by Richard Koch, Nicholas Brealey, 2003.
This book applies Pareto’s 80/20 principle to practical allocation of resources – to the most creative 20% of employees, to the most potentially profitable ideas, to capital investment. The principle can also be a competitive weapon – to concentrate on the 20% of most neglected opportunities.
(Reviewed by Kevin Barham in November 2003)
(These book reviews offer a commentary on some aspects of the contribution the authors are making to management thinking. Neither Ashridge nor the reviewers necessarily agree with the authors’ views and the authors of the books are not responsible for any errors that may have crept in.
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Innovative individuals, we are told in this book, are taking over the world. No longer is the corporation or capital king. According to Richard Koch, creative individuals and their teams are the new driving force of the economy, creating and capturing wealth and wellbeing. Individualism is replacing capitalism and most successful companies now revolve around a few individuals (of whom the most obvious example is Bill Gates of Microsoft). This revolution follows the 80/20 principle which says that in every walk of life 80% of results flow from 20% of causes, i.e. success comes from focusing exclusively on the few very powerful forces operating in an arena.
This book is a sequel to Koch’s bestseller The 80/20 Principle. Whereas his previous book showed how the 80/20 principle could be used to raise a firm’s business results and how the reader could use the principle to be more effective personally, this book shows how to use the 80/20 principle professionally, to create wealth and wellbeing as an individual.
Koch makes the connection between the rise of the individual and the 80/20 principle - achieving more with less to create great wealth. The old way was for managers to aggregate, to add assets and management structure. The new 80/20 way is for individuals to divide, to take averages apart, and concentrate on the small parts of the system that have extraordinary power to generate wealth.
Wealth, Koch says, is most effectively multiplied by the subtraction and rearrangement of industries, rather than through the traditional routes of aggregation of activities and assets. Separate enterprises are created, fostered by a new idea from new individuals, and linked together by markets rather than by hierarchy and central planning. Koch suggest that the 80/20 revolution is as important as three other major transitions in economic history - the agricultural revolution, the industrial revolution, and the managerial revolution, each of which produced new economies and societies. The 80/20 principle will do the same over the next few decades. Already the most successful corporations now revolve around a few individuals. Most of the economy still follows the old pattern of managerial capitalism but that will come to an end abruptly and radically. We will then see a huge transfer of wealth away from institutions to individuals, to entrepreneurs away from passive investors.
Throughout the book, Koch gives 60 real life examples of 80/20 individuals, all of whom have created something valuable and gained control of their own lives in the process. They have all latched on to a powerful idea and given it a new twist to create a very specialised and profitable social or business enterprise that has enriched the world and their own lives. So how can you emulate them and become a part of the 80/20 revolution and an 80/20 individual? The answer is to follow what Koch calls ‘the nine essentials of 80/20 success at work’ which he claims can ‘turbo-boost’ your career, to enjoy not only high financial rewards but also a fulfilled and relaxed work life.
We need to identify and then nurture and grow the 20% of ourselves which is the truly distinctive self that contributes more than 80% of our impact and happiness. Koch calls this the ‘20% spike’ - a distinctive strength that is unusually powerful. Creative individuals are different, they are aware of and use their individuality more. So, if you want to create a new business, don’t start by thinking about the business. Start by thinking about yourself. And then look for the opportunity that you will exploit better and more creatively than anyone else. Your destiny is to find a venture that is more suited to you than anyone else, something that nobody could do as well as you.
Don’t forget, however, about the other 80% of things you’re not brilliant at. Koch says the meat in a hamburger (the 20%) needs the bread roll (the 80%) or it’s not a hamburger. In other words, we should focus on the vital 20% but make sure that the other 80% is also well catered for by other people with complementary skills who are part of the same team.
Business is all about ideas. Just as Darwin’s process of natural selection (a classic example of the 80/20 principle in action) is driven by genes and just as success in life comes from having good genes, success in business comes from great ideas - Koch calls these ‘business genes’ - and from being the best available vehicle for those ideas in a specific market. The most important competition in business takes place at the level of business ideas and involves the ‘winnowing of the trivial many and the triumph of the vital few’.
The trick is to identify the vital few ideas that can bring success. One way to do this is to combine and tweak previous ideas. Koch suggests you start by defining the domain within which you will enclose your great idea. Shortlist the vital few ideas at work there. Then try combining the ideas until you come up with a unique new business idea that you think will work. Think about the dimensions of uniqueness - for example, in terms of product, service, time, customer, geography, or activity (design, research, manufacturing, etc.). Then test your shortlist on as many people as possible and try small-scale experiments with any ideas that survive this process. Work out the numbers to confirm the economics of an 80/20 enterprise - unless they demonstrate very high return on capital, your new great idea is not one.
The next challenge is to identify the vital few forces that create wealth in any arena. Who are the vital few people in the firm? Who are the vital few customers? Who are the few super-profitable customers or the ones with the highest ratio of value to cost? What are the vital few activities, products and services? One approach is to segment and then re-segment the market to create a bigger market by combining products. Another approach is to ask if there is a mass market that offers an opportunity to create a niche serving upscale, rich customers - or if there is a niche that might be turned into a mass market. We might also pursue value innovation where the aim is to provide better value for a new part of the market by adding some better or extra services or by subtracting some parts of the traditional product or service package. Another possibility is to focus exclusively on the most profitable parts of the value chain (design, development, manufacturing, marketing distribution, etc.). Koch says that using cheaper, direct distribution channels is often the clue to creating a new 80/20 venture.
By this Koch means we need to change our perspective on time and to think of it as part of our products and services, not as something that is separate from them. We need to think of ‘product-time’ and ‘service time’. Time is part of what we add or subtract. For example, providing an existing product or service in a much faster way could change its economics and offer a great new business idea. Koch also makes us think about how we use our time. If 80% of the wealth we create happens in less than 20% of the time available, then there is no shortage of time and we are using our time most productively for only a small part of our existence. This means that any person or venture could achieve much more while using much less time. What we are best at, the activities that make the very best use of our time, must define our new business and make it unique.
Koch recommends, therefore, that you try to identify your most valuable activities, that small portion of time that nearly always leads to most of the value created - the flash of insight that leads to the new idea for a business, for example. Think about how to stimulate such insights. Whatever you did before when they occurred, try spending more time on it and see if new insights arise. What we learn faster than others and replicate faster than others is also what we are better at than others. Craft your business strategy around your most vital uses of time and those of your partners. What we choose as our new venture must express our unique ability to create ‘time-value’, and that of our partners.
The 80/20 principle tells us that there is an enormous difference between the few, best performers and the rest - that fewer than 20% of any peer group will typically achieve 80% of its results. Koch’s analysis shows that the wealth creators produce many times more wealth (on average 16 times, he says) than the merely competent majority of employees. Talent does not create wealth by itself, however - it turns into wealth only when brought into contact with powerful business genes - the vital few business ideas.
Koch shows that you, as an 80/20 individual, can enlist other great individuals to work on your great business ideas by exploiting the theory of ‘wealth/talent arbitrage’. This says that talent rarely has the right price. At the very beginning of its career, before talent has properly fused with the powerful business genes, it has little value and is overpaid. Before long, however, if talent mutates into wealth-creating ability, it may be underpaid. 80/20 individuals snap up young talent before its wealth-creation potential is appreciated. At first, the deal favours the talent. But before long the talent is converted into wealth creators and the 80/20 employer has a great bargain.
Koch also recommends bringing in creative ‘oddballs’ to the team but says that this process must be managed. Make sure that there is enough affinity between the oddball and existing staff for the mix to work. Ensure the oddball is integrated into the firm’s normal processes and not left as an ‘island of eccentricity’.
80/20 individuals take control of their own fate. Koch suggests that individuals who create extraordinary value typically produce returns that are between 20 and 200 times their compensation. There is no way that most firms can pay 80/20 individuals what they are really worth. To get reasonable value you may have to leave your firm and start your own business. You may be reluctant to do so, however, perhaps because you enjoy working with your current colleagues and are reluctant to go it alone. You may still be able to achieve your due monetary rewards and stay in the company. Business ‘incubators’ (such as those set up by BT and PricewaterhouseCoopers to spawn in-house entrepreneurial ventures) offer one approach. Consulting firms and their consultants - classic, mobile ‘knowledge workers’ - also offer equity/reward models for the future. Koch cites BCG which is run as a professional partnership sharing the profits among staff but retaining a significant portion for working capital. Management buyouts, though stressful, can be a great way to get rich if the conditions are right (Koch says that buyouts are in many ways a conspiracy between the management and the private equity financiers to pay less to the vendors than the business is worth.)
The 80/20 individual’s privilege is to select only the most profitable activities and most profitable parts of markets: the ones where the very highest returns on capital are made, with the minimum of management effort. The challenge is then to serve the customers in these market niches far better than anyone else. To do so, the 80/20 individual can use older and larger firms - and be much more profitable than them. For example, it is possible to take advantage of large firms’ over-capacity. 80/20 individuals don’t need factories, warehouses of offices - they can rent the property of larger firms or enter revenue-sharing arrangements with them, thus avoiding the need for capital. They can buy surplus assets or brands at a fraction of the original cost. Koch says that 80/20 individuals are lucky because large and mature firms are more willing than ever to do things for new or small ventures.
A tiny minority of capital creates a large majority of wealth. Wealth accumulates by allocating capital to the most productive users: 80/20 individuals. Koch says it is easier for such individuals to obtain capital than ever before. The 80/20 principle has smashed the link between capital investment and economic growth. Growth today is not greatly driven by capital but by technology, ideas and 80/20 individuals. In generating wealth today, it is not capital that matters but a small nucleus of capital coated with a large outer ring of powerful ideas and initiative pursued by 80/20 individuals. Koch’s guidelines for enlisting capital are: Use it where you can multiply it. Reduce your need for capital by using that of other firms. Raise more capital than you need - allow a margin of error in estimating your need for capital because the 1% of capital you don’t have can cause 99% of the damage to your business. Provide capital from your own savings - this one of the cheapest forms of capital so make it an iron rule to save 10-20% of your income for investment. Be obsessed with cash, says Koch - this is the acid test of 80/20 individuals who create unusually high value by adding a small amount of cash to extraordinarily powerful ideas.
To find the new 20% of inputs that will yield the 80% of results requires experimentation and insight. No successful or remodelled business can keep its formula unchanged for many years. Within three or four years, the 80/20 individual should be thinking about the great next leap forward, building on the success of the formula while extending and changing it significantly. Success, not failure, most urgently requires change.
Like its predecessor, this is a thought-provoking book that offers a new way to look at the world. Koch concludes by telling us that success at work is not a mystery. We are successful when we create more with less. This is the principle that drives all progress. Koch maintains that, whoever you are, you can create something new by following the formula. What are you waiting for, he asks?