The 80/20 Principle: The Secret of Achieving More With Less (3 page)

Winner take all

A century after Pareto, the implications of the 80/20 Principle have surfaced in a recent controversy over the astronomic and ever-rising incomes going to superstars and those very few people at the top of a growing number of professions. Film director Steven Spielberg earned $165 million in 1994. Joseph Jamial, the most highly paid trial lawyer, was paid $90 million. Merely competent film directors or lawyers, of course, earn a tiny fraction of these sums.

The twentieth century has seen massive efforts to level incomes, but inequality, removed in one sphere, keeps popping up in another. In the United States from 1973 to 1995, average real incomes rose by 36 percent, yet the comparable figure for nonsupervisory workers fell by 14 percent. During the 1980s, all of the gains went to the top 20 percent of earners, and a mind-boggling 64 percent of the total increase went to the top 1 percent! The ownership of shares in the United States is also heavily concentrated within a small minority of households: 5 percent of U.S. households own about 75 percent of the household sector’s equity. A similar effect may be seen in the role of the dollar: almost 50 percent of world trade is invoiced in dollars, far above America’s 13 percent share of world exports. And, while the dollar’s share of foreign exchange reserves is 64 percent, the ratio of American GDP to global output is just over 20 percent. The 80/20 Principle will always reassert itself, unless conscious, consistent, and massive efforts are made and sustained to overcome it.

WHY THE 80/20 PRINCIPLE IS SO IMPORTANT

The reason that the 80/20 Principle is so valuable is that it is counterintuitive. We tend to expect that all causes will have roughly the same significance. That all customers are equally valuable. That every bit of business, every product, and every dollar of sales revenue is as good as any other. That all employees in a particular category have roughly equivalent value. That each day or week or year we spend has the same significance. That all our friends have roughly equal value to us. That all inquiries or phone calls should be treated in the same way. That one university is as good as another. That all problems have a large number of causes, so that it is not worth isolating a few key causes. That all opportunities are of roughly equal value, so that we treat them all equally.

We tend to assume that 50 percent of causes or inputs will account for 50 percent of results or outputs. There seems to be a natural, almost democratic, expectation that causes and results are generally equally balanced. And, of course, sometimes they are. But this “50/50 fallacy” is one of the most inaccurate and harmful, as well as the most deeply rooted, of our mental maps. The 80/20 Principle asserts that when two sets of data, relating to causes and results, can be examined and analyzed, the most likely result is that there will be a pattern of imbalance. The imbalance may be 65/35, 70/30, 75/25, 80/20, 95/5, or 99.9/0.1, or any set of numbers in between. However, the two numbers in the comparison don’t have to add up to 100 (see Chapter 2: How to Think 80/20).

The 80/20 Principle also asserts that when we know the true relationship, we are likely to be surprised at how unbalanced it is. Whatever the actual level of imbalance, it is likely to exceed our prior estimate. Executives may suspect that some customers and some products are more profitable than others, but when the extent of the difference is proved, they are likely to be surprised and sometimes dumbfounded. Teachers may know that the majority of their disciplinary troubles or most truancy arises from a minority of pupils, but if records are analyzed the extent of the imbalance will probably be larger than expected. We may feel that some of our time is more valuable than the rest, but if we measure inputs and outputs the disparity can still stun us.

Why should you care about the 80/20 Principle? Whether you realize it or not, the principle applies to your life, to your social world, and to the place where you work. Understanding the 80/20 Principle gives you great insight into what is really happening in the world around you.

The overriding message of this book is that our daily lives can be greatly improved by using the 80/20 Principle. Each individual can be more effective and happier. Each profit-seeking corporation can become very much more profitable. Each nonprofit organization can also deliver much more useful outputs. Every government can ensure that its citizens benefit much more from its existence. For everyone and every institution, it is possible to obtain much more that is of value and avoid what has negative value, with much less input of effort, expense, or investment.

At the heart of this progress is a process of substitution. Resources that have weak effects in any particular use are not used, or are used sparingly. Resources that have powerful effects are used as much as possible. Every resource is ideally used where it has the greatest value. Wherever possible, weak resources are developed so that they can mimic the behavior of the stronger resources.

Business and markets have used this process, to great effect, for hundreds of years. The French economist J-B Say coined the word “entrepreneur” around 1800, saying that “the entrepreneur shifts economic resources out of an area of lower productivity into an area of higher productivity and yield.” But one fascinating implication of the 80/20 Principle is how far businesses and markets still are from producing optimal solutions. For example, the 80/20 Principle asserts that 20 percent of products, or customers or employees, are really responsible for about 80 percent of profits. If this is true—and detailed investigations usually confirm that some such very unbalanced pattern exists—the state of affairs implied is very far from being efficient or optimal. The implication is that 80 percent of products, or customers or employees, are only contributing 20 percent of profits; that there is great waste; that the most powerful resources of the company are being held back by a majority of much less effective resources; that profits could be multiplied if more of the best sort of products could be sold, employees hired, or customers attracted (or convinced to buy more from the firm).

In this kind of situation one might well ask: why continue to make the 80 percent of products that only generate 20 percent of profits? Companies rarely ask these questions, perhaps because to answer them would mean very radical action: to stop doing four-fifths of what you are doing is not a trivial change.

What J-B Say called the work of entrepreneurs, modern financiers call arbitrage. International financial markets are very quick to correct anomalies in valuation, for example between exchange rates. But business organizations and individuals are generally very poor at this sort of entrepreneurship or arbitrage, at shifting resources from where they have weak results to where they have powerful results, or at cutting off low-value resources and buying more high-value resources. Most of the time, we do not realize the extent to which some resources, but only a small minority, are superproductive—what Joseph Juran called the “vital few”—while the majority—the “trivial many”—exhibit little productivity or else actually have negative value. If we did realize the difference between the vital few and the trivial many in all aspects of our lives and if we did something about it, we could multiply anything that we valued.

THE 80/20 PRINCIPLE AND CHAOS THEORY

Probability theory tells us that it is virtually impossible for all the applications of the 80/20 Principle to occur randomly, as a freak of chance. We can only explain the principle by positing some deeper meaning or cause that lurks behind it.

Pareto himself grappled with this issue, trying to apply a consistent methodology to the study of society. He searched for “theories that picture facts of experience and observation,” for regular patterns, social laws, or “uniformities” that explain the behavior of individuals and society.

Pareto’s sociology failed to find a persuasive key. He died long before the emergence of chaos theory, which has great parallels with the 80/20 Principle and helps to explain it.

The last third of the twentieth century has seen a revolution in the way that scientists think about the universe, overturning the prevailing wisdom of the past 350 years. That prevailing wisdom was a machine-based and rational view, which itself was a great advance on the mystical and random view of the world held in the Middle Ages. The machine-based view converted God from being an irrational and unpredictable force into a more user-friendly clockmaker-engineer.

The view of the world held from the seventeenth century and still prevalent today, except in advanced scientific circles, was immensely comforting and useful. All phenomena were reduced to regular, predictable,
linear
relationships. For example,
a
causes
b, b
causes
c,
and
a
+
c
cause
d.
This worldview enabled any individual part of the universe—the operation of the human heart, for example, or of any individual market—to be analyzed separately, because the whole was the sum of the parts and vice versa.

But in the second half of the twentieth century it seems much more accurate to view the world as an evolving organism where the whole system is more than the sum of its parts, and where relationships between the parts are nonlinear. Causes are difficult to pin down, there are complex interdependencies between causes, and causes and effects are blurred. The snag with linear thinking is that it doesn’t always work, it is an oversimplification of reality. Equilibrium is illusory or fleeting. The universe is wonky.

Yet chaos theory, despite its name, does not say that everything is a hopeless and incomprehensible mess. Rather, there is a self-organizing logic lurking behind the disorder, a
predictable nonlinearity
—something which economist Paul Krugman has called “spooky,” “eerie,” and “terrifyingly exact.”
⁹
The logic is more difficult to describe than to detect and is not totally dissimilar to the recurrence of a theme in a piece of music. Certain characteristic patterns recur, but with infinite and unpredictable variety.

Chaos theory and the 80/20 Principle illuminate each other

What have chaos theory and related scientific concepts got to do with the 80/20 Principle? Although no one else appears to have made the link, I think the answer is: a great deal.

The principle of imbalance

The common thread between chaos theory and the 80/20 Principle is the issue of
balance
—or, more precisely,
imbalance.
Both chaos theory and the 80/20 Principle assert (with a great deal of empirical backing) that the universe is unbalanced. They both say that the world is not linear; cause and effect are rarely linked in an equal way. Both also place great store by self-organization: some forces are always more forceful than others and will try to grab more than their fair share of resources. Chaos theory helps to explain why and how this imbalance happens by tracing a number of developments over time.

The universe is not a straight line

The 80/20 Principle, like chaos theory, is based around the idea of nonlinearity. A great deal of what happens is unimportant and can be disregarded. Yet there are always a few forces that have an influence way beyond their numbers. These are the forces that must be identified and watched. If they are forces for good, we should multiply them. If they are forces we don’t like, we need to think very carefully about how to neutralize them. The 80/20 Principle supplies a very powerful empirical test of nonlinearity in any system: we can ask, do 20 percent of causes lead to 80 percent of results? Is 80 percent of any phenomenon associated with only 20 percent of a related phenomenon? This is a useful method to flush out nonlinearity, but it is even more useful because it directs us to identifying the unusually powerful forces at work.

Feedback loops distort and disturb balance

The 80/20 Principle is also consistent with, and can be explained by, reference to the feedback loops identified by chaos theory, whereby small initial influences can become greatly multiplied and produce highly unexpected results, which nevertheless can be explained in retrospect. In the absence of feedback loops, the natural distribution of phenomena would be 50/50—inputs of a given frequency would lead to commensurate results. It is only because of positive and negative feedback loops that causes do not have equal results. Yet it also seems to be true that powerful positive feedback loops only affect a small minority of the inputs. This helps to explain why those small minority of inputs can exert so much influence.

We can see positive feedback loops operating in many areas, explaining how it is that we typically end up with 80/20 rather than 50/50 relationships between populations. For example, the rich get richer, not just (or mainly) because of superior abilities, but because riches beget riches. A similar phenomenon exists with goldfish in a pond. Even if you start with goldfish almost exactly the same size, those that are slightly bigger become very much bigger, because, even with only slight initial advantages in stronger propulsion and larger mouths, they are able to capture and gobble up disproportionate amounts of food.

The tipping point

Related to the idea of feedback loops is the concept of the tipping point. Up to a certain point, a new force—whether it is a new product, a disease, a new rock group, or a new social habit such as jogging or roller blading—finds it difficult to make headway. A great deal of effort generates little by way of results. At this point many pioneers give up. But if the new force persists and can cross a certain invisible line, a small amount of additional effort can reap huge returns. This invisible line is the tipping point.