Productivity and Price’s Law, Part 2

Overcoming Price’s Square Root Law

Productivity is defined as “the measure of economic performance that compares the amount of goods and services produced (the output) against the inputs used to produce those goods and services.” So if a company with 100 employees generated $20M in profits that year, that means each employee’s output generates an average of $200K in profits per year.

But Price’s Law (a theory put forth by Dr. Derek J. de Solla Price, a Yale professor) says output is not generated equally. Price’s Law postulates that “in any productive community, 50% of the output will be achieved by the square root of the total group.” This applies to a host of settings and situations. So, in a company of four employees, two employees (the square root of four) produce half the work and the other two produce the other half. In that scenario, everyone is generating an equal amount of work. But, in a company with 25 employees, it means that 5 employees (square root of 25) are responsible for 50% of the company’s output and the other 20 employees generate the other 50%. That’s not great. But it gets worse the bigger the organization. In a business with 100 employees, 10 employees (square root of 100) are responsible for 50% of the company’s output and the other 90 employees generate the other 50%. If the company were generating $20M in revenue, 10 people were responsible for generating $10M and the other 90 generated the other $10M.

If Price’s Law is always true (and that is a big IF), what is a business owner or leader to do? No entrepreneur wants a tiny percentage of company employees generating half of the company’s output while the vast majority are far less productive. And what happens if the company grows and there are 900 employees generating $200M in profits annually? According to Price’s Law, it would mean that about 30 people are generating $100M while the other 870 employees are generating the other $100M. That seems unsustainable. 

In fact, that might explain, in part, why Fortune 500 companies don’t last long at the top of the heap. In 2020, the average lifespan of a company on Standard and Poor’s 500 Index was just over 21 years, compared with 32 years in 1965. And, by 2040, it’s expected that about 75% of the current companies on the list might not exist anymore. The chart below shows the top 25 companies on the S&P in 2001 vs. 2021. Only six companies out of the top 25 Fortune 500 companies are still in the top 25 two decades later. Obviously, none of those companies have gone under, but staying at the top long-term is difficult. Companies come and go in part because it is very hard to manage growth and stay productive, innovative and relevant in an ever-changing economy. 

The speed at which giant companies rotate in and out of the S&P 500 might be a reflection, at least in part, of Price’s Law at work.

What to do about Price’s Law?

Should a business owner cut those employees who are not part of the square root group producing 50% of the results?  Is that even feasible?  Do the math.  If – in a downturn — a business owner employing 100 staff were to let go of the employees who weren’t part of the super-productive core group producing 50% of the results (per Price’s Law), who would be left?  In that situation, a company of 100 people generating $100M in revenue would need to cut the 90 moderately-productive people and keeping the 10 super-productive employees who account for 50% of the productivity.  What would happen to a company that let go of 90% of its staff and cut productivity 50%?  Surely the company would be much leaner with just 10 employees generating $50M in revenue.  Sounds great, right? 

Then what?  The remaining 10 employees, pulling all the weight of the company on their shoulders, would likely feel fearful after such drastic cuts and become increasingly disgruntled because they are now responsible for 100% of productivity.  Since the company is producing half of what it used to, they would likely be pushed to do more and get stretched thin.  Not only would the optics be bad, it would likely upset customers and demoralize remaining employees.  Competitors would start recruiting remaining employees, cannibalizing those who showed the most initiative and ability.  If even one person left the company at that point, it would reduce productivity by 10%.  Such huge losses of productivity would make it more difficult for the company recover from a downturn. 

Then what? That would lead to more austerity measures.  It would be a race to the bottom.  Price’s Law would postulate that of the remaining 10, roughly three employees would eventually be producing 50% of the output and the other seven would be producing the rest.  So would the employer need to lay off another seven people?  Eventually, there would be no one left.  Trying to overcome Price’s Law by cutting staff is not a solution.

So, how does a department, division, company or organization deal with Price’s Law?  If a small core are generating half the productivity of an organization, what can be done to fix that?  What’s the solution?  Is Price’s Law inevitable?  Are organizations simply destined to have an imbalance of workload and productivity?  Or is there a way to overcome this phenomenon? 

Price’s Law Can Be Overcome

Despite its title, Price’s Law is a theory.  It has been observed in many situations, especially as it relates to labor productivity, but it is not an immutable law.  It is just what happens when things are left unmonitored.  And, even when it is observed, it is clear that Price’s Law gets exponentially worse as an organization grows.  Size is the key.  Overcoming Price’s Law is easier when companies are small and stay “small”. 

1. Stay small.  Growth is usually seen as a good thing, allowing a company to achieve economies of scale.  Does that mean a company should not be allowed to grow?  Of course not.  Companies can grow while still “staying small” by dividing divisions and departments and into small modular teams of no more than four to eight.  Ideally, responsibilities should be split up in such a way that, if one module / team fails, nothing else fails with it.  If one team — working on the development of a new product — were to suddenly disappear, the company should be able to replace it with a brand new team without destroying the rest of the company.  The key is to keep all the interfaces between that team and the rest of the organization intact by clearly delineating responsibilities and clearly defining communication channels.  But, by keeping the number of people on a team down to a handful, it is easier to ensure that everyone is carrying their share of the load of that module of work.
   
2. Hire team managers carefully and then trust them.  Entrepreneurs tend to have a problem letting go of control as their company grows. But it is imperative to choose team leaders that can be trusted to do the job so that the leadership can focus on the bigger picture.  Team managers that are empowered and feel that their work has purpose will be able to keep tabs on productivity.  And by being trusted, team managers are more likely to stay loyal and do great things with their small teammates.  It is a flatter, less hierarchical approach to management.
   
3. Hire for quality, not growth.  There is such an urge to grow exponentially, especially when a company is doing well.  Expand into new markets.  Buy divisions.  Develop new product lines.  It’s tempting to grow incessantly and grow fast.  But growth for the sake of growth can mean adding candidates that don’t really meet the need.  If an organization has a dozen openings but of the 100 applicants only three are truly qualified, hire the three candidates and keep looking.  Bad hires feed Price’s Law.

There is a lot more that can be done to help measure, monitor and balance workload.  And a lot can be done to help keep productivity high for everyone on the team.  Price’s Law should serve as a reminder that, if left unchecked, the output of each team member will either increase or decrease depending on a multitude of factors.  It is the job of management to keep an eye on that and ensure that everyone has the support to be as productive as possible.  And that will help turn Price’s Law into Price’s Myth.

Quote of the Week
“If you want something done, give it to a busy person.” Preston Sturges

© 2022, Keren Peters-Atkinson. All rights reserved.

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