Pareto Principle: How To Use It To Make Smart Business Decisions
The Pareto Principle, or the 80:20 rule, is a simple yet very important decision-making tool. It was developed by Italian economist Vilfredo Pareto (1848-1923) who noted how uneven land distribution in Italy was at the time- 80% of it was owned by only 20% of the population.
Pareto’s 80:20 rule focuses on selecting the most appropriate course of action when many options are available, and there’s a shortage of resources to pursue all the options.
The good news is that the Pareto Principle isn’t a classified tool. Individuals, corporations, and industries can make the most of the 80:20 rule. As an actuary, you can use this tool to weigh your options and channel your resources only where you’re guaranteed the greatest positive outcome.
In this article, we’ll explore how the Pareto Principle works and why. We’ll also give an in-depth breakdown of the steps involved. Don’t forget to contact us if you need more practical, apt, and helpful business advice. As always, the team at Wakely Actuarial is ready and willing to help.
Understanding the Pareto Principle
The Pareto Principle is a general rule-of-thumb that states that 20% of the causes leads to 80% of the effects.
Think of it as a probabilistic approach to decision making where you select a limited number of tasks that produce the greatest overall results.
The idea is that by doing 20% of the project you can generate 80% of the benefit of doing the entire project.
While it was Vilfredo Pareto who first discovered the Pareto Principle (aka the 80:20 rule), Dr. Joseph M Juran was its greatest proponent. In the 20th century, Dr. Juran applied this rule to quality control and even preferred to call it the law of the vital few: the vital few inputs drive most of the inputs.
The key takeaway here is that it’s impossible to have a ratio of 1/1 in a business environment, where each unit of input (labor, time, effort) contributes exactly the same amount of input.
Making Business Decisions Using the Pareto Principle
Let’s face it, the Coronavirus pandemic has left devastating imprints on companies and industries across the US. The current business climate is almost unbearable. To survive, actuaries have to utilize a few vital inputs to drive the greatest positive result.
Still, getting staff acquainted with smart decision-making is something most insurers have failed to do.
While it’s evident that insurance deals have taken a serious dip, actuaries are having little success in trying new deals.
Meanwhile, underwriters and pricing actuaries are failing at creating robust pricing plans.
The Pareto Principle acknowledge these loopholes and provides a tool to make improvements. Read on as we take a closer look at the 6 steps of the Pareto Analysis.
The 6 Steps Of the Pareto Principle: Choosing the Solution With the Most Impact
Identify- Pinpoint and List Out the Problems
Be as concise as you can. If possible, gather feedback from team members and clients. This could take the form of:
Claim reports
Big data from bookkeeping, databases, and accounting records which are crunchable by software
Market study reports
Formal complaints
Field underwriters
And helpdesk logs
Some of the problems might include: “our competitors are charging higher individual premiums” or “our quarterly ROI has dropped.”
Using the Pareto Principle, actuaries gather accurate, timely, and relevant feedback. Whether you’re applying the 80/20 rule in your professional or personal life, this is an important start-point.
Deconstruct- Identify the Root Cause Of Each Problem
Next, get to the heart of the issue.
Your reasons might include: “Our pricing model is not comprehensive” or “some of our clients are terminating their insurance contracts.”
Techniques such as Cause and Effect Analysis and the 5 Whys can be incredibly useful in this step.
Rank- Score Each Problem
Go ahead and rank each problem in the order of importance. Keep in mind that the scoring technique you adopt will depend on the type of problem you aim to solve.
For example, if you want to grow your quarterly ROI, you could score the problems in terms of cost. Or, if you’re trying to retain or even increase your pool of clients, you might score them based on the number of complaints you’ve received.
Classify- Group The Problems Together
Remember the root cause analysis you pursued in step 3? Now use it to classify the problems together by common cause. If four of your problems are caused by lack of a comprehensive pricing model, you could put these under the same group.
Tally- Add Up Scores From Individual Groups
This is where you tally the scores from each group you’ve identified. Ideally, the group with the lowest scores should be your lowest priority and the group with the highest scores, your highest priority.
Act! – Fix Problems Based On Priority
Finally, take the necessary course of action. Your highest scoring will likely have the greatest impact once fixed, so tackle this one first. Don’t bother about the low-scoring problems especially if they cost a pretty penny.
By using the Pareto Principle, you save energy, time, and resources for what’s important. You won’t be chasing the wind.
The Pareto Principle: Why It Works For Smart & Quick Decision-Making
Decision-making is hugely regarded as an intuitive process, but you can- and should- back it up by hard facts.
The Pareto Principle provides an avenue for this, making it easy to define parts of a project that need closer attention, stricter deadlines, and more resources. In short, it is a prioritization technique that makes decision-making easier, faster, and more effective.
If you’re a decision-maker in actuarial consultancy, keep in mind that the value of the 80:20 rule lies in staying focused on the crucial 20% (factors) that directly affect your company’s bottom line. By doing so, you’ll achieve 80% of the results from a paltry 20% inputs. Better still, you’ll be able to be able to concentrate your resources and energies on the tasks that matter the most.
Our Final Thoughts
The Pareto Principle, whilst being a mere approximation, is a good basis for making smart and rapid decisions in the actuarial consultancy world. You can utilize it to:
Rank and and understand which options to pursue when resources are limited.
Visualize the root cause of a problem and take swift action
Prioritize specific measures to ensure maximal organizational benefit
Like Dr. Juran, utilize the vital few inputs (20%) at your disposal to drive maximum results (80%). Call it probabilistic thinking, call it a mug’s game, but the truth is that the Pareto Principle is the tool that actuaries and underwriters really need to fine-tune their decision-making.