Screen shot 2013-05-25 at 2.58.19 PM[ I keep coming across reasons to dig up this old post, most recently here and here on Google+. And before that a Video post by Ze Frank via my Google+ buddy and futurist, Steve Faktor. Also this great post: Pay attention to power law distributions.

And none other than Paul Graham, of proto-startup-incubator Y-Combinator fame, can’t stop talking about it in regards to #Startup Investing, e.g. here how Angel or Early-Stage Seed investments are like “Black Swan Farming”:

the huge scale of the successes means we can afford to spread our net very widely. The big winners could generate 10,000x returns. That means for each big winner we could pick a thousand companies that returned nothing and still end up 10x ahead.
If we ever got to the point where 100% of the startups we funded were able to raise money after Demo Day, it would almost certainly mean we were being too conservative. [4]
We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should. What would it mean to take 10x more risk than Demo Day investors? We’d have to be willing to fund 10x more startups than they would. Which means that even if we’re generous to ourselves and assume that YC can on average triple a startup’s expected value, we’d be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.
I don’t know what fraction of them currently raise more after Demo Day. …But the percentage is certainly way over 30%. And frankly the thought of a 30% success rate at fundraising makes my stomach clench. A Demo Day where only 30% of the startups were fundable would be a shambles. Everyone would agree that YC had jumped the shark. We ourselves would feel that YC had jumped the shark. And yet we’d all be wrong.
For better or worse that’s never going to be more than a thought experiment. We could never stand it. How about that for counterintuitive? I can lay out what I know to be the right thing to do, and still not do it. I can make up all sorts of plausible justifications. It would hurt YC’s brand (at least among the innumerate) if we invested in huge numbers of risky startups that flamed out. It might dilute the value of the alumni network. Perhaps most convincingly, it would be demoralizing for us to be up to our chins in failure all the time. But I know the real reason we’re so conservative is that we just haven’t assimilated the fact of 1000x variation in returns.”

“…The big winners could generate 10,000x returns. That means for each big winner we could pick a thousand companies that returned nothing and still end up 10x ahead.

[So]… We can afford to take at least 10x as much risk as Demo Day [presentations of the most recent batch of 50 odd YC startups; YC funds them for a 3 months at ~ $20k up to that point;] investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should.

What would it mean to take 10x more risk than Demo Day investors? We’d have to be willing to fund 10x more startups than they would. …we’d be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.

And frankly the thought of a 30% success rate at fundraising makes my stomach clench. A Demo Day where only 30% of the startups were fundable would be a shambles. Everyone would agree that YC had jumped the shark. We ourselves would feel that YC had jumped the shark. And yet we’d all be wrong.

For better or worse that’s never going to be more than a thought experiment. We could never stand it. How about that for counterintuitive? I can lay out what I know to be the right thing to do, and still not do it.

…Perhaps most convincingly, it would be demoralizing for us to be up to our chins in failure all the time. But I know the real reason we’re so conservative is that we just haven’t assimilated the fact of 1,000x variation in returns.”

Some causes have wildly disproportionate effects... Basically, Pareto’s Rule is everywhwere, and applies in nearly all contexts, even though it’s easy to forget about or disregard it 80% of the time… Ha! ]

— REPRINT with updates and addenda:

The 80/20 Rule, or 80/20 Principle, or Pareto’s Law (or Rule), or “law of the vital few”, or law of factor sparsity, or any of the other names that this idea has been named, is often quoted, yet little understood when it comes to really thinking about it and applying it in depth.

Just for some light examples: 20% of the carpets in your house will receive 80% of the wear (this is probably the most quoted), 20% of your friends will drink 80% of your booze, 20% of people on Match.com will go on 80% of the dates, and so forth. The imbalance of input to output that the principle predicts holds surprisingly well across pretty much all contexts.

By the way, here is the first important thing to get about the 80/20 rule: The exact ratio of the imbalance could be more or less than 80% [is “caused” by] 20%, the point is that there will be a distinct imbalance away from 50/50. Most often it seems to range from about 65/35 up to 95/5, and overall it averages out very conveniently around 80/20.

Richard Koch has written a number of seminal books about it, and if you haven’t at least read his “The 80/20 Principle”, you really should get started soon.

More recently, it was brought to people’s attention in Timothy Ferriss’ book “The 4-hour Workweek” during his PR blitz through a number of major internet marketing players’ virtual interview rooms. [Since Tim’s very successful book, all of the non-fiction book and business/self-help world is awash in references to 80/20…]

Great book by the way, really a must read for anyone dreaming of the vaunted “Internet Lifestyle” (the one where money appears in your bank account on auto-pilot while you sip on fruity drinks with colorful straws and little, even more colorful umbrellas in them lying on a beach in an exclusive resort somewhere).

Now, seriously though, the 80/20 Rule has far reaching applications for how you manage your time, your business, and your life in general, since it basically says that 20% of your activities are producing 80% of the results, profits, joy, etc. And that by extension the other 80% of activities are mostly wasting your time. Heavy, I know.

So a few causes cause the vast majority of all effects. And the next important thing that you really want to get about it (and very few do, even Koch doesn’t make a clear mention of it as far as I know) is this: The 80/20 Rule is recursive. Hunh?

What that means is that you can apply the rule to itself to arrive at further ratios. So for example, if 20% of the 20% of your most valuable customers generate 80% of 80% of all of your profits, then you get about a 64/4 “Rule” – 64% of your profits come from 4% of your customers. Have you identified those and thanked them lately?

As mentioned already the exact ratios are not as important, the often drastic imbalance is. Run the recursion one more time and you get about a rounded 51/1. So we could say that 1% of speakers [i.e. usually ONE speaker] at a conference provide over half the value.

[ Even the heavens/stars follow this principle: Apparently Jupiter, i.e. 12.5% of our solar systems planets, has 71% of the total mass… closer to home, in 2011 “2% Of Tumblr’s Users Account For 43% Of Its Visits”.

This recursion business should also convince you that most of those pie charts showing the 80/20 Rule as a 20% pie slice/wedge surrounded by an 80% “pacman” remainder of the 100% pie, are actually getting it wrong: The causes and effects are “apples and oranges”, so to speak, don’t necessarily need to add up to 100%, and don’t belong in the same pie.]

Maybe one day this will go down in history as the “Schleber 51/1 Rule”, not to be confused with the “Schleber 151 Rule” which revolves around a certain New Year’s Eve celebratory punch… :)

Another example where I think the distribution can be proven out very well is on all of the social networking sites: 20% or members create 80% of the activity, 4% or members are creating well over half of the activity, and so forth. So if you’re trying to get a forum or membership site off the ground for your business, you better identify that 20% somehow (start with the 1% or 4%). Someone should run the numbers on one of the nascent Web 2.0 sites, I may post a little Perl script to do that sometimes.

So there you have it. Put your thinking cap on and begin investigating the numbers for your own business. Fair warning: This can sometimes be shocking. [See Paul Graham’s example in the quote near the top. He is a smart man, and even he can’t quite fathom/stomach the implications…]

I’ll discuss the deeper implications for what I call 80/20 Time Management in a later post. Teaser: Right now you’re likely spending 80% of your time on things that are only getting you 20% of your results. In other words, you’re wasting massive amounts of time… what would happen if you spent all of your time on the 20% activities that are currently getting you 80% of results? Your results could up to quintuple. Ouch!

[ Addendum:

In the years since writing this post, I have often wondered about the ultimate reason for the Pareto Rule being so patently observable in the world, which is BTW another aspect of it that is little researched or understood. It is sort of just taken as an irrefutable datum by most who understand it at this point.

And what I’ve come up with is this: It is ultimately about “alignment”. When a plan of action, or cause, or chain-of-events, or really any form of energy flow is extremely well aligned (with the moment, the right time and place, the parties involved, the universe, whatever…), there is a sort of Quantum Leap that occurs that greatly increases its impact. A bit like the idea of the Superconducting cable with next to zero loss of electricity, or for the use in a near effortlessly gliding magnetic bullet train track.

Imagine for a moment two pieces of identical 4″ diameter pipe of say 3 feet each, with water continuously being pumped through the first, as if through a lower-pressure firehose. If you held the second piece of pipe up to the first at a very well aligned angle, nearly all of the water would continue on through it. The moment you begin to angle it further and further away from straight however, more and more water would get lost, and more and more additional friction and pressure would result, requiring a lot of extra effort just to hold the second pipe.

This is how poorly aligned projects are in essence: Energy just leaks out and dissipates until there is none left. In a way it’s just entropy. So how can some causes be so adept at defying entropy and creating new (even strengthening) effects, new things, new products, new companies, new entire empires…?!

]

2 thoughts on “UPDATED: What you don’t know about the 80/20 Rule…

  1. Hi Alex,
    Just found your blog as I was searching for the Pareto Principle…love the article. I plan to read your blog more often as it offers valuable, content-rich information.

    Write on,
    Ruth Klein

  2. Definitely something to take into consideration especially when starting a new venture… Thanks, although I think I would like to partake in the “Schleber 151 Rule” could be painful… :)

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