Thesis: Software companies are leveraged-people-service firms. Man-hours are the input and man-hours saved are the output. The better your people, the better the machine.
Our faith in freedom does not rest on the foreseeable results in particular circumstances but on the belief that it will, on balance, release more forces for the good than for the bad.― Friedrich A. Hayek
Human beings are born with different capacities. If they are free, they are not equal. And if they are equal, they are not free.― Aleksandr Solzhenitsyn
We live in a relatively free market. The traditional barriers of education and connection for labor advancement have been falling precipitously and while there are some pockets of friction, the whole of economic advancement and skill acquisition have become Galileo’s frictionless plane. People have choices on where they work.
In the realm of software, the war for talent is as extreme as it is ironic. Software magnifies human potential. This means that software, all still made by humans, is also making that labor input more powerful and more strategic. Software doesn’t replace humans; it equips humans with superpowers. But this also makes enterprising humans strive for higher pay.
A founder’s pay anchors the company, literally
Entrepreneurs are opportunistic. We hunt for deals and deal on hunches. The labor problem is particularly interesting for the entrepreneur. Not only does the drive to find a deal come into play but the entrepreneur is anchored on what they are being paid as a starting point. Reciprocity drives the founder to cap new hires at their pay. However, this often hamstrings the company.
The talent a founder needs skews to the more expensive side of a range. This is because founders need experienced talent that is also risk seeking. Experienced talent that is not risk seeking would never apply for a position at a young company. However, the combination of experience and risk appetite means a small pool of potential candidates… supply and demand… hence, skew expensive.
A story of an anchored company
Most founders learn this lesson the way I did. In a past company I ran I fell into the salary anchoring trap. I met several qualified candidates and because I had presented a pro forma to investors which included my pay I felt anchored to that pay as a maximum. However, that artificial limitation is market friction. It is a de facto price control which likely results in adding a bias to the set of potential candidates. Now, if that price control is set below market (which is likely), the accepting candidate either doesn’t know their worth or isn’t as experienced as the founder thinks. This worked out poorly in my story. Several hires and tough conversations later I had learned my lesson. Good people are not cheap.
The costs of anchored hiring
Founders learning this lesson the hard way will discover several areas of cost implications. First, they will hire the wrong person more frequently than not. This results in dead costs associated with the salary for the time between hiring and the team member off boarding. Those costs can be steep. Another area of costs is the organizational impact of the wrong person. This could dwarf the direct costs to the role by stimulating a ‘right person’ exiting the company. Additionally, there are initiatives launched, systems changed, and strategies communicated which all must be redone. Then, lastly, and most importantly, the opportunities lost because of the detour of the wrong hire. These opportunities can be the difference between an exit and a failure. The early-stage journey is fraught with danger and not one to take lightly.
The antidote to the chaos is to pay up for talent
The antidote to this pitfall is simple in theory and difficult in practice. Experienced founders know to check the market for the proper rate for talent and then lean on the higher side of the range. This is because the stakes are higher as illustrated above. The antidote is to pay up. The talent you need demands a premium and if the people you are talking to for the role do not fight for that premium it is either because they aren’t worth it or they don’t know better. The former will become apparent later and the later will realize their mistake and discontentment will settle in.
Conclusion, people are worth what they cost
People are worth what they cost. Hire cheap and you are optimizing for the short run. If you do that, you don’t need to worry about the long run because your company won’t make it that far. Founders need good people to offload tough issues. Learning this lesson the hard way, results in unimaginable chaos at best and, in most cases, abject failure.
This article is an extract from a case study we published recently published titled “Software Companies Require Great People to Build Them“, written by Dougal Cameron that shares some of our experiences building startups and journeying towards meaningful exits.