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1. INTRODUCTION AND HISTORY OF PARETO ANALYSIS
The Pareto effect is named after Vilfredo Pareto, a nineteenth century Italian economic stand
sociologist who lived from 1848 to 1923. Pareto analysis is based on the 80:20 rules that were a
phenomenon first observed by Vilfredo. He observed and noticed that 80 percent of the wealth of Milan
was owned by 20 percent of its citizens. This method steams in the first place from Pareto’s suggestion of
a curve of the distribution of wealth in the book of 1896.
Several years later, Joseph Juran applied the principle to quality control and the Pareto Analysis
was born. Whatever the source, the phrase of ‘the vital few and the trival ma ny’ deserve a place in every
manager’s thinking. It is itself one of the most vital concepts in modern management. The results of
thinking along Pareto lines are immense.
DEFINITION OF PARETO ANALYSIS
Pareto Analysis can be defined as:
 A formal technique useful where many possible courses of action are competing for attention.
 It is creative way of looking at causes of problems because it helps stimulate thinking and
organize thoughts. This technique helps to identify the top 20 percent of causes that needs to be
addressed to resolve the 80 percent of the problems.
 A method of analysis based on the concept that 20 percents of the variables included in an
analysis are responsible for 80 percent of the results.
 A statistical technique in decision making that is used for the selection of a limited number of
task that produces significant overall effect.

2. STEP TO USE PARETO ANALYSIS
IDENTIFY AND LIST ALL
THE PROBLEMS
IDENTIFY THE ROOT
CAUSE OF EACH
PROBLEM
GROUP PROBLEMS
TOGETHER BY ROOT
CAUSE
ADD UP THE SCORES
FOR EACH ROOT CAUSE
PLOT A GRAPH
TAKE ACTION
Example of case: To determine the causes for delay in project.
STEP 1: Identify and list all the problems
First, we must write down the problem that requires investigation. This can be done through
brainstorming, focus groups, surveys or any other method appropriate to the given business. For example,
the problem is to determine the cause for delay in the project. We must clear about the problem that we
want to address. Then, we need to identify all the possible causes that could be leading to the problem.
The possible causes can be machine breakdown, heavy rain, unskilled workers, stocks damages or legal
procedure.

3. STEP 2: Identify the root cause of each problem
After we identify and list all possible problems we need to identify the root cause of each
problem. In this case, the possible causes can be technical failures, environmental problems, workforce
problems, raw material problem or governmental approvals.
No Problem (step 1) Root cause (step 2) Total
1 Unskilled worker Workforce problems 15
2 Machine breakdown Technical failure 28
3 Weather Environmental problems 9
4 Absenteeism Workforce problems 18
5 Legal procedure Governmental problem 18
6 Supplier send wrong stock Raw material problems 16
7 Stock damages Raw material problems 7
Table 1: Step 1 and Step 2
STEP 3: Group problems together by root cause
Next, group problems together by it root cause. In this case, unskilled workers and absenteeism
are caused by workforce problem. Other than that, supplier send wrong stock and stock damages are
caused by raw material problem. So, put these in same group.
No Root cause (Step 3) Total
(Step 4)
Frequency
(%)
Cumulative
frequency (%)
1 Workforce problems 33 30 30
2 Technical failure 28 25 55
3 Raw material problem 23 21 76
4 Government approval 18 16 92
5 Environmental problem 9 8 100
Table 2: Step 3, Step 4 and Step 5

4. STEP 5: Plot a graph
We can start create a bar and line graph using the tabulate data as well as Table 2 above. The
chart can easily create by using application in Microsoft Office sets. The bar representing frequency while
the line representing cumulative percentage. Below is chart by using data in Table 2.
35
30
25
20
15
10
5
0
STEP 6: Take action
100.00
90.00
80.00
70.00
60.00
50.00
40.00
30.00
20.00
10.00
0.00
Frequency
Percentage
After we draw the chart, we need to draw the 80% cut off line first and find the intercept point in
order to know which area we need to focus on. From that, we can see that the left side area, which is
called “vital few’ and the right s ide “trivial many”. In applying Pareto, the vital few become area which is
we should focus more. We will get the biggest benefits by providing attention and fixing on workforce
problems, technical failure and raw material problem. Once this is done, it may be worth looking at
reducing delay in project. By carrying out a Pareto Analysis, we are able to focus on the right issue and
can work smart.

5. APPLICATION OF PARETO ANALYSIS IN MANAGEMENT ACCOUNTING
The Pareto Analysis is a very powerful tool problem solving technique. It is very simple to use
and very effective in finding solutions to problems. Even though the technique is mostly based on finding
the 20 percent fundamental causes that lead to 80 percent of the problems, it can still be effectively used
in solutions where the 80:20 rules does not apply clearly.
The main objective of this approach is to identify the principal causes and respond to them
immediately, so as to improve the overall output of a project or activity. The Pareto chart will illustrate
occurrence of problems in a descending order. It is used for making decision at significant points in
different process and it is used in the development process as well as when products are in use. The Pareto
Analysis is generally applicable to the following business situations:
a) Pricing of product
In the case of business dealing with multi-products, the possibility to analyze cost-profit-price
volume relationships for the entire product is very impossible. In practice, in case of
such business just about 20 percent of products may account for about 80 percent of total
sales revenue, Pareto Analysis is used for analyzing the business estimated sales revenues
from various products and it might indicate that approximately 80 percent of its total
sales revenue is earned from about 20 percent of its products. Such analysis will helps the
top management to impose the pricing decision for approximately 80 percent of its
product to the lower levels of management, thus freeing them to concentrate on the
pricing decisions for products approximately 20 percent which are essential for the
company’s survival.
b) Quality control
Pareto analysis also can be used to discover from an analysis of defect report or customer
complaints which “vital few” causes are accountable for most of the reported problems.
Often, 80 percent of reported problems can usually be traced to 20 percent of the various
principal causes. By concentrating once efforts on fixing the vital 20 percent, it can be
have the greatest immediate impact on product quality.

6. c) ABC Analysis- Stock Control
Moreover, Pareto analysis can be applied in stock control where it may be found that only
a few of the goods in stock make up most of the value. In practice, about 20 percent of
the total quantity of stock may account for about 80 percent of its value. The outcomes of
such analysis is where a business may well be able to control most of monetary
investment in stocks by concentrating on small proportion of stock item that jointly
accounts for 80 percent of the total value. Moreover, it can also help in grouping items by
annual sales volume and that are the most important ones to control for effective
inventory management.
d) Application in Activity Based Costing
In Activity Based Costing it is well said that 20n percent of an organization cost drivers
are responsible for 80 percent of the total cost. A better control and understanding of
overheads will be obtained by analyzing, monitoring and controlling those cost drivers
that cause most cost.
e) Customer profitability analysis
Instead of analyzing products, customers can be analyzed for their relative profitability to
the organization. Again in practice, it is often found that approximately 20 percent of
customers will generate 8- percent of the profit. There will always be some customers
who are less profitable than others. This Pareto analysis is useful tool for evaluation of
the portfolio of customer profile and decision making. We can decide whether to continue
serving a same customer group and what the extent of promotion costs to be incurred.

7. ADVANTAGES AND DISADVANTAGES OF PARETO ANALYSIS
Organizational Efficiency
A Pareto analysis requires that individuals list changes that are needed and then they are ranked in order
from the biggest to the least severe. The problems will be ranked based on their severity. Focusing on
problems causes and problem resolution contributes to organizational efficiency. Companies operate
efficiently when employees identify the root causes of problems and spend time resolving the biggest
problems to yield the greatest organizational benefit.
Enhanced Problem-Solving Skills
Problem-solving skills can be improved because it enables people to organize work-related problems into
cohesive facts. Once the problems had been outlined, the necessary planning to solve the problems can
begins. The analysis can be conduct in a group and it need the group consensus about the issues that
require change fosters organizational learning and increases group cohesiveness.
Improved Decision Making
The person can measure and compare the impact of changes that take place in an organization. With a
focus on resolving problems, the procedures and processes required to make the changes should be
documented during the analysis. This documentation will enable better preparation and improvements in
decision making for future changes.
Focus On The Past
The sole reliance on past information in Pareto analysis can be deceptive. Small-businesses owners may
find that the past data does not accurately represent the company's current situation. For instance, the data
may include past changes in the price of raw materials but may not accurately reflect how frequently and
in which direction those changes are likely to occur in the future. Thus, it may also fail to take into
account recent policy changes, economic conditions or government regulations, which can lead to faulty
decisions and inefficient allocation of resources.
Inaccurate Problem Scoring
A major step starts with scoring the severity of the problems faced by the small businesses. For instance,
if the small-business owner applies try to find a cost centers, he may choose to assign values to problems
based on how much they are costing the company. The cost centers are vital to how the business operates
and any attempts at cutting costs could do more harm than good. Small-business owners should examine
the quality and relationships within each problem, rather than using it for a strictly quantitative
conclusion.
Mistaken Applications
Some small-business owners may extend the usefulness of Pareto analysis beyond its intended
applications. For instance, a small-business owner may wish to apply the analysis to his clients to
determine which ones bring in the most revenue. However, the owner should also evaluate clients on a

8. qualitative basis, as well as evaluating their quantitative returns. A business owner who disregards
customers who don't deliver massive revenue dollars stands to lose those clients.
Inaccurate Scoring
The core facet of a successful Pareto analysis lies in the accuracy of the scoring of each issue. Small-business
owners who fail to assign the proper scoring to each factor on the chart will receive inaccurate
results. For example, say the company's shipping manager conducts a Pareto analysis on problems within
his department. He wants to see where the most problems occur within the shipping process. If the scores
reflect that the problem lies in the transportation section, when the real problems stem from packaging
and preparing items for shipping, the manager will focus on the wrong problem while the real issue
persists.
CONCLUSION
It is the discipline of organizing the data that is central to the success of using Pareto Analysis. Once
calculated and displayed graphically, it becomes a selling tool to the improvement team and management,
raising the question why the team is focusing it energies on certain aspects of the problem. Pareto analysis
provide visual tool to highlight for most critical issues and involves a drill down to find root cause.

9. REFERENCES