I recently had a conversation with one of our senior managers about our company’s new banking division; he told me that only 21% of our cardholders account for 80% of spending. That skewed situation worried him greatly, and he wondered what we could do to spread our lending book more evenly. I’ve had similar conversations with the fundraising manager of a nonprofit I chair: The bulk of the funding comes from some 20 donors, which she tells me is unsustainable. The way she sees it, the organization is heading toward a cliff. Both of these reactions reveal a common cognitive error that has profound implications for leadership.
We Need to Let Go of the Bell Curve
Most human activities as well as many disciplines — from physics and biology to linguistics, finance, and computer science — follow a Pareto distribution instead of a “normal” Gaussian curve. In Pareto distributions, a small change in one variable is associated with a large change in another, because it reflects variables multiplied with each other rather than added to each other, as in the normal distribution. This is also referred to as a “power law.” This isn’t an obscure intellectual point, but instead carries serious practical consequences. Because of this error, our approach to most problems is, at best, suboptimal. What does this mean for business leaders? The author presents three practical implications for innovation, risk management, and people.