The Pareto Principle, Part III:

Entropy and the Impossibility of Equality 

“If you don’t like something change it. If you can’t change it, change your attitude.” – Maya Angelou

Let’s talk about the Second Law of Thermodynamics…

The Second Law of Thermodynamics states that “the entropy of a system never decreases over time. Instead, systems evolve towards thermodynamic equilibrium, which is the state of maximum entropy.”

In layman’s terms, this means that everything in the universe has a natural tendency to fall apart. To become less structured and more chaotic.

And by ”everything,” I mean everything: the galaxies, the solar system, and the Earth. The Earth’s oceans and mountains, its countries and cultures, its denizens, molecules, atoms, and subatomic particles.

In our day-to-day lives, entropy is the reason that absolute order – in anything – can never be maintained. As James Clear, author of Atomic Habits, explains, there are simply so many more ways that things can go wrong than right:

“Imagine that you take a box of puzzle pieces and dump them out on a table. In theory, it is possible for the pieces to fall perfectly into place and create a completed puzzle when you dump them out of the box. But in reality, that never happens. Mathematically speaking, an orderly outcome is incredibly unlikely to happen at random.”

Entropy and Equality 

Let’s switch topics for a moment and get back to an idea that we looked at in Part I of this series. [LINK 7/13] I’m talking about the idea of equality and the current global movement to achieve equality in economics, governance, education, and even health.

When I was young, the campaign for equality was about the protection of equal rights under the law. The law was based on the Constitutional thesis that all men are created equal and are thus endowed with the unalienable rights of life, liberty, and the pursuit of happiness.

Today, the call for equality is very different. It is a call for equality in terms of outcomes. The logic is that inequalities in desirable circumstances – e.g., income or social standing – are inherently bad.

(Please notice that I am not addressing the “why” argument advanced by post-modern leftists: that the cause of inequality of outcomes is “systemic” racism and gender bias. We don’t need to address that for the purposes of this discussion.)

Question: How does this idea of equality – this ideal of equal outcomes – work in the real world? How does it fare in a discussion that accepts the validity of one of the most important laws of physics?

Answer: Not very well.

Let’s start with this…

Equality is about order. It’s about balance, aesthetic preferences, and, for many people, ethics: how things should be.

But from the perspective of the Second Law of Thermodynamics, it’s easy to see that it is an impossibility. Actual equality – in any form whatsoever – is a state that is contrary to that law. Nature is designed to destroy it. Its chances of existing in any system (anything, anywhere) are one in a trillion. And if, by chance, some state of equality occurred, it would be dissolved in a nanosecond because of entropy.

As applied to wealth, equality is an idea that we may find appealing. We can, if we want, make it an ideal towards which to strive. But the effort, however great and sustained, will be futile. Because the universe, as I said, will not tolerate it.

Imagine wealth equality as an acre of landscaping – a patch of perfection that you create in a tropical jungle. If you worked 24 hours a day trimming, fertilizing, watering, and otherwise tending to every blade of grass, you might be able to maintain its perfection for a while. But the moment you took a nap, the jungle would reclaim its rightful domain.

Consider the many historical revolutions that occurred to (at least partly) establish economic equality. What happened with them?

In every single case, it was the same. The revolutionary leaders (who were mostly upper- or upper-middle class) replaced the former rulers (also mostly upper- or upper-middle class). Most of the wealth of the ejected class was claimed for “the people,” but stayed in control of the new rulers. A sprinkling of that wealth was dusted on the poor. (Which did them no economic good at all, as their numbers, as a percentage of the population, did not diminish.) The laboring class continued on as the laboring class. The big losers were usually the merchant class – the entrepreneurs that were responsible for the wealth that existed. They paid the bill. (No need to believe me now. I will prove it to you in a future essay.)

My big point is this: Attempts to equalize wealth have never worked. The inequality that was so unbalanced before the revolution was always – after a year or so – equally unbalanced after the revolution. The only difference was that some of the faces at the top changed.

Once again, the Pareto Principle :

This, of course, gets us back to where we started: the 80/20 Rule, a.k.a. the Pareto Principle.

We have established that in virtually every free market economy (and even most controlled economies), there is an inequality of wealth ownership/control that is roughly 80/20. And we have wondered why that is.

My idea is this: Pareto’s Principle “works” because it is aligned with the Second Law of Thermodynamics, one of the most universal principles of physics. The Pareto Principle is, in fact, a mathematical ratio that roughly describes the natural state of entropy.

Put differently, the Pareto Principle tells us that with respect to wealth, the universe wants there to be an imbalance that is roughly 80/20. And that, however much we try to equalize wealth through legislation and economic incentives, nature will do everything it can to achieve this preferred equilibrium.

So what? 

You may find my little proposition repugnant. The notion that inequality is nature’s preference rubs against the grain. It argues with your better instincts. You want to dismiss it out of hand. You find it absurd.

I get it. But I think the evidence is on my side.

Two questions I’ve been trying to answer since I got on this train of thought:

1. Why would nature want entropy to be the standard? Why would the universe be designed to move from order to disorder? It seems like the wrong direction.
2. If the universe is programmed to move towards disorder, why do people keep trying to create order? Why do we continue to try to improve our lives? Why are we always trying to make everything better?

For the moment, I have only two weak answers to these questions.

Why is the universe falling apart? It’s not really falling apart. It’s expanding. Falling apart is how it feels when you are a tiny part of it. For you, things are always out of order. But for the universe, things are moving as they should – outward.

Why do we keep trying to create order out of chaos? Why not just give up and go with the flow? Because it’s just the way we are. Homo sapiens is a peculiar animal. It is 99% the same as all other animals, but 1% different. And that 1% has to do with our undeniable and unstoppable instinct to change and improve things.

Whether it’s a question of how we find shelter or feed ourselves or protect ourselves, the history of Homo sapiens is the history of one of 100 million animals trying to create change.

And that, to me, explains the current ideal of equality in the US. Since the old standard of equality under the law has been largely attained, social justice warriors now are clamoring for a new standard: equality in outcomes. Today, if you are some version of a thinking ape and equality is your subject matter, you are being pressured to advocate for this change… regardless of whether it makes any sense in terms of the Second Law of Thermodynamics or the Pareto Principle.

It’s not going to work. But you can try. And if you do, you will likely feel virtuous – righteous and morally superior.

If you try very hard, you may be able to change the wealth inequality ratio from 80/20 to 70/30 or even 60/40. But remember this: The new equilibrium will last only for a brief moment in time. Because the very second you achieve that bit of change, everything in nature, including the people you are “trying to help,” will begin the relentless move back to nature’s comfort zone. Which, thanks to Vilfredo Pareto, we understand.

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“The way is long if one follows precepts, but short… if one follows patterns.” – Lucius Annaeus Seneca

The Pareto Principle, Part II:

A Universal Law That Even Applies to Business 

The Pareto Principle would be a significant contribution to learning if it applied only to economics. But as I said in Part I of this series, it applies to just about everything. Whenever and wherever you measure resources or the relationship between cause and effect, you’ll find this lopsided distribution.

A few examples:

* 80% of taxes are collected from 20% of taxpayers.

* 80% of government spending goes to 20% of its expenditures.

* 80% of new technology is patented by 20% of technology companies.

* 80% of the drugs approved each year are made by 20% of the research labs.

* 20% of criminals commit 80% of all crimes.

* 20% of drivers cause 80% of all traffic accidents.

* 20% of factories produce 80% of the pollution.

* Through the 2015-2016 NBA season, 20% of franchises won 75.3% of the championships.

I could go on, but you get the point. Economics. Science. Human behavior. Sports. In playing with his pea plants, Vilfredo Pareto seems to have discovered some sort of universal pattern.

We’ll look into the philosophical implications of this on Friday in Part III. Today, let’s take a look at how the Pareto Principle applies to something very practical. Let’s talk about business.

Understanding business through the 80/20 lens 

I don’t remember exactly when I first read about the Pareto Principle, but I’m certain I did not grok it early in my career. It wasn’t until I was running a multimillion-dollar company in which I had secured a profit share… and there’s a good reason for that. There’s something about aligning one’s interests with those of the business that makes such insights invaluable. It is immensely helpful in analyzing problems, understanding challenges, and making important decisions.

Since then, I’ve written about the 80/20 rule many times. And now that I think about it, I can say that the Pareto perspective was responsible for all of my bestselling business books, including Automatic Wealth and Ready, Fire, Aim.

There are so many examples of how the Pareto Principle applies to business:

* 20% of a company’s salesmen produce about 80% of its sales.

* 20% of a company’s customers/clients account for 80% of the purchases made.

* 80% of all customer complaints come from 20% of the customer base.

* 80% of customer complaints are related to 20% of the company’s products.

I could list hundreds.

But there are three categories that stand out:

1. The 80/20 rule in product development 

If you look at almost any business, you will find that about 80% of its revenues come from only 20% of the products sold.

This seems obvious to me now. It’s almost a bromide. But it was a revelation when I first figured it out.

At the time, we had about 20 product lines and were doing about $20 million in revenues, with average revenues of $1 million per product. I was well aware that some products performed much better than others. But until I looked at our sales from the Pareto perspective, I didn’t realize how lopsided the distribution was.

Sixteen of our products generated sales of $5 million. They averaged just $312,500 each. The rest of our sales – $15 million worth – came from just 4 products. An average of just under $4 million each.

The imbalance was much more extreme than I would have guessed. But it allowed me to understand, instantly, that my habit of giving equal attention to all of our products was a big mistake.

The cost of producing and marketing each product was about the same, but the revenues were so terribly uneven. It was easy to see that we were basically losing money on 80% of our products and making huge profits on just 20% of them.

If profits were the lifeblood of a business (and they are), why was I not giving 80% of my time and attention to the 20% that would yield 80% of our profits?

We had ben dividing our marketing resources equally among the products we were selling. After understanding the Pareto Principle, we directed 80% of those resources to the top three or four. That resulted in a much faster-growing customer base, and, subsequently, higher revenues and profits.

2. The 80/20 rule in customer spending 

After learning that lesson, I began to apply it to every other aspect of our business. One challenge had been the issue of customer lifetime value.

In our industry (information publishing), we measured our long-term success by renewals. The average first-year renewal rate was about 20%. It was generally accepted that if you could raise it by increments – to about 50% in the second year and 60% thereafter – you could grow the business.

Then one day I met a man named Jay Abraham who had a crazy idea he was peddling about what he called “the back end.” The idea was that instead of trying to boost our renewal rate by increments, we could do much better by immediately selling existing customers more expensive versions of what they had already bought. If, for example, they had spent $39 for a newsletter on executive productivity, we could sell them a special report “on the backend” written by an expert on the same topic for, say, $79.

I got it instantly, because I was thinking in terms of 80/20. I was pretty sure that 80% of our existing subscribers would never buy a more expensive back-end product, but that 20% of them would. And the first test we did – selling an information product for hundreds of dollars – more than verified that. It blew us away! (Today, the same sorts of back-end information products often sell for thousands.)

3. The 80/20 rule and the people you depend on to make your business grow 

Those two applications of the Pareto Principle made me a better at developing products and marketing them. But I’m most excited about a realization that came late in my career.

I was thinking about the writers, editors, publishers, copywriters, and marketers I had worked with, and it occurred to me that Pareto’s Principle applied to them as well: A relatively small percentage – maybe 20% – had been responsible for the great majority of the business success I had witnessed.

I should qualify that. Building a business is a collaborative effort. Dozens or hundreds of people are involved in getting the work done.

But it would be naïve to pretend that everyone is equally responsible for its success. There is always a small number that stand out clearly. They work harder. They think harder. They never run away from a problem. They never hide a mistake. They treat your business as if they owned it. In the skyscape of any company’s employees, they shine where the best of the others only glow.

Although money matters to them, these superstars are not motivated by it. Nor are they motivated by the desire for approval. They are unique. They are rare. And they are worth their weight in gold.

Based on my observations, if you are very lucky, 20% of your employees will be superstars.

Something to seriously consider.

I’ve heard it said that the Pareto Principle is the best-kept secret in business. That’s difficult to believe if you are familiar with business literature. There are literally thousands of articles, essays, and manuals written about it every year.

So, no, it’s not the best-kept secret in business. But it is routinely ignored. I’m not sure why that is, but I do know this: If you pay attention to the Pareto Principle in your business, you will be glad you did.

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