Bauman, Paweł - Vilfredo Pareto – Biography, Main Ideas and Current Examples of their Application in Practice (2009).pdf

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Paweł Bauman
Uniwersytet Łódzki
V
ILFREDO
P
ARETO
–
BIOGRAPHY
,
MAIN IDEAS AND CURRENT EXAMPLES
OF THEIR APPLICATION IN PRACTICE
Introduction
The seventies of nineteenth century played very important role in the history of economy.
From that time for the nearest half of the century we see the most economical changes and
the scientifically-organizational progression in almost every area. A great impact for those
changes had a rising system of a global economy. There was a place for multilateral exchange
of goods, capitals, services and human resources leading to enormous development of the
countries. Frequent changes caused that economic reality was every day more and more com-
plex. This complexity was caused by increasing amount of data which extended number of
variables complicated conducting precise analysis. The progression required making wide
analyzes of economical processes which were not possible in that time. The end of XIX
th
century was a period in which the economy derived a lot from mathematics. During this time
there was also an application of the differential calculus which enabled making more accurate
analyzes of the economical processes. Throughout this time there was an emphasis of mar-
ginal values. That is why some theoreticians describe the 1870‟s as a „marginal revolution‟.
What is more a notion of the „marginal utility‟ was applied almost in the same time by three
schools of economic thought: Austrian, Lausanne and British-American. The end of XIX
th
century was a period when economy proved that it belongs to exact sciences.
The Lausanne School and its Representatives
The Lausanne School also known as a Mathematical School contributed to usage of procedural
language in economical literature
1
. Antoine Augustin Cournot was the precursor of that economi-
cal school. Well-known for his passion to mathematics he created the law of demand and was
leading an advanced analyzes about demand, supply and price in changing market conditions such
as monopoly, oligopoly, duopoly and the perfect competition. The crown of his analyzes was
a book „Researches into the Mathematical Principles of the Theory of Wealth‟ which was appre-
ciated after the economist‟s death.
Léon Walras and his successor Vilfredo Pareto are main representatives of Mathematical
School. They contributed to the fact that Lausanne School started to exist in the international area.
Léon Walras was a master of Lausanne School. He was a man with an amazing analytical aptitude.
A general equilibrium theory created by him is the base of making current econometrical models.
Vilfredo Pareto improved not only the general equilibrium theory made by his predecessor and
thanks to it strengthened the importance of his school in the world of economy. For a lot of years
he was making analyzes of economy and society which to this day these analyzes are the incredible
facilitation in a lot of branches of knowledge. Moreover the creativity of Italian economist is these
days commonly used in such branch of knowledge as quality management.
1
W. S t a n k i e w i c z,
Historia myśli ekonomicznej,
Warszawa 2000, s. 254.
165
Vilfredo Pareto
Pareto was born in 1848 in Italian aristocratic family in Paris. He was a person of a wide
range of interests. As a self-educated man he pored over the theories of economy and hu-
mane studies with the success. He studied engineering at the Polytechnic Institute of Turin.
He acquired here his proficiency in mathematics and basic ideas about mechanical equili-
brium which he developed in the future. After graduation at the top of his class in 1870, Pare-
to took his first job as a director of the Rome Railway Company. In 1874, Pareto becomes
the managing director of an iron and steel concern, the Societé Ferriere d'Italia in Florence
2
.
From that time his life was devoted to discovering new economical and sociological depen-
dences. He is a creator of the consumer theory which enables us to describe behaviors of
individual consumers on the market through the use of mathematical tools. We can also ex-
plain how the market mechanism works in the range of distribution goods and creating pric-
es. Very helpful in the theory mentioned before is Pareto‟s next discovery – indifference
curve described as a bundle of such combination of goods and services which brings custom-
er the same total utility. There is also a notion connected with this illustrious economist, such
as „Pareto optimality‟ (known also as a Pareto efficiency or Pareto optimal). This is a defini-
tion of economic phenomenon in which no one can be made better off by making someone
worse off.
The next great achievement of the Lausanne School representative is the Pareto principle.
This rule was made in 1897 as a researcher‟s effect on the incomes distribution of Italian
economist. Pareto noticed unbelievable dependence. According to the results of his analyzes
as many as 80% of the wealth of whole country was in possession of 20% of society. What is
more after the result of the analyzes were spread such dependence was noticed in a lot of
life‟s fields.
Pareto proved that 80% of the effects are made by 20% reasons. That is why, while mak-
ing revision we have to focus on these reasons which cause the superlative effect.
Principle 80/20 and some examples of its application
80% of complaints are made by 20% of clients
80% of bad loans are made by 20% of creditors
80% of total costs are made by 20% of products
80% of incomes from sales are made by 20% of products
80% of products are bought by 20% of clients
The Importance of the 80/20 Principal in Quality Management
Nowadays quality is becoming more and more important in creating competitive advan-
tage of the enterprise and that is why we need tools to help us in controlling this advantage.
The practice distinguishes two types of such tools. There are traditional tools and new tools
group. Traditional tools include cause-and-effect Ishikawa diagram
3
, Pareto-Lorenz analysis,
block diagram
4
and histogram
5
. New tools group include interrelationship diagram
6
, affinity
F. L. G o n ç a l o,
The history of economic thought website,
http://cepa.newschool.edu [acces:. 03.2009].
It is a graphical tool used to presentation of bilateral connection of causes which make the particular effect.
4
It is a tool presenting successive action in a projecting algorithm.
5
It is a graphical tool used to presentation of a characteristic‟s distribution.
6
The aim of interrelationship diagram is to find logical connection and dependences of that factors which
influence for analyzing issue.
2
3
166
diagram
7
, tree diagram
8
, matrix data analysis
9
, process decision program chart
10
and arrow
diagram
11
. An extremely useful and interesting tool is a Pareto-Lorenz analysis which is close-
ly connected with the 80/20 principle. The Pareto-Lorenz analysis is a tool that enables
putting in the order all factors which influence on the final results. It is a graphical image
showing relative and absolute distribution of mistakes, problems and their causes
12
.
Pareto–Lorenz Analysis Process and its Performance
13
Pareto-Lorenz analysis is divided into five steps:
1) defining causes which influence on the final result of the particular process;
2) collecting quantitative data about causes mentioned above;
3) putting in the order causes taking as a criteria: frequency of their occurring (from the
most frequent to the less) or their influence on the final result (from the strong influ-
ence to the weak) – drawing bar charts which represent particular causes (Pareto
graph);
4) drawing points which represent cumulated values of causes and after that linking
them - creating Lorenz curve;
5) putting percentage values for the chart.
Application of the Pareto–Lorenz Analysis
The statistics are taken from the annual reports (made in 2007, in bln $) of particular
branches of South-Korean Samsung holding company, also known as a „chaebol‟. Pareto-
Lorenz analysis should help us to answer for the question: which branch brings to Samsung
the highest incomes?
First of all, it is necessary to specify all branches with achieved incomes in the particular
year. It is shown in chart no. 1.
The next step is to put in the order incomes of particular branches. From the branch
which brings the highest to the lowest incomes. It is shown in chart no. 2.
Basing on the chart no. 2 we can start drawing the graph which will present values regard-
ing incomes above. The process of making a graph to the Pareto–Lorenz analysis is divided
into three steps.
First of all we have to specify particular branches on the X-axis together with their values
in bar chart.
Secondly we draw the line which represents the cumulated values. It is useful because after
that it is easier to see if the 80/20 principal works in that particular case.
Finally we assign percentage values for particular causes (branches) and effect (values in
bln $).
A universal tool, which is very useful in putting in the order the data from the „brain storm‟.
One of the tool in the planning process.
9
Used mainly in market analysis, helps in forming product market strategy and finding the market niche.
10
A tool which aim is to define an optimal way to achieve the goal.
11
A very useful tool in planning processes which are repetitive.
12
J. J. D a h g a a r d, K. K r i s t e s e n, G. K. K a n j i,
Podstawy zarządzania jakością,
Warszawa 2000, p. 91.
13
E. K o n a r z e w s k a - G u b a ł a,
Zarządzanie przez jakość,
Wrocław 2006, p. 196.
7
8
167
Chart no. 1
Name of the branch
Samsung Electronics
Samsung SDI
Samsung Elektro-Mechanics
Samsung Heavy Industries
Samsung SDS
Samsung Life Insurance
Samsung Corporation
Samsung Fire & Marine Insur-
ance
Samsung Techwin
Samsung Everland
Samsung Corning Precision
Glass
Samsung Card
Cheil Industries
Samsung Engineering
Samsung Securities
Samsung Total Petrochemicals
Samsung Petrochemical
Source:
Samsung Electronics.
Chart no. 2
Incomes
(in bln $)
91,9
7,2
2,6
6,8
2,3
29,1
10,2
8,8
3,1
1,6
0,9
2,4
1,5
2,2
1,3
3,5
1,5
Name of the branch
Samsung Electronics
Samsung Life Insurance
Samsung Corporation
Samsung Fire & Marine Insur-
ance
Samsung SDI
Samsung Heavy Industries
Samsung Total Petrochemicals
Samsung Techwin
Samsung Elektro-Mechanics
Samsung Card
Samsung SDS
Samsung Engineering
Samsung Everland
Cheil Industries
Samsung Petrochemical
Samsung Securities
Samsung Corning Precision
Glass
Incomes
(in bln $)
91,9
29,1
10,2
8,8
7,2
6,8
3,5
3,1
2,6
2,4
2,3
2,2
1,6
1,5
1,5
1,3
0,9
Pareto–Lorenz analysis
Source:
Own elaboration.
168
Thanks to foregoing Pareto–Lorenz analysis we can notice that such branches as: Samsung
Electronics, Samsung Life Insurance and Samsung Corporation which participate only in
20% of all branches of South-Korean chaebol bring about 80% of annual incomes.
Nowadays Pareto–Lorenz analysis enables us not only to specify in unequivocal way on
which part of our enterprise we should focus but also it shows how to make improvement of
our product by identifying problems which should be removed first.
ABC Classification
Pareto–Lorenz analysis was popularized in first half of XX
th
century by American economist
Joseph Juran who was engaged in the theory of quality management. From that time Pareto-
Lorenz analysis was applied in a lot of areas. That is why it needed to be adjusted to changing
conditions. These adjustments did not change its original postulates
14
. ABC classification is such
an example which is applied mainly in logistics especially in warehouse economy.
ABC Classification Process and its Performance
ABC classification is divided into four steps:
1) collecting data and making Pareto-Lorenz graph;
2) drawing two horizontal lines. First line represents 80% of cumulated values, second
line represents 95%;
3) we divide whole graph into three parts – A, B and C.
All categories for which Lorenz curve lays below 80% is the A part.
All categories for which Lorenz curve lays between 80% and 95% is the B part.
All categories for which Lorenz curve lays above 95% is the C part.
4) we make an analysis basing on the new chart.
ABC analysis
Source:
Own elaboration.
14
J. Ł a ń c u c k i,
Podstawy kompleksowego zarządzania jakością TQM,
Poznań 2006, p. 296.
169

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