A Pareto chart is based on the Pareto Principle postulated by Vilfredo Pareto in the 19th century. Pareto was an economist who claimed that a large percentage of wealth is owned by a relatively small percentage of the population. It went on to define the Pareto Principle which says that 80% of any problem is accounted for by 20% of the factors. Hence, it would be wise to concentrate on the ‘vital few’ rather than the ‘trivial many’.
A Pareto Chart is a type of graph which combines both a bar graph and a line graph to represent the factors affecting a variable. While the bars represent the individual factors in decreasing order (of their value), the line represents the cumulative value of the factors.
The objective of a Pareto chart is to highlight the most important factors that affect a variable. While the left vertical axis represents the percentage of occurrence (or other unit of measure), the right vertical axis represents the cumulative percentage of total number of occurrence (or other unit’s total). Since the factors are represented in decreasing order, the line graph is always concave.
An area where the Pareto chart and Pareto principle are widely used is inventory control. For example, a retail chain wants to reduce its investment on inventory and storage costs. They would like to maintain the inventory at an optimum level for fast moving goods and only stock minimum levels of slow moving products. A Pareto chart analysis can help them classify the stock into fast moving and slow moving categories, or essential and non-essential categories. Based on the results of this Pareto chart analysis, the managers can focus their resources towards better inventory control and strict management of vital and essential items (and introduce systems like Just In Time inventory for these), and lesser controls for non-essential stock categories. This will help bring down the overall investment on inventory and reduce costs.
The most important benefit of using Pareto chart analysis is that it helps to highlight the important factors in a scenario where there are a large number of factors to be considered. Secondly, the diagrammatic representation is extremely simple to understand and interpret and allows us focus on the few key factors by directly showing their percentage of influence. Hence, it allows us make the best use of limited resources. Further, it is extremely useful when we want to identify the frequency of occurrence of certain events to decide upon its importance and design a solution for it.
Quality control, inventory control, customer grievance handling are some of the business areas where Pareto Chart analysis is frequently used. It is often used to identify training needs of a team or investment opportunities in a market. Social and economic studies to determine important causes behind a phenomenon can be conducted using Pareto Charts and analysis; say what are the major reasons behind workforce migration from a country or what are the major factors leading to economic backwardness of a region? The simplistic graphical representation makes a Pareto chart easy to understand and an efficient tool to present or explain a scenario and its underlying causes to an audience.
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