Review: The 80/20 Principle
Every Friday Free From Money reviews a book you might find useful for your personal or professional life
“Things that matter most must never be at the mercy of things that matter least”
Johann Wolfgang von Goethe
The 80/20 Principle, aka The Pareto Principle, is a theory originally formed based on the observation that 20% of a country’s population produces 80% of the wealth.
In this book, author Richard Koch argues that the Pareto Principle can be applied to many different situations in both business and in our private lives.
Here is a brief walkthrough of The 80/20 Principle:
Part One: Overture
Most systems have an imbalance in them where a minority of causes or inputs create a majority of the results or output. This is caused by small fluctuations in seemingly minor events, similar to chaos theory. Feedback loops keep a system moving in one direction until hitting a tipping point, at which point small efforts make a big difference.
There are two ways to apply the 80/20 principle: 80/20 thinking and 80/20 analysis. Thinking 80/20 requires you to investigate the facts and quantify the output. The analysis provides insight from the collection of thoughts. One point to remember when reading. First, the fact that 80 and 20 add up to 100 is a coincidence. The point is that a small amount of input creates a majority of the results. It could be that 20% of your effort only creates 70% of the output, or maybe it creates 90%.
Part Two: Corporate Success Needn’t Be a Mystery
In this section the author explores how to apply the 80/20 principle to a business. Generally a business will want to focus on the few areas where it can excel, in those areas where it has a competitive advantage.
Segmentation - understanding each portion of your business and how it affects profitability through revenue and margins, is key to the business analysis. The most profitable areas are the areas where you should focus your effort. The author pushes for business simplicity; a focus on key areas can help your business excel by cutting waste. In addition to finding the 20% of the business that fuels the most profits, its important to find the core customers and provide exceptional service to them.
Overall thinking 80/20 means you begin to move towards high-value uses, high-value assets, and high-value customers. We need to realize that change will happen, equilibrium is an illusion. Take a look at Microsoft Windows. After over a decade of domination, Mac OS X and Linux are slowly building up steam and bringing a serious challenge. When Michael Dell suggested Apple pay back share holders, he never thought that Apple would have the resurgence that it did by leveraging their success with the iPod.
Part Three: Work Less, Earn and Enjoy More
Brining the 80/20 principle into your personal life means recognizing that very few events contribute to our overall happiness. We should try to leverage those good times, and focus less on the low value times. The same goes for productivity. It’s difficult to be productive all hours of the day, so you should do high value activities in the times you are most productive.
Applying the 80 principle to your career is similar to applying it in a business. Finding the appropriate career requires doing something that you are both good at and that you enjoy doing. When you do this you will likely excel above your peers and be rewarded for your contribution. The author outlines his thoughts on the 10 rules to career success, as well as 4 ways to leverage your time to create the most rewards.
Recommendation:
The 80/20 Principle is a mixed bag. I think it is definitely a step in the right direction for someone looking for an analysis framework. But I feel like some of the ideas in the book are dangerous to follow.
For instance, the author suggests that if an investment is successful you should double and redouble your bet. This kind of leverage can be good for your profits, but it can also be disastrous for your portfolio should your analysis prove to be wrong. If you are a business you might find out that just because an area of business was profitable doesn’t mean that you should bet the farm on it. The banks that have gone under from bad mortgage debt are proof of that.
In the chapter on time management the author makes the ludicrous statement that Warren Buffet became rich by doing a limited amount of analysis and being lazy with his investment portfolio, since there is very low turnover compared to most trader’s portfolios. Anyone who knows about Warren Buffet’s investment style knows that his investment method, while simple, is far from easy or “lazy.” I think these kinds of beliefs can get people into trouble.
There also seems to be very limited application of the 80/20 principle itself. There are only so many ways that you can tell a reader that small inputs create large output. Overall I think this book is worth reading, but it’s probably better to skim through it. You can actually start putting the 80/20 principle to work right away. Reading 20% of this book will probably give you an 80% understanding of the principle.
The 80/20 Principle is a part of the Personal MBA reading list under Finance & Analysis.
