A group of five engineers and product people get together, raise some angel funding, build a startup, make little to no money and sell for $10 million. What just happened? Common narratives assert that it’s the tech bubble; it’s a naive acqui-hire; it’s collective irrationality.
Maybe it’s something else altogether: a fundamental shift in how we compensate the extreme top end of the labor pool.
About a decade ago, before the latest tech boom, many of the best and brightest college grads started their careers on Wall Street. Today, they increasingly set their sights on Silicon Valley, the new economic hub of America — where, despite the cultural emphasis on idealism and changing the world, like Wall Street, the promise of money and power alluring young, smart people is widespread.
The similarities don’t end there. Technology, like finance, relies on scale and convexity of returns to thrive. Billion-dollar hedge funds are often run by a half-dozen people. Likewise, a few engineers can build a billion-dollar product. In this way, both industries are incredibly labor efficient. As the saying goes, one great engineer is worth 10 good engineers.
This creates an enormous incentive to hire the best, and, conversely, a massive cost to hiring poor performers. Furthermore, we are still in the early stages of the technological revolution, and in this wild west, where large companies are fighting for relevance and long-term market share, hiring decisions can have long-lasting impacts that cascade into the future.
Unlike finance, however, in tech it’s harder to identify and compensate value drivers — namely engineers, designers and other product people. In MBA-speak, this is because bankers and traders are revenue centers, whereas engineers and designers are cost centers. In the world of banking, your contribution to the bottom line is easily measured. In many cases, identifying stars in your business is as simple as “show me the money.”
On the other hand, the contribution of an engineer to an overall project, and the success of that project to the overall viability of the business, is much more opaque. A trader is worth as much as the money he made on his last trade. How much is a specific engineer on an infrastructure analytics team worth?
Hiring decisions can have long-lasting impacts that cascade into the future.
The tech world is still discovering what compensation for its elites looks like. Never before has a cost center wielded so much leverage and power over the bottom line of an entire industry. The pharmaceutical industry, for instance, also stands on the shoulders of its product (R&D), but the friction and cost of building a pharma startup is typically too high to throw something together in a garage, so while the contribution of the R&D team is high, their bargaining power against their employer is not.
All this creates an interesting incentive system. Employers want to hire the best and are more than willing to pay for it, but information asymmetry and bargaining power of elite employees make that a challenge. The Googles of the world can and would pay exorbitant amounts for a star coder, but when it comes to new grads from Stanford, for instance, they can’t measure, let alone predict, who will be a star — at least not enough to justify a million-dollar signing bonus.
The incentives of young, smart, ambitious people in technology are equally misaligned with conventional labor models. You could join an established company and spend years proving your worth and politicking to ensure that that worth is recognized, and ultimately still likely be underpaid for your contributions should they be extraordinary. Or, instead, you could build a startup, where, if successful, you’ll earn a lifetime’s worth of salary in a matter of a few years.
In these types of cases, startups do not rely on traditional metrics like revenue, because they generally never intend to be full-pledged businesses in the first place. In the best case, they are niche products that can fit into a broader suite of a larger company with a sales team to scale it, but even in the worst case, they are proof points that your team can build product. They are living resumes designed to reduce the information asymmetry of a hire.
In this way, startups are beginning to fill a void in the labor market. They are a way to prove that you’re worth hiring and a way to gain leverage where you can accrue more of the value you create. A company can’t hire someone’s historical trades, but they can acquire a product someone took years to make and the rights to the brain that helped build it.
What’s the most common startup path? If we’re being honest, it’s failure. But among the success stories, blockbusters are rare, and for all the talk of company missions and changing the world, most startup founders just want to make a few million so they can quench their egos and their wallets.
If we judge the value of startups only according to the paths of the high-profile blockbusters, a lot of what’s going on in Silicon Valley looks insane. If we instead look at some startups as a functional addition to the labor market, things start to look a bit more rational.