Management Accounting-Decision Management: Grahame Steven Explains How the Identification of Vilfredo Pareto's "Predictable Imbalance" Can Help a Business to Improve Its Performance

By Steven, Grahame | Financial Management (UK), March 2009 | Go to article overview

Management Accounting-Decision Management: Grahame Steven Explains How the Identification of Vilfredo Pareto's "Predictable Imbalance" Can Help a Business to Improve Its Performance


Steven, Grahame, Financial Management (UK)


The Italian economist Vilfredo Pareto derived what has become known as Pareto's law from his studies of income distribution in a number of countries at the turn of the 20th century. He found that roughly 80 per cent of the wealth was held by 20 per cent of the people and that the number of people holding a particular level of wealth fell by a constant factor each time that level was doubled. While his findings were taken as proof by some people of the inequities of capitalism, Pareto predicted that his law of "predictable imbalance" would also apply to communist societies. Studies conducted in the Soviet Union during the Seventies confirmed the accuracy of his forecast.

The law, which identifies the "vital few and the trivial many", has been observed in a wide range of situations. For example, 80 per cent of a tutor's time is taken up by 20 per cent of the students; 80 per cent of interruptions come from 20 per cent of the class; and 80 per cent of decisions in meetings come from 20 per cent of the time.

One of the first uses of Pareto analysis in business was for the purposes of quality management. Joseph Juran, a pioneer of modern quality methods, observed that most quality problems arose from only a few causes. Pareto analysis enabled managers to focus on the problems whose resolution would bring the greatest benefit to the enterprise. For example, IBM found, after analysing computer processing time, that 80 per cent of processing time was concerned with executing 20 per cent of software operating code. As a result, its programmers rewrote the code to make the most frequently used parts of it as streamlined as possible.

Pareto analysis is also a valuable management accounting tool, because it can be applied to a company's customers, products, departments, branches, suppliers, employees and so on to obtain insights with a view to improving efficiency and effectiveness. Consider figure 1, which shows the sales income gained by a company called Customer Focus Ltd (CFL) from each of its 20 customers over the past year. The first step in a Pareto analysis is to sort the customers in descending order according to their sales values; the next step is to calculate cumulative sales; and the final step is to calculate cumulative sales percentages, as in figure 2. While this shows that 73.9 per cent of CFL's sales come from 20 per cent of its customers, its figures can be used to create a Pareto chart to give a more visual representation of the importance of the "vital few". The data can be entered into Microsoft Excel's graphing function to produce plots showing cumulative sales by value or percentage (see figure 3).

Like any management accounting technique, Pareto analysis must be used with care, since it provides only an insight into a particular business issue. Further consideration and analysis is required to determine what action should be taken. Although it is tempting to conclude from this analysis that CFL should stop supplying goods to most of its customers, such a course of action may prove short-sighted. More information is required to determine whether or not a withdrawal strategy is appropriate for these customers. What is the total business available at that company? Is the business expanding? Is CFL part of a larger group?

It wouldn't make sense for the company to stop doing business with large customers to which it currently makes few sales, small customers that are expected to expand their businesses or customers that are part of a larger group. The object of the exercise is to identify customers with poor current and future sales potential. Decisions, made after further analysis, would then be taken based on which customers CFL is prepared to do business with in the future.

[GRAPHIC OMITTED]

Multiple analyses of the same data--sales, contribution and profit--may also be undertaken to provide a more in-depth view of the issue under consideration. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Management Accounting-Decision Management: Grahame Steven Explains How the Identification of Vilfredo Pareto's "Predictable Imbalance" Can Help a Business to Improve Its Performance
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.