Pay attention to power law distributions

My mom is a dermatologist and her favorite drug is Accutane. If you haven't heard of it, Accutane is the amazing pill that cures even the most extreme cases of acne. Despite being a wonder drug, Accutane requires a fair amount of explanation for new patients. After 25 years of perfecting her talk, it still takes 10 minutes to touch all the bases.

One morning a few weeks ago, right before her first patient of the day, she decided to film this 10 minute explanation on an iPad. Now when she has a new Accutane patient, she hands them the iPad, goes to see another patient, and then comes back to answer any questions that remain.

The results have been incredible. Not only do her patients rave about the new video, but she now has more of her most valuable resource: time. Relative to the investment of a few hundred dollars for an iPad and 10 minutes of her time, the payoff has been astronomical.

Power law distributions

A couple of days after discussing the iPad video with my mom, I reread a discussion about the importance of power law distributions between Peter Thiel, Paul Graham and Roelof Botha. These are the notes from Peter Thiel's class called "Startup" at Stanford business school as recorded by Blake Masters. It's a great read.

Power law distributions are really important to understand. The class at Stanford discusses this concept with respect to startup investments: you plot all your investments from best to worst on the x-axis, and your investment returns on the y-axis. Most people expect that this curve would be fairly flat (a linear distribution), implying that the difference between the return of each investment would be about the same. In practice, most venture capital funds live in a world of power laws, where the best investment returns more money than the rest of fund combined, the second best returns more than the rest combined, and so on.  Venture capital is one obvious manifestation of power law distributions, but we see this phenomenon all over. In industries susceptible to the "superstar effect", such as sports, movies, or politics, the outcomes of top performers tend to follow a power law curve. The best baseball player makes a lot more than than the 100th best player, who makes much more than the 1,000th best player. "A-list" actors do dramatically better than "C-list" actors, who do dramatically better than struggling artists in Manhattan. The president has much more power than senators, who have much more power than local officials, who have much more power than me.

There are more power law distributions in our lives than we think

In my mom's case, if you lined up everything she has done to try and improve her practice's efficiency from best to worst, the payoff from the iPad video would be on the far left of her power law curve. It was probably worth shockingly more to her efficiency than her average improvement.

We are all constantly exposed to these kind of curves in our own lives with our investments of money and time.

We spend money on a lot of things that don't provide us with that much happiness, but a small number of purchases produce amazing returns for our happiness (think your favorite shirt, an incredible pillow, a perfect gift for a friend, or maybe even the dopamine-releasing iPhone, despite the offsetting high cost). The curve for our time investments is probably even more pronounced. Sometimes we spend hours making little progress on problems that won't even be that helpful if solved, and other times we spend 30 seconds writing an email that turns out to be hugely valuable in our personal or business lives.

The important thing to remember is that there are outsized returns for a small number of our "investments", and it's worth a great deal of our time and energy figuring out how we can be more likely to make these investments. For my mom this may mean asking other dermatologist what high impact changes they have recently made in their practices.

Almost always, these outliers have an element of unpredictability; you can never know for sure which early stage startup will be worth a billion dollars, which email will be worth a huge multiple of the time it took to write, or what new improvement will make a medical practice drastically more efficient.

However, we can reduce this unpredictability by removing focus from the types of investments that almost never have outsized payoffs, and by adding focus to the types that often do. By trying to be acutely aware of what activities have a high likelihood of ending up on the far left of our personal power law curves, we can give ourselves a much better chance to see great returns.
21 responses
Jack, in your example of the power law, you mention plotting all your investments from best to worst on the x axis. however, in the normal distribution, you dont plot from best to is the comparison seems like its apples to oranges and im trying to understand it better. does that make sense?
Thank you Jack, I never understood what thiel was talking about in his book but now i can see where he is coming from.
good article
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