5-takeaways: The 80/20 Principle, Richard Koch
First 5TA for the year! I will be covering this gem that has been staring at me from my bookshelf since I got it almost a year ago. The 80/20 Principle is a book that is based on the Pareto Law, first discovered by Vilfredo Pareto, an Italian economist. Who noticed patterns in wealth and income distributions in nineteenth-century England.
On average, the mathematical relationship between the total population and the total wealth was about 20% of the population held about 80% of the wealth. Pareto’s other finding was that the pattern of 80/20 repeated itself whenever he looked at data referring to a different time or a different country.
However, He never fully realized that the principle could be applied to a lot more than just wealth and income distribution. Several other great thinkers throughout the remaining and next centuries rediscovered and advanced the principle.
Richard Koch, a former management consultant, and entrepreneur, just so happens to be the writer that brings the principle to the masses. The book is an easy read. Koch explains the principle well, using relevant examples and giving different ways to utilize the 20% of the effort that translates into 80% of the results in other business and life aspects. The book is a great read, hopefully you can utilise my little insights.
1. 20% causes provide 80% results.
A classic use of the 80/20 principle is on business clients, 20% of whom provide 80% of the revenue. Most businesses could determine these numbers quite easily. Where are their efforts wasted or not well used on lesser clients that don’t provide enough compensation? Let’s say like in terms of they have larger projects in the pipeline. So, in practice, out of the remaining 80% of clients that only provide 20% of revenue, and if only half have notable future projects, you could remove 40% of total clientele and then the business would be able to free up time for new clients or double-down on current ones.
This also translates into products produced or services provided. 20% of products or services generate 80% of revenue. This is very counterintuitive. You would think that having a variety of products would see a relative relationship directly proportional to the number of items provided.
“The 80/20 Principle states that there is an inbuilt imbalance between causes and results, inputs and outputs, and effort and reward. Typically, causes, inputs or effort divide into two categories:
- The majority, that have little impact.
- A small minority, that have a major, dominant impact.”
Of course, this rule of 80/20 doesn’t just apply to business, as I will relate in other takeaways.
2. 80/20 doesn’t have to equal 100 or is strictly 80/20
This was one of my misguided interpretations when I initially came across the principle. I thought that: a) the data sets had to equal 100% and b) that the relationship was fixed at 80% to 20%. Koch notes that both of these aren’t integral parts of the principle. 80/20 is just an easy way to name the disproportionate relationship between the causes and the results. The relationship could be 65/35 or 90/1. One such example from the book below.
“One of the most dramatic examples of the 80/20 Principle at work is with movies. Two economists made a study of the revenues ad lifespans of 300 movies released over an 18-month period. They found that four movies – just 1.3 per cent of the total – earned 80 per cent of box office revenues.”
Koch notes that one limitation of the 80/20 Principle is that it is only a snapshot of the time when the data was collected. However, Koch does relate the 80/20 Principle to Chaos Theory, which states that outcomes are based on "sensitive dependence on initial conditions". So the chance that the first company to the market will be the biggest at a later date is massive compared to a new-comer. Not only will larger companies hold most of the market value, but they will also gain more and more of the market.
A great example is Coca-Cola, one of the first to the market and now holds 48.6% of the market share. Imagine that one company owns almost half of the market. Let's say that there are 100 cola companies in total. That’s a 49/1. This stat is neither 80/20 nor equal to 100%, yet it is significantly skewed.
3. 80/20 your Money.
Typically, 80% of your wealth will come from a small percentage of your activities. For myself, 100% of my money comes from one activity, my job. Similarly, if you look at someone like Warrant Buffett, most of his wealth comes from a small part of his investments. I would hazard a guess that’s its stocks. Speaking of stocks, we can use our new-found knowledge on it. Koch has some wise words on wealth, “You are more likely to become wealthy, or to obtain the greatest increase in wealth, from investment income rather than from employment income.”
So, what should you do with most of your money? Around 20% of your money (of course, this can be more or less depending on your personal & financial situations)? Save and invest. And of that 20%, most of it should be put into long term investments, otherwise known as blue-chip shares; a good place to park the money is in an index fund. Koch describes what compound interest is, how it works and why you should use it to your advantage. I won't go into it as it needs another post of its own. I can suggest looking it up or playing around with some values on a compound interest calculator(which can be found here).
4. 80/20 your Time and the rest.
Do you ever feel like you waste a lot of your day away? I know I do. Whether I get sucked into scrolling through Instagram, or doing things that aren't productive, or not enjoyable. Now, some things are essential, such as work and sleep. These will take up more of your time. But the rest of your time can be 80/20’ed. There are 168 hours in a week; and you work a 40hour week and sleep for 8 hours a day, you are left with 72 hours. Then you factor in travel to and from work and eating. So, we’ll say that your left with 50 hours (being conservative). Of these 50 hours, you may only really enjoy doing 20% of the things you do or 20% of the people you see.
To get more out of your time, break down what goals you want and track your time and see where you are losing it. There are many ways to do this and find one that works for you. I often use a time blocking technique (which I wrote about). Once you’ve done that, go out and achieve those goals. See more of the friends or family members you want to see, or you could optimize your time to learn a new skill, start a business or a blog, get to the gym more.
Of course, all of these things will lean toward something that you enjoy. You could 80/20 your spare time for happiness if you so desire. You might even go so far as removing work altogether. Which is not advised if you don't have another way to bring in money. The better alternative is finding work that you enjoy.
5. Change your mode of thinking.
Koch really does get into how effective the 80/20 principle is outside of finance and business. Once the basics are understood, and the reader can start thinking with the imbalanced required. This was a bit easier for me as I had already been introduced to this mode of thinking by Tim Ferriss and Gary Keller. I had meant to get the knowledge from the source, and this is my biggest takeaway.
The universe and the world is not fair and most likely never will be. Things will always improve, but the balance of 80/20 will remain. Instead of worrying about how life isn’t fair, and you feel downtrodden. Try and make your own life 80/20, try and break out of the social norms you have grown accustomed to. Instead of thinking about things in the standard direct cause and effect way, start to think 80/20, as Koch describes below:
“To engage in 80/20 thinking, we must constantly ask ourselves: what is the 20 per cent that is leading to 80 per cent? We must never assume that we automatically know what the answer is, but take some time to think creatively about it. What are the vital few inputs or causes, as opposed to the trivial many?”
Change is hard. Going into the unknown is difficult, but with discipline, you can develop a habit, and with time the habit will become a lifestyle choice. I am trying to make 80/20 a lifestyle choice. I would love it if you could join me.
Koch has produced a gem of a book that has inspired many who use it for their own businesses and personal lives. The 80/20 principle teaches its readers that 50/50 is incredibly rare. If you can figure out what the small minority that has a huge impact is, you will maximize your time, money, and happiness towards achieving your goals and life visions. As usual, I will leave you with a powerful quote from the book.
“The greatest thing about the 80/20 principle is that you do not need to wait for everyone else. You can start to practice it in your professional and personal life. You can take your own small fragments of greatest achievement, happiness, and service to others and make them a much larger part of your life… You can become a better, more useful and happier human being. And you can help others to do the same.”
Thanks for reading.
If you liked my 5 takeaways and want to pick up the book for yourself, consider buying through my affiliate link. If you do, I will receive a small commission.
Book link: https://amzn.to/3sQ8TP0
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