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Thursday, March 11, 2010

Compensation is hard, let's go shopping!

Whenever you hear about a spate of acquisitions by big companies of innovative small companies, there's always a temptation to point fingers and laugh at how the behemoth can't innovate any more. Of course, that's a myth, as How the Mighty Fall shows: most big companies are quite innovative (especially in capital intensive industries), and failures of large successful firms aren't usually caused by too little innovation. The problem usually has to do with incentives.

With the cost of starting a startup decreasing by the year, it is far easier for entrepreneurial employees to leave big companies and start their own thing than to push through the bureaucracy at a large company to launch their product. Part of it is because large companies have a lot to protect (compare YouTube's early days with Google video's early days, and you'll see that the innovation differences had very little to do with technology), and the other part is that a large company like Microsoft cannot launch a product without it having to scale immediately, while a small unknown startup has the luxury of making mistakes and trying several ideas out in order to find one that gains traction.

But what about incentives? Leaving aside the fact that it's very difficult to use compensation to reward creative problem solving, it turns out that it's very difficult to reward entrepreneurial activity in a large firm. You might think that you could for instance, offer an entrepreneur a higher risk/reward ratio by asking him (and possibly his team as well) to risk a portion of the salary in order to potentially receive startup-like rewards. Now, you can't offer everyone this, or you'll discover that everyone who's part of your existing fast growing revenue engine will take the deal and get out-sized rewards without actually taking any risks. The problem lies in that any project/employee who has strong enough connections to get this offer, by their very nature also has the political capital to negotiate their own goals and metrics by which they can get that out-sized rewards. This leads to extremely negative incentives, like launching a product while knowing you can't possibly scale to meet demand, or launching a product missing a critical feature that would have been needed to drive adoption in order to meet an artificial, pre-negotiated deadline. In fact, this problem is so endemic that even for external-acquisitions, earn-outs are being abandoned because of the costs and undesirable side-effects associated with them.

Ok, pre-negotiated goals don't work. How about post-facto awards? Since those aren't expected, you won't have negative incentives, and people would stay on if they believe in their projects, right? It turns out that people are actually pretty good at figuring out that a project is successful or going to be successful. Someone I know was on a project that obviously had great trajectory, and he was amazingly unhappy about large groups of senior engineers and managers suddenly descending on his (previously under-the-radar) project trying to take credit for a piece of it in order to get an out-sized award. The resulting feeding frenzy isn't good for morale, and obviously leads to entrepreneurs thinking that starting their own companies just isn't that bad an idea after all. Worse, after you hand out that out-sized awards, everybody now has an incentive to leave that project in order to find the next big thing so they can repeat the process. Of course, not rewarding such successful projects doesn't work either, since you then risk losing valuable employees to other companies.

If you ask me, there's no real easy solution to any of these problems. You'd have to have an amazing top-level manager, who is so aware of everything that happens at every level of the company to be able to avoid all of the pitfalls I detailed above, which doesn't even scratch the surface of the fundamental problems in compensation. This is one reason why when faced with these issues, many top-level executives just throw up their hands and say, "Compensation is hard, let's go shopping for acquisitions instead!"


Unknown said...

Wow! I never wondered in to these details of the rewarding programs. To me the last point of people leaving the project after getting rewarded strikes the most.
I can also imagine how the late entry members getting similar high awards for nothing but timely entry lets the morale of others in different projects down.

Anonymous said...

Regarding your statement:

> and the other part is that a large company like Microsoft cannot launch a product without it having to scale immediately, while a small unknown startup has the luxury of making mistakes and trying several ideas out in order to find one that gains traction.

What about a private beta that is released in phases? That's one way Microsoft could avoid solving the scaling problem right away (not, perhaps, without other issues).

Unknown said...

That doesn't work for social products. For instance, Google Wave was launched piece-meal, and that wasn't very successful. Buzz needed to scale from day 1, and there was no way around it.

Anonymous said...

To me, it takes a smaller company to really innovate. Eventually they become stale and react to change like an iceberg but by then they've likely been bought off by a small company anyway. Take a look at where a lot of interesting social innovation comes from. 4square was once a non-entity but now is approaching hundreds of millions in valuation. DirtyPhoneBook is taking a very obvious idea of identifying people with phone numbers and creating an amazingly humorous real-life sort of chat-roulette.

Microsoft and Google and other companies can only refine. They can't really create entirely new concepts as well as other companies that are smaller can. Apple and maybe Nintendo are two of the only ones that actually can innovate.

Piaw Na said...

It depends on what you mean by innovate. For instance, Google has the ability to push large scale distributed infrastructure research in a way that no one else can. Google will continue to push the pace on that front, and no one else will really be able to compete (certainly not startups).

Now, when it comes to social products, that's something Google fundamentally doesn't understand, so I'm not sure to accuse them of lacking innovation there is appropriate.

For instance, Apple made a big hash out of .MAC. I don't see people criticizing them there either.

In business, it's far better to be good at what you're doing, and do well at it, than to spread yourself so thin that you end up losing focus on what's important. To a large extent, when Microsoft got distracted and took their eye off the ball from their core (OS and Office), they really got themselves into trouble.

Patrick said...

Which is why it is so critical to get the compensation incentive scheme right at all levels - so you get everyone going in the direction that is needed. Each organization is different so each compensation scheme will be different.

But, if all you have is a pirate ship - we're in it for the loot - then maybe plundering or acquiring is your only option. Just make sure you share the spoils.

Unknown said...

Cisco experimented with spin-ins, and experienced the same issues you describe; first with Andiamo (FC storage switch), then with Nuevo(the Nexus 5000). Some engineers stayed behind with the grind of the installed base, IOS software bug fixes and big company hours; some moved out for higher risk, less mothership support, much less product process, and a different reward structure. Recombining those teams into the same business unit wasn't easy ..

Piaw Na said...


It's important to get compensation/incentive structures right if you wish to retain strong engineers.

At the most basic level, you don't want two people doing essentially the same job getting paid wildly different amounts (as in, with $250k/year difference), which is what happens in some of these cases. When the lower paid engineer finds out, he's going to leave.

And yes, every different organization needs to have a different compensation scheme. I'm not an advocate of paying engineers on commission, or sales people on stock options. But within the same department, you want some sort of consistency.

But I don't pretend to have any answers: if the answer was easy and obvious, Google would have done it. It's not easy, which is why great managers who can solve these problems are worth their weight in gold.

Piaw Na said...


Yes, spin-outs and spin-ins have got to be massive headaches. I didn't see Google do any of those, so I don't know what the obvious problems were, but I can imagine the headaches are very similar.