Have you ever had trouble picking which business project to prioritize? Like many small business owners, you may have many ideas you want to tackle at once, but there’s probably one that should take priority. The Pareto priority index can help you make a rational decision about which project to do first.
What is the Pareto Priority Index?
The Pareto priority index, loosely associated with the Pareto principle, is a way to calculate the priority of quality improvement projects in your business. It’s a cost-benefit analysis you can apply to projects to see their estimated benefits to your business before you begin working on them. The index takes into account the project’s savings, the probability of the project’s success, the project’s cost, and the project’s implementation time.
A Closer Look at the Pareto Priority Index’s Inputs
This index, which was created by AT&T, is used extensively during Six Sigma quality improvement projects and analyses. The first input to calculate the project’s index value is savings. This is a specific dollar amount that your accounting department determines, and it refers to how much money your business can save if the project is implemented and successful. Usually, this value comes from increased sales, decreased labour costs, or lower overhead, materials, administrative, or other costs. For some projects, the value is a combination of all of these factors.
The probability of the project’s success is another factor in the Pareto priority index calculation. Unfortunately, not all quality improvement projects your business undertakes are going to work. Figuring out the probability of success, namely how likely your project is to succeed and meets its objectives, can be difficult. You should have a meeting with key employees and decision makers in your company to analyze each project and determine which factors affect its likelihood of success. Try to arrive at a probability of success everyone can agree on. If the probability of success is 85%, you’d use 0.85 in your calculation; if the probability is 67%, you’d use 0.67; and so on.
The cost of the project is the third input, and your accounting department also determines this. The cost means the dollar price of pursuing the project, vis-a-vis raw materials, extra labour costs, data collection costs, etc. Your key employees need to figure out the exact inputs required to complete the project and record how much those inputs cost in terms of dollars.
The last factor in the formula is completion time. This can also be hard to estimate, but do your best to gauge how long the project takes to start, complete, and implement. Don’t forget to include lead time for materials delivery and any training time employees might need. Most importantly, always express completion time in weeks, never days or months.
How Do You Calculate the Pareto Priority Index?
Calculating the index is straightforward. Take your dollar savings, and multiply it by the probability of success. Next, take your total dollar cost, and multiply that by the completion time in weeks. Take the first number you calculated, and divide it by the second. As an equation, it looks like this: Pareto priority index = (savings x probability of success) / (cost x completion time in weeks).
In all cases, the higher the value of the index, the higher the priority of the project.
Examples of Pareto Priority Index Calculations
Assume you have four quality improvement projects in mind for your business. Let’s call them Project A, B, C, and D. Your team does all the analysis to find the variables of the Pareto priority index calculation for each project.
You find Projects A, B, C, and D have the following savings. Project A should save $500,000, and B should save $180,000. Project C and D should save $60,000 and $900,000, respectively. As for the probability of success, you determine that A, B, C, and D have success probabilities of 85%, 90%, 95%, and 75%, respectively. Costs associated with the projects, in order, are $70,000, $40,000, $9,000, and $105,000. Finally, the completion times of the projects are estimated to be 17, 15, 21, and 16 weeks, respectively.
The Pareto priority index of each of the projects is calculated as:
Project A = ($500,000 x 0.85) / ($70,000 x 17) = $425,000 / $1.19 million = 0.36
Project B = ($180,000 x 0.9) / ($40,000 x 15) = $162,000 / $600,000 = 0.27
Project C = ($60,000 x 0.95) / ($9,000 x 21) = $57,000 / $189,000 = 0.3
Project D = ($900,000 x 0.75) / ($105,000 x 16) = $675,000 / $1.68 million = 0.4
Since Project D has the highest index value, you should pursue it first, even though it has the lowest probability of success. Project B, while having a high probability of success and the shortest completion time, is the worst project to pursue because of the savings and cost values.
The Pareto priority index is a simple, straightforward way to gauge how important a quality improvement project is for your business. Whenever you have ideas for projects to pursue, take time to rank their importance by doing these simple calculations.