Applications of Pareto Analysis
Pareto Analysis is generally very powerful and essential technique required for solving problems like errors, defects, etc. It is one of the simplest, easiest, and very effective tools that are used in identifying effective and essential solutions to problems. Pareto Analysis can also be used very effectively and clearly in various situations where the 80/20 rule does not apply. The 80/20 rule simply means that usually, 80 percent of problems or defects occurred due to 20 percent fundamental causes.
Pareto Analysis is generally applicable to various situations of business or organization. Some of them are given below –
- Pricing of Product :
In any business, Cost-Volume-Profit (CVP) relationship of product is very important. It is simply an analysis that shows relationship among factors like cost, volume of sales, and their impact on the amount of profit. But there are some cases where an organization has to deal with more than one product.
In such cases, it is very difficult to analyze and determine CVP relationship for all products. It is very difficult to determine which product is essential for company’s growth and survival because only 20% of products may account for 80% of total sales revenue. It is difficult for management team to take decision regarding pricing also.
Therefore, in such cases, Pareto Analysis is used. Pareto Analysis helps management team to concentrate more on pricing decisions of products (approx. 20%) that are essential for growth and survival of the organization.
- Customer Profitability Analysis :
In business, the customer role is also important. Therefore, each organization or business or company analyze customer relationship in specific period of time. Customer Profitability (CP) to an organization is analyzed rather than analyzing products.
CP basically means profit gained by organization or business from serving or giving product to customer or group of customers over given period of time. Profit is analyzed by difference in revenues earned and costs that are associated with customer relationships in specific time period. There are some customers that are more profitable and some are less profitable.
It is very difficult to determine which customer or customer groups are essential for company’s growth and survival because only 20% of customers may account for 80% of profit. It is difficult for the management team to take decision regarding profit also. Therefore, in such cases, Pareto Analysis is used.
Pareto Analysis helps management team to analyze profits gained from different customers of customer groups and then make decision whether or not customer is profitable or not. They decide whether or not serving should be continued to same customer or customer group.
- ABC Analysis (Stock Control) :
ABC analysis simply means to classify products or items according to their consumption values. Here, consumption value simply means total value of product or item that is being consumed over given period of time.
Products that come under A category are very important to organization, products that come under B category are less important to the organization than A, and lastly, C category in which the number of products will be more but are very less important due to their lowest portion for consumption value. But again, it is very difficult to determine that which products are make up most of value because only 20% of the total quantity of product or stock may account for 80% of its value.
Therefore, in such cases, Pareto Analysis is used due to which focus will be more on less number of stock products that accounts for 80% of the total value. With help of Pareto Analysis, one can take decision regarding investing money in stocks.