What is Pareto Chart and 80-20 Rule

What is Pareto Chart and why it is so great?

The Pareto principle, also called the 80/20 rule, says that 20 percent of the causes lead to 80 percent of the effects. This there is also called the law of the vital few: the vital few inputs drive most of the outputs.

The Pareto principle was first suggested by a management consultant named Joseph Juran. Juran named the principle for Vilfredo Pareto, an economist in Italy who wrote that 20 percent of the nation’s people owned 80 percent of its land. The principle has become common in various circles. Business professionals commonly state that 80 percent of sales come from 20 percent of customers, and volunteer organizations usually operate with 20 percent of the people doing 80 percent of the work.

The principle is critical to Six Sigma not because causes and effects line up nicely via an 80/20 breakdown, but because it almost universally applies that a few inputs create more impact than all the other inputs. Individuals seeking to reduce defects can almost always identify three to four inputs that, if improved, will create dramatic impact on the outcome. While resources, costs, and difficulty of improvements also play a role in solution selections, understanding which inputs or root causes are high on a Pareto chart let project teams determine where improvements will make the biggest impact to the bottom line.

The Pareto principle is best displayed using a Pareto chart, which is a graphical representation of data elements – usually inputs or causes – in a ranked bar chart. Unlike a regular bar chart, the bars are arranged in order of height, with the highest on the left and the lowest on the right. Statistical software used to create such charts adds formatting and other elements automatically, but you can also create a basic Pareto chart in Excel.

To illustrate the Pareto principle, we’ll look at a common situation involving defects in the medical field—specifically in the process for submitting medical claims. Payers often deny claims, and they do so for a variety of reasons. When claims are denied, provider offices have to rework, resubmit, or appeal the denials. Some denial reasons are not appealable, which means the provider’s office loses the revenue associated with the claim.

We’ll imagine a medical office that is experiencing a cash flow problem because of claim denials. The office gathers data about the denials and creates a Pareto chart, so the team can see where the bulk of the denials are coming from. The data is listed below, followed by a basic Pareto chart created in Excel.

Reasons for Denying Medical Claims

Duplicate claim18012
Timely filing13245
No beneficiary found10215
Claim lacks of information4548
Service not covered2154
Medical necessity1423
Date of service issue526

what is pareto chart

From the Pareto chart, you can see that the top three denial reasons account for 80 percent of the denied claims. An experienced billing team could tell you three things just from looking at this data:

  1. The office has waste (muda) of rework or Correction (Refer to Types of Waste in Lean). They are sending a large percentage of claims more than one time.
  2. The office has an efficiency problem. Almost a fourth of their claims are not making it to the payer prior to timely filing deadlines.
  3. The office has an insurance verification problem, because a fifth of their claims are being sent with information that doesn’t match anything on the payer’s end.

Addressing duplicate claims is important because it reduces rework and could enhance the office’s relationship with insurance companies. However, the team might choose to work on the timely filing problem first because timely filing denials are final, which means the office is losing the revenue associated with all those claims. Filing claims on time is not difficult in many cases, given the fact that most payers allow months or even a year for claims to be filed, so this could be an “easy” win for the team. A Pareto chart often uncovers low-hanging fruit in this manner.

We will continue on How to Create Pareto Using Microsoft Excel in our next post