with money we don't have to impress the people we don't like. At this rate, we are doomed to generate twice the waste by 2025 that we generate today. Global poverty has been spurred on by the inefficient and inequitable distribution of opportunities in this current system.

As is well known among social scientists, Pareto’s work drew the attention of Benito Mussolini (1883-1945) who in his first years of power (1922-1945) destroyed political liberalism, and gradually gave the Italian state its fascist, totalitarian character. With the ever widening of the wealth gap, are we witnessing the underpinning of a resurgent fascism in our time?

Unless our generation finds a better system that guarantees an equitable distribution of opportunities, which is at the heart of wealth gap, I am afraid we shall witness what was once 80% in Pareto’s time to grow to 99% and higher.

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