Are You Clear on the 20% That 80% of Your Returns Depend On?

by | Jan 12, 2021

You’ve probably heard of Pareto’s Principle. It explains why:

20% of your time leads to 80% of your happiness. ⏱️

20% of investments produce 80% of the portfolio gain. 📈

20% of customers are responsible for 80% of complaints. 📣

20% of my (many) idiosyncracies are cause for 80% of my wife’s frustration. 😖

As Pareto’s Principle explains… the world often tends to operate in a non-linear, disproportionate way.

Pareto's Principle

As investors and operators, the forces that dictate our success are imbalanced. Some variables are just more important—and have a considerably greater impact on the outcome—than others.

Eg. Mathematically, in a recurring revenue business, a 5% improvement in customer retention over a 5-year hold-period can have a materially greater impact on Year 5 EBITDA than the same 5% improvement in close rate on new business.

Apply this principle to driving people-powered performance in your portfolio companies, and it’s likely that 20% of the people in your portfolio companies drive 80% of the results in the business—and return to investors.  📈

In other words, certain people/roles are considerably more value-creating than others.

This, of course, doesn’t mean you don’t need the other 80%, or that they aren’t valuable. But it does bring to light the importance of getting these 20% right. 

Eg. If a big part of your investment thesis hinges on moving down-market to the SMB space… you better be sure you have an A-player in a growth-marketing role.

Eg. If investment success depends on keeping current customers aboard, keeping the business flat & cash-flowing… make sure you have a star in the customer-success or account-management leadership role.

As shorthand, we’ll call these roles “the vital few.”

And for investors that get that people drive performance, there are perhaps no more important questions to ask themselves than these… ⤵️

 

✅  ARE WE CLEAR ON WHICH ROLES MATTER MOST TO INVESTMENT SUCCESS? i.e. The 20% that will be responsible for 80% of the results? Our “vital few?”

Think of these “vital few” as being the fulcrum to your investment lever. In the same way as getting a fulcrum positioned at the point of max leverage makes a lever capable of lifting so much more… getting the right people into these critical roles puts the business in a position to deliver so much more.

Formulate a view on “the vital few” in due diligence, and get in the habit of having this discussion as a board early in the investment life.

In doing so, it is important that you think past the executive ranks.

According to a McKinsey study, “Of the 50 most value-creating roles in any given organization, only 10 percent normally report to the CEO directly. Sixty percent are two levels below, and 20 percent sit farther down.”

The best CEOs take a methodical approach to matching top talent with roles that create the most value. They don’t delegate this to HR.

As Ram Charan says in his book, Talent Wins, “something this big is a job for the CEO.” And I’d take Charan’s idea a step further: something this critical to investment success is also the responsibility of the board.

 

✅  DO WE HAVE TOP-NOTCH TALENT IN THESE CRITICAL ROLES?

Hate to break it to you, but research and psychology bear out that most of us believe we are great judges of talent… when the data tells us that that the average among us is, in fact, not.

In other words, many investors and execs live under the false impression that they’re more effective at answering this question than they actually are.

Not trying to insult anyone’s intelligence here (my own included :). It’s just science. See, there is this thing called the Dunning Kruger Effect that explains why people with low ability at something —in this case, evaluating talent— tend to overestimate their ability. Like a bug in our mental operating systems.

(This phenomenon explains why I can easily convince myself that I could go toe-to-toe with Pippin when playing my own shadow in an empty gym… only to get clobbered once I’m playing with other people!)

The overconfidence that this mental glitch causes can lead to costly errors in assessing leadership talent, and making critical personnel decisions.

And it shows in the data on hiring effectiveness.

Across industry, pay grade, and job title, approximately 50% of hiring decisions turn out to be mistakes.

In other words, the average professional talent decisions tend to be about as accurate as guessing the flip of a coin.

Good news is: there are a few practices that you and your portfolio leaders can use today to boost your effectiveness at answering the question: do we have top-notch talent in our most critical roles?

Check them out here ⤵️

Free Guide - Right Leaders Right Roles

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