Posted by: Dr Pano Kroko Churchill | April 6, 2015

The Power Law for Investors in Life

The 80/20 rule is frequently found in my businesses and in my writings because it works rather well on any type of Business Stage Investments, such as the Pareto principle, also known as the 80–20 rule, the Power Law, the law of the vital few, and the principle of factor sparsity.

As a matter of fact, the “law” states that, for many events, roughly 80% of the effects come from 20% of the causes.

Management consultant Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who, while at the University of Lausanne in 1896, published his first paper “Cours d’économie politique.” Essentially, Pareto showed that approximately 80% of the land in Italy was owned by 20% of the population; Pareto developed the principle by observing that 20% of the pea pods in his garden contained 80% of the peas.

It is a common rule of thumb in business; e.g., “80% of your sales come from 20% of your clients.” Mathematically, the 80–20 rule is roughly followed by a power law distribution (also known as a Pareto distribution) for a particular set of parameters, and many natural phenomena have been shown empirically to exhibit such a distribution.

The Pareto principle is only tangentially related to Pareto efficiency. Pareto developed both concepts in the context of the distribution of income and wealth among the population.

I believe it’s fundamental to every business person and especially to early stage Investors in StartUp companies, and indeed to every business endeavour – so if you have never applied this rule, in your investments with Startups, please read on and absorb everything I’m about to tell you, because it could change your life significantly for the better.

The 80/20 rule sounds like a statisticians dream and in some ways it is. BUt for young StartUp companies and young Investors it is a dream come true when you start seeing the patterns and the returns unfolding.

I’m a big fan of algebra, math, web statistics, things like pageviews, impressions, unique visitors, conversion rates and split testing, but I try and avoid all complex numbers in presentations, because in our work I found out that for the early stage companies, we can work better with Information and data that quantify, innovation, consumer sentiment, principle feelings, marketable key ideas and concepts, that when blended with simple maths — they make sense for all involved, but above all — they work.

And the reason why Good Arithmetic, and Proper Math, makes sense for all involved is because they work. Such is also the simplicity of the Power Law. It works every time…

The good thing about the 80/20 rule is that you don’t have to understand statistics to be a believer. Yes it has foundations in economics and yes, it was “proven” using statistical analysis by a man named Pareto, but it is not meant to be understood only by economics professors.

The principle was suggested by management thinker Joseph M. Juran. It was named after the Italian economist Vilfredo Pareto, who observed that 80% of income in Italy was received by 20% of the Italian population. The assumption is that most of the results in any situation are determined by a small number of causes.

Living The 80/20 Way: Work Less, Worry Less, Succeed More, Enjoy More by Richard Koch is a good book to read when you have time but for now you can just glean the facts here:

In business & economics, the original observation was in connection with population and wealth. Pareto noticed that 80% of Italy’s land was owned by 20% of the population. He then carried out surveys on a variety of other countries and found to his surprise that a similar distribution applied.

A chart that gave the inequality a very visible and comprehensible form, the so-called ‘champagne glass’ effect, was contained in the 1992 United Nations Development Program Report, which showed the distribution of global income to be very uneven, with the richest 20% of the world’s population controlling 82.7% of the world’s income.

Distribution of world GDP, based on 1989 figures:
% of population vs Income
Richest 20% 82.70%
Second 20% 11.75%
Third 20% 2.30%
Fourth 20% 1.85%
Poorest 20% 1.40%

I can’t remember exactly when I was first exposed to the 80/20 Rule but I know when it first really hit home. Living The 80/20 Way fit me well because it discussed living life productively seeking maximum satisfaction by focusing on your passions (Koch has written other books focusing on the 80/20 Rule for business and managers that I didn’t enjoy quite as much). At the time I sometimes accused myself of being lazy for not “working hard” but I realized what I was doing was living an 80/20 lifestyle and in fact probably being a lot more productive than those working harder than myself.

What Exactly Is The 80/20 Rule?
By the numbers it means that 80 percent of your outcomes come from 20 percent of your inputs. As Pareto demonstrated with his research this “rule” holds true, in a very rough sense, to an 80/20 ratio, however in many cases the ratio can be a lot higher – 99/1 may be closer to reality.

It really doesn’t matter what numbers you apply, the important thing to understand is that in your life there are certain activities you do (your 20 percent investment) that account for the majority (your 80 percent returns) of your success, happiness, and outputs.

You may have expected me to say that 20 percent of your activities produce 80 percent of your financial rewards, and that is true, but there are probably a handful of activities you do each week that produce most all of your income.

You can definitely apply the 80/20 Rule to most aspects of your business or working life, however I believe your overall happiness and satisfaction are much better variables to focus on here. Money certainly plays an important role in your happiness and your money is influenced by 80/20 relationships, but it is only a component that leads to your overall well being, which should be your primary concern.

So the 80/20 examples for your gainful involvement with business ventures is the Angel Investing game where now most of you can get into. Early stage investing in the US has been opened up and democratized significantly because the JOBS Act has allowed literally Millions to now become “accredited investors and to play this rather profitable game.”

Go see for yourself how the rules apply to you as described by the Securities and Exchange Commission and manage your portfolio to get in the Angel Investing so you can have profits, fun, Mentor involvement and also support the creation of American Wealth and American Jobs.

There are many more economic conditions, where the Power Law of 80/20 apply as for example the distribution of wealth and resources on planet earth, where a small percentage of the population controls the biggest chunk, which clearly demonstrate the 80/20 Rule.

And there are pure business examples such as 20 percent of employees are responsible for 80 percent of a company’s output or 20 percent of customers are responsible for 80 percent of the revenues (or usually even more disparate ratios).

But the most striking successful experience of the Power Law is with the Early Stage StartUp ventures where a tiny percentage of them will provide all the great returns for you. For every Twitter and Google, you will have another 98 companies that you invested into and they disappeared off the deep end…

These are not hard rules, and not every company will be like this, and the ratio won’t ever be exactly 80/20, but chances are if you look at many key metrics in any business — there is definitely a minority creating a majority.

The Power Law distribution appears in several different aspects relevant to entrepreneurs and business managers inside the specific business also: For example:

80% of a company’s profits come from 20% of its customers
80% of a company’s complaints come from 20% of its customers
80% of a company’s profits come from 20% of the time its staff spend
80% of a company’s sales come from 20% of its products
80% of a company’s sales are made by 20% of its sales staff

Therefore, many businesses have an easy access to dramatic improvements in profitability by focusing on the most effective areas and eliminating, ignoring, automating, delegating or retraining the rest, as appropriate.

The Power law of 80/20 in Business is very clear. It is obvious to anyone who uses proper Metrics, that a small handful of repeat customers account for most of the income. The customers who become longterm users, who gain the most from the services and fit well demographically and socially with the business model, are the key to continued success. They provide 80 percent of the value but only represent 20 percent (or much less) of the overall people that use the business.

The job of a Good Manger, any Corporate Leader or CEO is to determine the best way to attract and convert more customers into longterm users that easily fall in the boundaries of the 20% or less and this area is the best hunting ground for new customers and clients.
Similarly, there are a handful of activities that I do every day that produce the most results. Breaking things down further, there are usually a key 20 percent of elements within an individual product line, that have the most dramatic effect on results, and impact on the bottomline.

For the Boards and especially where Strategy and CEO impact is concerned — the numbers of various courses of actions are not always a clean 80/20 ratio, but there are definitely dominant factors at play. And change of the lateral kind is always more successful if it falls within the Power law dynamic.

In a business sense, finding the 80/20 ratios is crucial for maximizing performance. Find the products or services that generate the most income (the 20 percent) and drop the rest (the 80 percent) that only provide marginal benefits. Spend your time working on the parts of the business that you can improve significantly with your core skills and leave the tasks that are outside your best 20 percent to other people. Work hardest on elements that work hardest for you. Reward the best employees well, cull the worst. Drop the bad clients and focus on upselling and improving service to the best clients.

You Can also Live An 80/20 Lifestyle in Business and in Practice of Life… because when you start to analyze and breakdown your life into elements it’s very easy to see 80/20 ratios all over the place. The trick, once your key happiness determinants have been identified, is to make everything work in harmony and avoid wasting time on those 80 percent of activities that produce little satisfaction for you.

The message is simple enough – focus on activities that produce the best outcomes for you. This applies to both your business/working life and your “other” life. I happen to think that they are all part of your “life” but people often prefer to distinguish them, as if to make a break from their reality into two … It’s a daft plan but there you have it.

The problem for most people is how to make a living from what you really enjoy, so lets focus on that…

How many of you now reading this article are working day jobs, jobs you probably don’t like much, while you work hard after-hours to get your dream business up and running?

In truth, and this is a sad fact, most people in the world work jobs they don’t like and only truly live their passions on weekends and outside of working hours. Only a small sample actually live their passions day in and day out, how they want to and when they want to. If you want to become one of the special few so you can live your passions on your terms there are a few things you can do.

The simple fact is not everyone can be a famous artist. Not everyone will start a million dollar business. I’m not going to tell you stop striving for those goals, I’m working on them myself, however you can work smarter TODAY to find greater fulfillment, and that is what living an 80/20 lifestyle is all about. Best of all, your likelihood of becoming one of the famous artists or entrepreneurs is enhanced if you tweak your life to follow the 80/20 Rule because you tap into what you do best more often.

The first thing you must decide, and this is often the hardest step, is to determine what it is exactly you have passion for. Some people can answer this question easily – “I want to be a famous pianists/singer/poet/author”, “I’d like to run my own real estate agency/coffee shop/advertising company” etc. Others may have a general idea “I don’t want a day job” or “I want to run a business” but the specifics are not sorted yet. If you are not sure what your passions are all I can suggest is test yourself. It’s usually easy to determine what you DON’T like so keep doing that until you find what it is you DO like.

Focus On Your Passions and Talents — Not on Material Possessions, nor Outcomes, because You may consider the activities I just mentioned mere passions, but it’s hard to find a sustainable passion if all you do is consume. To foster an 80/20 lifestyle you need to locate activities that are passions for you because you create outputs for others to enjoy. Yes you can get paid to have sex, watch movies, eat at restaurants and read books, but chances are you won’t find it fulfilling or sustainable for very long or you will be required to provide something back as part of your involvement – that’s your output, the value you create.

It’s okay to love eating out at restaurants and claiming your passion is food, if your intention is to also create output by starting your own restaurant, or a restaurant reviews website or a newsletter or magazine or becoming a chef. If you enjoy listening to music you might also enjoy producing your own music or covering the music industry as a journalist on your own blog.

Only by producing useful output for other people to enjoy or make practical use of can you expect to convert a passion into a sustainable income. You should understand this already as I suspect the times in your life that you have created something for others or worked on something that benefited other people you experienced the most fulfillment. If you suffer from a lack of direction now, if you are depressed because you don’t even know what your passions are to start applying the 80/20 Rule to, you need to do one thing – start being creative and giving back – produce output! You won’t find fulfillment only by consuming.

An 80/20 Lifestyle Blueprint: To start living 80/20 today you have only to do one thing – focus your energies on what you enjoy. Part time work – Part time passion. Many people work a full time job and work after hours on a business or hobby or creative talent. If this is you I suspect your ratio is not 80/20 and probably closer to 20/80. You spend way too much time at a job you don’t like, you are probably not very motivated to do it well so you don’t fall into the vital 80/20 employees for that company, and by the time you get home you are too exhausted to spend time on your passion. You feel like you are getting nowhere fast. This lifestyle is not good for anyone since all the relationships fall into the 80 percent that produce 20 percent of the value. You get very little from it and the people you work for get very little from you.

If this currently describes your situation what you need to do is start changing those ratios. Reduce the amount of time you spend at a job you don’t like and increase the amount of time you spend on your passion. You may say you can’t do that because you need the money but I suspect you don’t really need as much as you think you do. Most people can live off part time work but choose to work more because they want more things. You may see your peers enjoying material goods which creates desires in you. Your wants start to outweigh your needs, which is probably the biggest pitfall in our modern, advertising driven, materialistic society.

I’m not saying you have to live like a pauper but I know that your real happiness comes from spending time doing things you enjoy the most, not from earning more money. Chasing the dollar for the sake of the dollar does not work. Chasing passion often leads to a greater income because the quality of your output is so much higher. Focus your energy on increasing investment in your core strengths and you will reap rewards.

Drop your working hours to three days per week and spend more time attracting more clients, booking more singing gigs, finding more time to write your novel or to develop your invention or code your software or find investors or whatever it is you really want to do.

For those of you who have no intention of turning your passions into money generating enterprises this is still a good option. If money isn’t your primary concern but your music is, why do you spend so much time working to earn more money than you need? Yes you need to plan for the future and build assets, but clearly for your musical soul it’s not something that needs to take the majority of your time and energy. You can be happy without that mansion by the sea and you never know, if you spent more time on your music the eventual album sales may one day lead to that mansion by the sea. If not, at least you will be a lot happier for following your enthusiasm rather than the dollar.

If financial freedom is important to you and a big part of your plans look at this step as phase one and work to convert your passions into income generating propositions. Grow your business client-by-client, gig-by-gig or sale-by-sale. keep adjusting your work vs passion time ratio as your business grows to support you and you no longer need your job income. Look for 80/20 activities in everything you do and drop any inefficiencies as soon as you can.

Yours,
Dr Kroko

PS:

Don’t Give Up before you even start…

Don’t allow the FUDS to stop you cold in your tracks.

Fear, Uncertainty, and Doubt have no place in this pursuit of Life’s Miracles…

Don’t Let Fear Stop You, because the biggest factor that stops most people from chasing their dreams and working towards their real goals is fear.

Fear of the lack of security, the reduced paycheck and of the unknown future keeps people locked into routines that are not satisfying. That path leads to sadness, depression, poor health, low income and ultimately an early death. Who wants that…

Don’t let fear be the reason for not achieving your goals.

Stop, reassess your real passions, remove the money equation long enough so you can think without worrying about finances, and make plans to move towards your 80/20 lifestyle activities.

Maximize what you are good at. Find the activities that produce the most results for you and your business and put your energy where the big rewards are.


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