80/20

Fractal Report
Your hosts: Perry Marshall, Bryan Todd and Sunny Hills

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TRANSCRIPT

The 80/20 Rule

Perry: First I want to mention The 80/20 Principle by Richard Koch. I think its the best business
book Ive ever read. Richard Koch is now actually a friend of mine. Hes very wealthy. His net
worth is in excess of $100 million dollars. His homes are in Gibraltar, Portugal, and Cape Town,
and hes made all kinds of money doing consulting work and getting pieces of deals. This book
just totally revolutionized my thinking. I will try to give you a flavor for this book.

I think most people have heard of 80/20. Most people have a basic idea what it is. I knew what
it was. Id heard about it for years. In fact, I remember when I had my Dilbert cube job I went
through all the orders that came in during a certain month, and I saw that, yup, just as people
like to say, 80% of the business did really come from 20% of the customers, and it was almost
exactly right. It was like, Well, okay, thats interesting. I guess that means you need to pay
attention to big customers more than little ones. Well, yeah, thats true, but theres so much
more.

I got to page 14 and it explained that the 80/20 principle is fractal. Its based on feedback and
chaos. That wouldnt mean much to most people, but it meant a great deal to me because I had
studied this stuff. To take a little bit of a detour, but its actually completely relevant, I had read
this book about fractals and chaos theory like 15 years before when I was in college, and it
showed how things like trees and rivers and sand dunes and ice crystals are repetitions of
simple patterns. You could actually take a pretty simple formula and just run it and run it and it
will create an infinitely complex pattern, and the pattern repeats. Ill get into this in a little bit.

I remember walking out to my car the next morning and seeing the ice crystals on the top of the
car and going, Oh my goodness, this is everywhere. All the sudden I saw this is everywhere,
and I couldnt not see it anymore, and all the sudden I had this new way of seeing the world.
Every time I looked at a tree or a river or really all kinds of things the way your veins branch in
your lungs or your hands, all kinds of stuff I saw that micro-pattern macro-pattern repeating
repeating.

What this book explains is that 80/20 is the same way, and all the sudden I got it and I
understood it and it lit my mind on fire. Im like, Oh my word, I think everything in my business
fits this pattern. I went home and started looking through my papers and files and numbers
and everything, and it was exactly right. This is always going on inside my head whenever I do
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anything, whether Im writing copy or segmenting the email list to blast out an email or if were
setting prices or just about anything.

So this is a great book and I definitely recommend you pick this up. When I read this book when
I was in college it talked about fractals, and what you see here is three different kinds of
fractals. A fractal is a very surprisingly simple little equation that you stick in a computer, you
assign colors to numbers and then you put a number in, you get an answer, and you take the
answer and feed it back in, and just keep cycling it around and around and around.

If you plot it on a two-dimensional piece of paper you get this pattern here on the left. This is
the pattern of a particular little math equation. Its very simple. If you look very closely you see
theres a circle, theres a circle growing on a circle, theres a circle growing on that circle, theres
another circle growing on that circle, and on and on it goes. Its actually infinite. You could
zoom into this picture an infinite number of times and you would keep seeing this pattern again
and again and again.

The Sierpinski triangle shows a triangle in a triangle in a triangle in a triangle and you could do
that infinitely. How many triangles will fit in this triangle? An infinite number of triangles.

The 80/20 rule works on the exact same principle. What that means is that the 80/20 rule is
actually infinitely powerful. In a finite situation its not infinitely powerful, but its pretty close
to it. This is so incredibly powerful. I hopefully will explain all this in detail to where you can all
suddenly see something that you probably never used to see before, and from this point
forward youll never be able to un-see it.

Take a look at a diagram of fractals. It could be branches of a tree, it could be the veins inside a
leaf, it could be the veins inside the veins in a leaf, it could be anything where we take a line
and then we make two more lines that are a little shorter than it, and they branch out at a
certain angle. Then at the end of that line we draw another line and set of lines, and it just goes
on and on. This is a fractal pattern.

There are fractal patterns in your business. If you know how to harness them, then you can
change one little thing and it reflects out into everything in your business. This is how you get
huge leverage points in complex businesses where theres just a few things you have to change,
and all the sudden everything gets better.

80/20 applies to almost everything in business that you can measure. Its not absolutely
everything, but most things have an 80/20 aspect.

80% of your sales come from 20% of your customers.
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80% of the customer service complaints come from 20% of the complainers.
80% of the customer service issues come from 20% of the things that are broken in your
business.
80% of the product defects come from 20% of the kinds of defects. Is it a transmission?
Is it a spark plug? Is it the brakes? Is it the engine? Whatever the list of things is, 80% of
the defects happen in 20% of the list.

When you start measuring stuff, everybody always starts talking about averages. We all know
what average means, and average is useful, but if youre an 80/20 thinker, average never tells
you the most useful things. This is really important. I want you to pay close attention.

Im sure most of us have gone to a class or taken a test and the teacher drew a little distribution
on the board and she said, Well, 15 of you got between 70-80, 13 of you got between 80-90, 4
of you got between 90-100, and 11 got between 60-70, and shell draw this bell curve. Shell
say, The average grade in the class was 77.

Okay, thats a useful piece of information. It tells you something about how much they all
learned, but 80/20 invites you to draw the picture differently. In 80/20 were going to line the
students up from bottom to top, from left to right. Were going to put the worst students on
the left and the best students on the right, and were going to put their ability to take the test
on the up and down scale on the Y-axis. When we do that were going to get a curve that looks
like that skew curve on the bottom.

The bell curve says how many people got what score. The vertical axis is the number of people,
and the horizontal access is the score. It emphasizes the average student. You look at the
above-average students and you go, Oh, those are outliers. They dont really have much
effect. But when you look at it in a skew curve, which is 80/20 oriented, what that curve tells
you is, Where are the brains in this class?

Now, theres different kinds of brains. Theres science brains, theres math brains, theres
literature brains, theres basketball brains, and theyre all different, but if were measuring one
certain thing, if this was a history test and if were measuring interest and capacity for history,
20% of the students have 80% of the interest, and almost all the action is in this small number
of students. Theyre the ones that are going to be a history professor when they grow up. The
ones that are average are not going to do that. They dont matter. What matters is the skew
curve, not the bell curve.

This is a really big deal. Almost everything that I ever see that is measured or counted, in my
minds eye I stick it on a skew curve and go, Okay, so who are the top 20%, and whats the
bottom 80% that I can just ignore?
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On that curve here, 20% of the area is in the 80% on the left, and 80% of the area is in the 20%
on the right. What were going to do is take a bunch of customers or a bunch of purchases or a
bunch of products or whatever it is that were interested in, and were going to line them up
from top to bottom.

In this particular example weve got 25 people, and person #25 accounts for $16,000 out of the
$50,000 of business. The one person generated a third of the business. The top five people
generated 80% of the business, and the bottom 20% of the people barely made any difference
at all.

This is how you want to look at everything. If you do this and you start focusing your energy on
the disproportionate small number of people that make a big difference, you save yourself a
ton of work.

The numbers 80 and 20 are not carved in stone. Its probably the most common, but it could be
60/40, 70/30, 95/5, 90/10, or whatever it happens to be. 80/20 is a nice typical number that
you run across thats very common, and your numbers almost always fall into this kind of
distribution.

This is called a Power Curve. Ive been applying this Power Curve for years, and it makes very
accurate predictions about whats going to happen. When we introduce a new product at a
price, and weve never even had anything at that price before, I can look at other things weve
sold and the price were offering and almost always my prediction is going to be pretty close to
right.

Most people, especially Americans, are trained to ignore inequality. The Declaration of
Independence says, We consider these things to be self-evident, that all men are endowed by
their Creator with certain inalienable rights life, liberty, and the pursuit of happiness, and we
believe that everybody is equal. Well, that is a spiritual judgment that really comes from
spiritual values. Its not based in anything that you can actually see or measure in the real
world.

Bryan: Thems fighting words there, Perry.

Perry: Hey, you know what? Nobody even thought of it before basically St. Paul. It never even
occurred to anybody that everybody was equal. If you went back 3,000 years and said, You
know, everybodys really equal, they would look at you like you were from Mars. What do
you mean were all equal? Theres kings, theres noblemen, theres peasants, theres slaves,
theres prisoners, and men are obviously better than women, and the Greeks are obviously
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smarter than Romans, or whatever the prejudices are. Everybody at one time would have
agreed that everything is unequal.

The concept of equality came from Christianity, and I agree with the equality idea, I espouse it, I
think its the only thing that makes our modern Western civilization possible. However, you
have to take off those glasses when you do business, or you have to be able to take them off,
because if you treat everybody the same you will be broke. Theres no business rationalization
for treating everybody the same. If you truly treated everybody the same, you just give
everything away and go bankrupt.

Real actual nature is unequal and unfair. Civilizations reason for existence is to fight the
inequality. Fighting inequality is the definition of a civilized world. Really what Im describing to
you is the conflict between a Darwinian world and a kinder gentler world. Sorry if this seems
philosophical, but its actually really important.

We all get one vote in an election. Were all equal. There are certain government entitlements
we have. We have means of taking care of the sick, taking care of the poor, taking care of
people who are handicapped, and all that kind of stuff. We have free education for everybody.
All the arguments in politics about how we do this kind of stuff and how much we should do it
and how much free handouts there should be and how much free education there should be
and how high taxes should be theyre all arguments about 80/20.

All of it is about 80/20, because the natural way that the world wants to work is that the poor,
the sick, and the old get tossed into a meat grinder, and the young, the strong, and the wealthy
get everything they want. When your usefulness has expired, we just send you to pasture or
shoot you dead or something. Im deliberately being dramatic about how I say this because I
want everybody to be consciously aware of what is going on and which set of rules youre
operating by on any given day.

In business you have to obey the law of the jungle to some degree, and its greatly to your
benefit if you want to harness it. Actually, if you want to be generous you have to harness
80/20. This is what everybodys arguing about on the Perrys greed blog post. A lot of you
have seen that. If you havent, go search Perrys greed and youll find it really easy.

I told a bunch of people at a seminar, I get all these lunch invitations, and theres no free
lunches. If you want to have lunch its $700 an hour, and I mentioned it on my blog and some
people got really mad. They were like, You need to be more generous, and I said, I am
generous. Im generous to poor people, not you. Im generous to people on the bottom of the
pile, not people in the middle of the pile. You have to be aware of what youre doing and who
youre being generous to.

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In your business you need to give much better service and much better attention to the people
that give you a lot of money as compared to the people that give you a little, and you need to
market much harder to people that give you a lot of money than people that give you a little.

Basic 80/20 says the 20% thats effective is 16 times more effective and more powerful than the
80% thats not effective. If 80% of your business comes from 20% of your customers, a top 20%
customer is spending 16 times more money than a bottom 80% customer.

If you go hire 10 sales people, at the end of the month youll find that two of them have sold
more than the other eight by a factor of four. Person for person, the two are 16 times better at
selling than the other eight. Youll almost always find this to be true.

Sunny: To illustrate that, we would say if your total sales were $1,000 and you had 10 sales
people, two of them are going to do $400 each and eight of them are going to do $25 each. If
20% of your people are giving you 80% of your return, the payback is a factor of four that Perry
just mentioned. If 80% of your people are only giving you 20% of your results, $200 total all
added together, your payback factor is 0.25. 4 is 16 times greater than 0.25.

80/20 is a relative term, so if it turns out that your factor really is 75/25, then you only get 9
times more, not 16, but if youre in an area where its really 90/10, you actually get 81 times
more return from a 90/10 situation if you focus on just the 10% who give you 90% of your
results.

Perry: Thats exactly right. This is one of the most important slides. Its like write this in blood.
When you do an 80/20 on any group of people or situations, the 80/20 rule still applies to the
top 20% even after you got rid of the bottom 80%.

If 80% of your sales come from 20% of your customers, that means that 80% of the 80%
also comes from 20% of the 20%.

If I have 1,000 customers and 80% of the sales come from 200 of them, then I can ignore
the 800, look at the 200, and the 80/20 rule will still be true of the 200. The top 20% of
200 is 40, and I will get 80% of my sales that are left from the 40, and only 20% will
come from the other 160.

That means that 64% of your sales come from 4% of your customers.
51% of your sales come from 0.8% of your customers.
41% of your sales come from 0.16% of your customers

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Lets take that 51%. Basically, if your business is properly built, if you have a product line with
enough different things in it, youll get half your sales from 1% of your customers. Taking really
good care of 1% of your customers is way easier than taking really good care of 100% of your
customers. Marketing to 1% of a population is way cheaper than marketing to 100% of a
population.

Sunny: Plus if 1% of your customers are giving you 50% of your sales, what a shame it would be
to give them only 1% of your effort.

Perry: Thats right, but thats what most people do, or they might give them 10% of their
effort, but they should really give them 50%.

80/20 shows up everywhere in Google AdWords. My famous How to write a book ad group had
7,000 clicks and 80% of the clicks come from two of the keywords. Actually, our experience with
keywords is its like 95/5 more than its 80/20. Theres a big long list of keywords in this ad
group, so thats actually about right.

Everywhere theres these tiny little leverage points, where you dont have to fix the whole
thing. If you fix 1% or 5% or 10% or maybe 20% of it, youve fixed almost all of it, and thats
really useful.

I just showed you here where theres 80/20 to the power of 1, 80/202, 80/203, 80/204, so its
got these layers. Its also got dimensions:

The ways customers behave in a certain month
The ways your customers behave over a period of time
Your product sales, like which products people buy
Which products are profitable
How long it takes to develop a product
Which vendors you give your business to
Which people refer people to you

80/20 will apply to all these, and it will apply to them in a different way. Every one of these is a
leverage point. You could look at your best customer this month and find that out, and it will
immediately indicate at least who you should be doing something for that will get you a lot of
results for not much effort.

The same thing with a long period of time. The same thing for the product that sells the best.
Maybe theres one little reason why most people buy that product, and if you improve that
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reason or make it better, you might get 10-20% more sales from very little change in your
product.

You might find that profitability is a completely different issue than sales, and that you really
want to focus on your most profitable product. This is a very common thing that people
overlook. All you have to do is look at things and you go, Well, I can measure this; therefore
its 80/20. Therefore, wheres the 20 that generates the 80 and what do I need to do to make it
bigger?

It also applies to the negative stuff in your business: problem customers, problem employees,
shoplifters, breakage, problem products, troublesome keywords. Who or what is the biggest
single frustration or irritation you constantly deal with?

You could go, Whats the product I have the most trouble with? Who are the employee I have
the most trouble with? Whos the customer I have the most trouble with? Whats the vendor I
have the most trouble with? Get rid of all those things and you just made your life a whole lot
better.

Bryan, I think you have a story to tell here.

Bryan: 80/20 is the best and most intelligent way to diagnose and track down problems and
issues, whether its in your business or in specific functions of your business or what have you.

This story comes from Nancy Schlessinger, whos a former Bobsledder and a former Round
Table member. She always loved our teaching on the Pareto Principle and 80/20 because it was
something that she had learned herself in her manufacturing and production days.

Years ago Nancy managed a department of a company that did all kinds of manufacturing and
production, and one of the things they produced was the little coin slot mechanisms for some
of the vending machines. This was back in the 80s, so they were slightly less sophisticated than
they are today, but they dealt with the coin dispenser mechanisms and they manufactured
them and sent them out.

When she arrived on the job and she was going to be the manager of all this production, one in
every four that they sent out to go put in a vending machine ended up coming back with some
kind of product defect. In other words, 25% of their products were coming back to them to be
repaired, returned, refunded, what have you, which was a pretty lousy quality control thing.

So what did she do? This was back in the days before you could just do this easily in an Excel
spreadsheet. She applied the 80/20 principle to these little coin boxes. She went through, and
with every single one that came back, she marked down on a chart what the reason was that
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the thing was defective, or if their team had to examine it they would mark that down for her.
She assembled this in a chart and ranked it using 80/20 in descending order from most frequent
to least frequent.

What she found was the single most frequent cause of defects in this was bad soldering. In
other words, if they got 100 of these things back, there may have been 20 or 30 of them that
had gone bad just because they had bad soldering. In another set maybe it was 15 or 20 where
the problem was a little light prism that they used back at the time in order for the transaction
to take place.

She fixed the soldering problem, which was the single most frequent cause. She fixed that first,
and it was actually fairly easy to deal with. When she did that, she went from basically 100
defective items down to 70 defective items. Then again using 80/20 she went to the next
biggest cause, which was something about the prism mechanism, which she said was a real
bear to fix, but she dealt with it. When she did that, she had gone from 100 defective units to
80 defective units, and now she went from 80 down to 61 defective units.

Boom, boom, boom, boom, starting with the most frequent cause all the way down to the least
frequent cause, she and her team figured out how they were systematically going to improve
the production of these so that they didnt have these things coming back. Thats what she did,
and without going through all of the causes of these defective machines, she ended up going
from a 25% return rate on these to a 2% return rate.

You start with the single biggest cause or the single biggest problem, frustration, or issue. You
devote all of your time, energy, and attention to solving that one problem, and boom, 20%,
30%, or 40% of the occurrences of that problem are gone just because you focused on one
thing. Then you go back and rinse and repeat, rinse and repeat, rinse and repeat, and you can
have the same success like she did in her particular manufacturing job, going from a 1:4 return
rate to a 1:50 return rate. Thats how you deal with the 80/20 rule.

When I go into an AdWords account, Im always ranking keywords in descending order either by
impression or by cost, because I always want to be doing the work at the top of the list where
theres the biggest impact to the bottom line. Its the same principle in an AdWords account as
Nancy was using with the vending machines.

Perry: Its pretty good when it works like that. Its like that fractal thing with the repeating
pattern, the repeating pattern once you see 80/20, you see it everywhere. The room Im
sitting in right now, the square footage is probably like 3-5% of the house, but it was 50% of the
decision. It was like, Oh, I love this room. I want this house. When people buy a car or buy
anything, theres usually one or two little things that tip them over the edge, and thats why
they bought it.
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Bryan: Let me mentions the Sierpinski Triangle again. I think this is really important. What if
you thought of lets say problem customers as being represented visually in something like the
Sierpinski Triangle? The little tiny black triangles represent customers that have little tiny
problems or create little tiny headaches for you and your staff, and the big triangles are the
customers that create the bigger headaches.

What would it mean to you, your staff, your organization or whatever if you simply started with
the single biggest troublemaker and dealt with that person? You either made them happy or
sent them packing, and then went to the next biggest cause. What would that mean? Can you
visually look at the Sierpinski Triangle and see what a big gap it would leave in your time,
energy, and efforts that you could fill with productive stuff rather than unproductive.

Sunny: Immediately and intuitively, of your problems would be eliminated with that one
person. Its the equivalent of eliminating 64 people who create small problems, and youve
dealt with just one person. Thats pretty powerful.

Likewise, I think the business advantage you have of using 80/20 in every aspect of your
business is tremendous because, for instance, in that earlier example where 1% of your
customers give you 50% of your profit, if your competition is giving 1% of their attention to
their best customers who are giving them 50% of their profit, and youre giving 50% of your
attention to that 1%, who do you think that 1% is going to stay with over time as far as
customer retention? Obviously the customer service you put into it, if youre doing it in the
ratio of 80/20, your best customers are going to immediately notice that.

I spent around 90 nights in Marriott hotels from May through September. I said, And guess
what? Im now Platinum Elite and they treat me like a king. It was amazing what they did.
Perry goes, 80/20. Hes right.

Bryan: In Planet Perry weve just seen this over and over with our favorite and most responsive
customers. The more time and attention we devote to them deliberately and purposefully, the
more they repay our efforts, in some cases very literally.

Sunny, youre an 80/20 example yourself. In other words, you were committed to the Bobsled
Run, obviously. You did a lot of work and stuck with us, and that gave us a chance to get to
know you better and develop that relationship further, and eventually it was a no-brainer for
Perry and me to say, You know what? Its time for Sunny to join our Bobsled Run as a coach.
When you view these relationships through an 80/20 lens, your best customers just become
even better and more valuable.

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Sunny: In the 90s I had a retail store, and I started that thing working out of my home with no
inventory and no employees and no money, and 12 years later had a huge store bursting with
inventory, 15 employees, and I got to sell that and retire at age 47 and live on Maui.

What was happening was over the time I didnt even know 80/20 and wasnt even thinking of it,
but I started identifying in my inventory essentially the 10% of inventory items that produced
90% of my net profit, and the 10% of my customers who produced 90% of my net profit.

If you have retail inventory, if you start identifying which of that inventory moves the fastest,
has the widest margin, or a combination of those two, and you focus on stocking that
inventory, and then figuring out the inventory that doesnt move or doesnt have enough
margin and shedding that inventory, suddenly your inventory itself is just becoming so effective
compared to your competition.

I think that kind of gets into the next slide about recency, frequency, and money, because thats
the kind of charting I did with the inventory and with the customers. I think thats where were
headed. 80/20 was being applied fortunately by me, without reading that book and without
really knowing the principle, and it made all the difference.

Perry: A lot of people do it instinctively, but when you all the sudden realize that theres a very
predictable pattern to the way the numbers work, it greatly increases your ability to make
predictions. This is why I did an entire two-day 80/20 seminar really a three-day seminar
several years ago. I spent an entire seminar talking about 80/20. Its really deep.

Lets go back to where we were. There are some things about 80/20 that just kind of tumble
right out. The first one is good enough is good enough. It means that when the most important
stuff is right, the unimportant stuff probably doesnt matter.

What that could mean is if a band makes an album, sometimes you know which song is going to
be the hit song. If the hit song is perfect, the other songs do not have to be perfect. If the other
songs are good enough, that is good enough.

An interesting aspect about 80/20 is that, first of all, 80% of the people in the world are never
ever going to hear any of those other songs. Theyre only going to hear the hit song, and the
only people that care about the other songs are the small percentage of people in the audience
that get into every song and follow the artist like crazy. Then it just has to be good enough for
them, which in a lot of cases might just mean you did like one interesting thing, but everything
doesnt have to be like that. Good enough is good enough.

It also defines an ascension process, and heres a writer-downer. Heres what it means. It
means that if you sold whatever it is that you sell if you sell tires, if you sold this certain kind
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of tire that costs $100 apiece and youve got 100 customers who bought $100 tires what it
tells you is that 20% of them are capable of, and in fact inclined to spend four times as much
money to scratch the same itch. In other words, 20% of the time, 20% of them would spend
$400 on a tire if they were offered a sufficiently awesome tire. That might seem hard to apply
to tires. Its easy to apply on things that are less commoditized.

If 100 people buy a $10 book, 20 of them would spend $50 buying a DVD, and of the 50, 1/5 or
10 of them would buy four times the $50. They would spend $200 on a training course or some
further extension of the book. Of the 10, 2 of them would spend $800 on coming to a seminar.

Youll find that these numbers are actually surprisingly accurate. 100 people buy a book, 20 buy
a DVD Im doing math in my head so I know some of its wrong, but you get the idea. These
numbers end up being surprisingly accurate, so I apply it to everything.

Am I paying attention to all the friends in my life and all my Facebook buddies? No. Am I paying
attention to my closest friends? As long as Im doing that Im not screwing up too bad.

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