Some thoughts on the 80-20 rule, aka the Pareto Principle

The Pareto Principle is the idea that small causes often make outsized effects. It’s sometimes called the 80-20 rule, because the numbers often (but not always) work out that way. For example, 80 percent of the traffic is on 20 percent of the roads, or 80 percent of a company’s revenues come from 20 percent of their products, or 80 percent of a company’s productivity is from 20 percent of the employees.

This principle can help companies to optimize their business. For example, if 80 percent of product defects come from 20 percent of the manufacturing errors, then if you can eliminate that 20 percent you have dramatically improved quality.

On the other side of the equation, if 80 percent of the work is done by 20 percent of the employees, why not fire the less-productive 80 percent and try to get more of those 20 percent types?

Jack Welch famously did something like this at GE. Each year he fired the bottom 10 percent of his managers, and required them to do the same with their workers.

Conceptually, you could dramatically improve the performance of your organization if you did this on a continuing basis — always keeping those top performers and getting rid of the stinkers. I’m sure it would work, but I wonder if there’s a limit.

There’s something about this 80-20 optimization concept that nags at me. Some of the books and articles I’ve read on 80-20 act as if it’s some kind of law of the universe. As if 80-20 is right up there with gravity and quantum physics. So, if the ratio is so universal, so built into the nature of things … does it fight back?

Here’s what I mean. If you get rid of the low performers and continually hire more high performers, does the 80-20 rule come and re-assert itself, causing some of the former high performers to become low performers? Is it possible that the super-effective 20 percent somehow need the less effective 80 percent?

Or think of it this way, in the context of the roads example — that is, 80 percent of the traffic is on 20 percent of the roads. So what if some too-clever-by-half social engineer decided to get rid of the 80 percent of the roads that weren’t “performing” as well? No neighborhood streets, for example, or back roads. Obviously that would be ridiculous.

Imagine that a publisher decided to eliminate 80 percent of his titles, and focus all his attention on the 20 percent that made the majority of his revenue. Would that work?

It certainly does to some extent. That’s how a lot of big box retailers make their living. They only carry the big sellers.

Still, I suspect it can be a mixed bag. In some cases you might be hurting yourself — by, for example, eliminating the long tail of titles that give people a favorable impression of your brand.

Another way to cast a skeptical eye at 80-20 is in the context of investing. Let’s say 20 percent of your investments make 80 percent of your revenue, so … gee, why not put all your money in that 20 percent?

Because that’s either a quick ticket to lots of wealth, … or poverty. It’s not a prudent investment strategy.

The 80-20 concept promises great opportunities for optimization, but you also need to apply a little common sense and not expect it to work magic.

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