Most everyone is familiar with Pareto Charts and how they can be used to help prioritize issues, ideas, and so on. But in addition to helping you prioritize your actions, you can use them with the addition of a ABC Classification to help you allocate limited resources, and become more focused and efficient in your job.
Pareto charts were named after the Italian economist, Vilredo Pareto, who discovered in the time he lived that roughly 20% of the population possessed 80% of the wealth. Some of us know this as the 80/20 rule or the principle of the vital few and the trivial many. This principle demonstrates many of the systems we’re familiar with today:
- 80% of caregivers’ time in a hospital ward is consumed by 20% of the patients
- 80% of the medication budget in a hospital is consumed by 20% of the patients
- 80% of laboratory costs are the result of 20% of laboratory tests
- 80% of the profits in a supermarket chain are from 20% of the stores in that chain
- 80% of the purchasing budget of an organization results from 20% of the suppliers
- 80% of a firm’s revenue are generated by 20% of the firm’s customers
Sometime during the 1940’s the 80/20 rule was expanded using what is known as ABC Classification. This classification breaks down the 20% portion of the principle into two groups and states that of the remaining 20%, 30% of the factors account for 10% of the outcomes and the remaining 50% of the factors account for the last 10% of the outcomes. The classification can be altered, but goes something like this:
- Group A – 20% of the process factors that are responsible for 80% of the process outcomes
- Group B – 30% of the process factors that are responsible for 10% of the process outcomes
- Group C – 50% of the process factors that are responsible for the remaining 10% of the process outcomes
When the classification is used with Pareto, this gives us an additional tool we can use to help us allocate our resources and time. Let’s take the example of a purchasing department that has limited resources and doesn’t have time to successfully negotiate with all its suppliers. Using Pareto chart and ABC Classification we can break the suppliers into three groups:
- Group A – 20% are big suppliers and account for 80% of the dollar value of all purchases
- Group B – 30% are medium suppliers and account for 10% of the total value of purchases
- Group C – 50% are small suppliers and account for the remaining 10% of the total value of purchases
Applying a differential policy to suppliers within each class may result in the following:
- Group A suppliers – a comprehensive negotiation should be carried out each year. In addition, a detailed case by case negotiation should be carried out on the largest purchase orders.
- Group B suppliers – a group of selected suppliers will be chosen and comparative price follow-up will be conducted.
- Group C suppliers – annual negotiations on price discounts will be carried out.
With respect to how purchasing resources would be affected could include the following:
- Most purchasing resources will be devoted to negotiating with group A suppliers
- Few resources will be invested in dealing with group B suppliers
- Group C suppliers will occasionally be evaluated by a purchasing employee
The example above allocated the methodology based on monetary contribution, however, this may not always be possible. You may have to use other criteria to classify the items based on things such as response time, delivery, risk, and so on.