managing

Modern companies as specialized venture capital firms

Philip Brewer — Wed, 15 Apr 2009 18:13:42 +0000

In the old days, companies actually produced stuff. They invented it, designed it, made it, marketed it, and sold it. Although there are still some companies like that, they're a lot less common now. Many companies have shifted to an "asset light" model where they no longer own their own factories and equipment. Instead, they hire other companies to do most of the work. Understand how this works and you can turn it in your favor.

I first came to understand this model with regard to publishing companies, so I'll use them as an example.

Publishing companies as specialized venture capital firms

What does a book publisher do? Very briefly, it finds things to publish, buys the rights, edits the manuscript, designs a book, markets it to bookstores (and other sales channels), has copies printed and bound, and sells them.

In the old days, one company would do all those things. Nowadays, very few do. In fact, some companies outsource every single one of those activities: Acquisition, editing, and book design are done by freelancers; marketing is outsourced to a marketing firm, printing and binding to a printer, and sales to a distributor.

Of course, a publishing firm may choose do one or more of those things, if it thinks it can do it better in-house--many firms still do their own acquisitions, a few old-line companies may do their own printing and binding, many do their own marketing. But they can all be outsourced if the company doesn't have the expertise in-house.

There is one exception: buying the rights. That--putting up the money--is now the core activity of a publishing firm.

This is why I call publishers specialized venture capital firms. Putting up the money--paying the writer's advance (and also fronting the money to pay the freelancers and the printer) in exchange for a big chunk of the profits from sales is a straight-up venture capital model. (Rights are usually acquired on a profit-sharing basis: The publisher pays an advance against royalties. If the book does especially well, the author will get further payments, if it does poorly he gets nothing more.)

Other companies as venture capital firms

As one aspect of globalization, more and more companies have shifted to this model over the last twenty or thirty years. Specialized tasks were outsourced early--everything from janitorial staff to lawyers got contracted out. Anything with high labor costs--manufacturing especially--was moved overseas in search of cheap labor. The idea was to identify a "core competence" and retain only that activity, outsourcing everything else.

To the extent that you can get things done better or cheaper, outsourcing is fine. At its current absurd limit, though, we've gotten to the point where companies no longer seem to have any "core competence" except hiring outsourcing firms. At this point their only competitive advantage would seem to be superior skill at managing deals with overseas contractors.

Actually, there's one other: cheaper access to money. In fact, for a specialized venture capital firm, access to cheap risk capital is the core competence. And US firms have had a huge competitive advantage, because in the years between the dotcom collapse and the recent financial panic, the Federal Reserve made money as cheap as it had ever been.

The financial crisis put an end to that. (The money is still cheap, but you can't get any of it.)

However, there's a more fundamental limitation to the whole system: When your competitors are all shopping from the same universe of outsourcing firms to hire things done, it gets a lot harder to find a competitive advantage.

Even if you have a real core competence, you're still suffering in this recession, but you're just suffering in the usual way--sales are down because your customers don't have any money. But if your so-called core competence was either your skill in managing outsourcing firms or your access to cheap money, you're in a world of hurt now. The people actually swimming in that quagmire don't need me to tell them that. But others are affected as well. Stockholders should take a close look at the companies they own. Vendors, clients, and suppliers should look at the companies they do business with. If the company still does something real, it may well have a bright future. If it hires everything out, though, there's no reason to think it will ever again do well (even if it might manage to hang on as a third-tier firm for a long time).

Why it matters

Having said all that, there are really two points I'd like to make.

First, ordinary people can also take advantage of the outsourcing phenomenon. If there's anything that you can do better than other people--if you have a core competence--there has never been a better chance to turn that into a business. The outsourcing firms that will do everything else for you will be begging for the work. Of course, since you're turning yourself into a specialized venture capital firm, you'd better have not only a core competence but also some capital--it's going to be tough to get much from the financial markets.

Second, though, understand that once your company gets to the point where it doesn't actually do anything except put some money at risk and manage contracts with other companies to do the work, it isn't really much fun to work for.

There are, I suppose, some people who like nothing better than managing contractors and managing risk, but the rest of us would prefer to actually do something--design something, build something, repair something, improve something, maintain something.

This matters for both managers and employees. Hire people whose skills complement your business's core competence. Work for companies where you'll be doing real work that you're interested in. Avoid owning or working for companies where there's no longer any real work going on. (Work instead for the outsourcing firms that are doing the work.)

In any case, understand what it means to own or work for a specialized venture capital firm: Success is mainly a matter of managing your contractors and coming up with risk capital that costs less than the profits of your firm. Finding some real work that you can do better than anyone else is both more promising for success and more fun.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Not the sort of person who ...

Philip Brewer — Thu, 13 Nov 2008 14:54:02 +0000

Wise Bread is stuffed almost to bursting with suggestions on how to live large on a small budget. We've got suggestions on how to spend less, how to earn more, and how to take control of your finances and your career. There are certain suggestions, though, that trigger a particular kind of negative reaction: The one where people say, "I'm not the sort of person who" does whatever it is that we've suggested. It turns out that lots of people think that way. Don't do that.

You can find them in the comments on practically every post. There are readers out there who say, "I'm not the sort of person" who:

rides the bus
wears used clothes
takes in boarders
rents a room in someone's house
has a roommate
borrows things
lends things
does manual labor
follows a budget
tracks every penny
buys food on its sell-by date

The reason I say not to do that, is that none of these things really have anything to do with the sort of person you are. For stuff like this, when someone says, "I'm not the sort of person who," what they really mean is, "I'm so rich I don't need to" do whatever it is. And, if they live in a rich country, they're almost certainly right--even if they're pretty poor, just living in a rich country means they're so rich they can imagine that they're some particular sort of person who doesn't need to economize in some particular way.

The thing is, there's a problem with this kind of thinking--with imagining that "you're not the sort of person" who does certain kinds of things: You can start to believe it.

If you really believe you're the sort of person who doesn't do certain things--when the truth is simply that you're so rich you can afford not to--what happens if you go through a rough patch? In particular, if you go through a patch rough enough that you're not so rich any more? Answer: That kind of thinking can turn a mere rough patch into a financial catastrophe for your entire family.

I'm not trying to tell you to take any particular bits of Wise Bread advice--this isn't a post to urge you to sell your car or to move in with your brother-in-law or use some web tool to manage your finances. Rather, I want to urge you to do just one thing: Be honest with yourself.

There's power in being honest about this sort of thing. Just go ahead and say, "I'm so rich I don't need to take the bus, wear used clothes, or have a roommate." There's a certain kind of satisfaction in that for someone who's never going to own a Rolex or a Maserati or a third home in Aspen. More important, though, it puts you in a much better position to make the right decision if times get tough and you're not so rich any more.

As for thinking, "I'm not the sort of person," save it for things that are real and true. "I'm not the sort of person who betrays a friend or takes advantage of a stranger or abandons a puppy." That's the sort of person you are. That other stuff you either do or don't depending on the circumstances. It's got nothing to do with who you are.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Incentive plans always go awry

Philip Brewer — Thu, 27 Mar 2008 18:04:00 +0000

Ever worked someplace that had an incentive plan (as in, "Hit these targets and you'll get a bonus")? Ever been a manager whose job it was to administer an incentive plan? Ever tried to create an incentive plan, hoping to get people to do more of what you want them to do? Here's a little tidbit for you: Incentive plans always go awry.

I don't mean to say that incentive plans don't work. They just never do what you want them to do. Here's why: They replace intrinsic motivation with extrinsic motivation.

Intrinsic and extrinsic motivation

Ever seen a kid try to learn how to do something he wants to be able to do? (For example, learn to beat a level on a video game or learn to jump a skateboard up onto a wall?) If so, you've seen intrinsic motivation. I've seen kids spend hours, doing the same thing over and over again, until they get it right. People offering bonuses have seen the same thing too. That kind of concentrated hard work is what they're trying to get, only they want it focused on their project.

They're never going to succeed, because only intrinsic motivation does that.

That's not to say that extrinsic motivation doesn't have an effect. Offer a bonus, and people will try to get the bonus. But observe: Their motivation is not to accomplish your goal--it's to "get the bonus."

Incentive programs and metrics

Any kind of incentive program has a metric--the thing that you're measuring to decide whether someone gets the bonus. For salesmen, it might be a target number of sales. For the quality-control guy, it might be keeping the number of bad units below some level. For a corporate executive, it might be some level of return on investment.

Whatever metric you pick, though, it will be something that can be gamed. A salesman can sell more units a dozen different ways:

He can stop pushing a single right-sized unit and start getting customers to buy two or three smaller units.
He can make aggressive use of financing to sell units to people who can't afford them.
He can stop providing support for his old customers and spend all his time chasing up sales to new customers.
He can make wink-and-nod deals to "sell" units with the understanding that they'll be returned next quarter.
He can kick back a fraction of his bonus to purchasing agents who buy what he's selling.

Now, the head office can thwart any of these moves. It can change the bonus metric from number of units to number of dollars in sales or number of dollars of profits. (Then the salesman puts all his effort into selling the most expensive or most profitable units.) It can delay credit for vendor-financed units until the bill gets paid. (Then the salesman stops using vendor financing even for customers where it makes sense.) It can mandate a certain amount of time spent supporting existing customers. (Measured how? Answer: According to some metric that the salesman can game just as easily.) In fact, it can spend all its time fiddling with the incentive plan, to the point where the head-office folks don't have time to do their own jobs--but nothing it can do will keep employees from gaming the metric, and nothing it can do will produce intrinsic motivation.

The point is that, under an incentive plan, everything is worse. Everybody's focused on the metric, and nobody's focused on doing the work that needs to get done.

Notice what the underlying assumption is: that the employees haven't already thought about what's best for the company and what's best for their customers. That their intrinsic motivation is something other than doing a good job. Some employers no doubt have plenty of disgruntled, unmotivated employees just there to pick up a paycheck for the least work they can get away with--but the answer to that problem is figuring out what's gone so terribly wrong with the business.

What to do instead

Whenever I point out that incentive plans make things worse, people always say, "But what should we do instead?"

Of course, just asking the question shows that you haven't grasped the essential point: Incentive plans make things worse. It's like whacking yourself on the foot with a hammer. The first thing to do is to stop. Once you've done that, you can focus on aligning employee's intrinsic motivation with the firm's business needs.

First, think for a minute about what people's intrinsic motivations are. My own experience is with software engineers. They're strongly motivated to:

do new, cool stuff with the latest technology
do work that's worth doing
gain the respect of their peers

Clever managers can use that to get employees to do what needs to get done. (For example, by making sure that every engineer gets to do some new, cool stuff, by not assigning pointless work and making sure that engineers understand why a task that might seem pointless is worth doing, and by making sure that everybody gets to see some of what their coworkers are doing.)

Most managers, though, have a different focus. They're too busy "managing" to have time to explain why the pointless work is worth doing--to them, it's worth doing because senior managers assigned it--and the new, cool projects go to key employees, because they're high-visibility, must-succeed projects and putting a junior engineer on it would be too risky.

With intrinsic motivations out of the picture, managers have to fill the gap with extrinsic motivations--praise, raises, promotions, and bonuses.

It's important to note that there's nothing wrong with any of these things--managers should lavish their employees with all of them. What's wrong is using them as an incentive. As soon as you do that, you've got your employees trying to hit the metric, rather than doing what needs to be done.

Minimizing the harm

Even though the harmful effects of incentive plans have been known for a long time, and the harm has been throughly documented--See for example, Punished By Rewards: The Trouble with Gold Stars, Incentive Plans, A's, Praise, and Other Bribes by Alfie Kohn--they haven't gone away. How then can we minimize the harm that they do?

For managers

First, remember that the harm is done by having an incentive tied to some metric. It does no harm to pay people for their work, nor does it do any harm to offer a bonus that isn't tied to an incentive plan. For example, a profit-sharing plan does no harm, and is often a good idea for everyone involved. (It means that the employer can lower payroll costs during bad times without having to lay people off or cut salaries.)

Second, if you have to have a metric, make it something that employees have no control over--total profits, for example. This will be de-motivating, of course--employees will be frustrated at having a bonus plan that's essentially a lottery ticket--but not as bad as if all your employees are spending their time trying to hit the metric.

Third, if you have a bonus tied to a metric, keep the bonus as small as possible. That way your employees can continue to follow their intrinsic motivations to do a good job without feeling like chumps for not gaming the bonus system.

Fourth, don't set your employees up to be competing against one another. You want your employees to be collaborating. Putting them in competition for a bonus is exactly the wrong thing to do.

Fifth, don't waste time trying to come up with a metric that your employees can't game. It's impossible. Unless their job is absolutely trivial, it will always be easier to maximize the metric than to do a good job. Any effort you put into creating a perfect metric is wasted effort.

To the greatest extent possible, though, avoid incentive plans. If your business has any kind of reasonable structure, your employee's intrinsic incentives are already aligned with the business's interests. (If they aren't--if your employee's natural inclinations to do work that's worth doing and to do it well doesn't lead them to do what you need done--then that might be a good place to focus your managerial efforts.)

For employees

I don't actually have much useful advice for employees suffering under an incentive program, except to try to find employers where the incentive programs are small and the target metrics are out of employee's control.

Really, your natural inclinations are going to be the right ones. If the bonus is small enough to be ignored, just ignore it and do your job. If the bonus is so large that you can't ignore it, put in whatever effort it takes to get the bonus, and then spend the rest of your time doing whatever you should have been doing. But you knew that already.

Everybody should read Alfie Kohn's Punished By Rewards. It will change the way you think about incentive plans--and change it for the better.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: