What’s Wrong With Management Practices in Silicon Valley? A Lot.

Everyone seems enamored of Silicon Valley. It has certainly spawned much new technology and created vast wealth. As a consequence, many executives visit Silicon Valley companies, read books about them and seek to copy the Valley’s approach to management. But as high-tech commentator Esther Dyson has perceptively noted, although Silicon Valley is good at generating new technologies quickly, it has been much less successful in building sustainable organizations or in using sound management practices. So, before you rush to copy the Silicon Valley approach to management, a word or two of caution seems in order.

Silicon Valley’s Approach to Management

What is Silicon Valley’s approach to management? In general, it encompasses four practices. First is the free-agency model of employment, featuring relatively little commitment on the part of companies to their people or vice versa. Individuals are expected to watch out for themselves (the term at Sun Microsystems is “career resilience”) and move on at a moment’s notice. Labor mobility and limited attachments are expected and accepted.

Second is the extensive use of outside contractors, even for hardware and software development. The Valley may be the home of the virtual or almost virtual company.

Third is the use of stock options as an important form of compensation. Stock options are used even by companies in relatively staid industries, such as the manufacture of tamper-evident bottle caps. If the company is located in San Jose, California, it feels obliged to offer options as part of the pay package.

Finally, long working hours are typical. Indeed, they seem to be a badge of honor. The feeling is, if you aren’t working constantly, you must not be essential to the success of your enterprise — a suspicion that is hard on the ego.

The Consequences

There are predictable and observable consequences for each of the four practices. The free-agent mentality, for instance, generates high turnover. Estimates range from 20% to more than 30% annually. The cost of recruiting and training replacements is enormous, particularly when combined with less direct costs: the productivity costs of positions going unfilled; the disruption to relationships with customers who must continually deal with employees in training; the costs to the product-design and development functions as knowledge walks out the door. And then there is the cost of building up one’s competition, as former employees take positions with established competitors and startups.

But isn’t high turnover inevitable in high-technology companies? In a word, no. SAS Institute, the largest privately owned software company in the world, with 1999 sales of more than $1 billion, had a turnover of less than 3% in the 12 months from June 1999 to June 2000 in its Cary, North Carolina, headquarters. MTW Corporation, a small, rapidly growing software- and computer-consulting company based in Kansas City, Kansas, has a turnover rate approaching 5% and falling. Cisco Systems has a turnover of about 8%, and there are some startups in Silicon Valley that have almost no turnover at all. If you tell people when they come to work for you that you don’t expect them to stay, and if you treat them accordingly, they’ll move on. Turnover has become an accepted way of life. It doesn’t have to be.

Nor does contracting everything out and using lots of temporary help always make sense. What sustainable competitive advantage can a company have when much of its core technology is in the hands of people with little loyalty? What kind of service does a customer get when talking to people who don’t even work for the company from which the customer has made a purchase?

The use of contractors has several predictable effects. First, contractors generally leave faster than permanent employees, exacerbating high turnover. In fact, in order to avoid problems with U.S. labor law and tax regulations defining who is a contractor, many companies now limit temporary and contract employees to a term of one year, necessarily guaranteeing 100% turnover in that portion of their labor force. Second, most contractors have less commitment to the company and its products and customers than employees do, with obvious implications for performance. Third, contracting out does not always save money. That’s an illusion. Few companies, if any, evaluate the full cost of using contract labor or outside contractors. They see the direct cost savings, but they don’t see the costs added through diminished customer retention, reduced productivity and fewer chances for developing internal intellectual capital.

Illustrating those problems is a recent study by Stanford University Ph.D. candidate Laura Castenada on the use of temporary help and contract labor at Applied Materials, a company based in Santa Clara, California. Most temporary employees there wanted to become permanent employees. When they knew they would not and saw their one-year term at the company drawing to a close, they held back from sharing their knowledge and skills with others, including their replacements — and spent many of their last days on the job looking for work. The loss in tacit knowledge and effort under such circumstances can be damaging.

Many of the Valley’s compensation practices, particularly the use of signing bonuses and stock options, inadvertently help fuel the high turnover. Giving a signing bonus that vests over four years rewards people for leaving. After earning the bonus, they simply move to another company to collect another signing bonus.

And what about options? Employee ownership is a great thing — it helps employees think like owners. But options are not ownership. In real employee stock ownership, employees purchase shares and thus have, to use the colloquial phrase, “skin in the game.” They are committed. Options aregiven to employees, not purchased. When the stock price goes down, the options are repriced or, now that repricing has become less acceptable to institutional investors, companies issue more options at the new, lower price, as Microsoft and Amazon.com have done. The potential dilution to earnings is enormous, even if accounting conventions do not yet fully capture the hit.

Moreover, as technology columnist and venture capitalist William Gurley has observed, options encourage a gambling mentality. Go for broke. If there’s a big win, fine. If there’s disaster, move on and try again. That is not the mentality of real ownership.

And finally, there are the long working hours. The practice of having people work until they are exhausted leads to both turnover and burnout. How many years or even months can you work 80-plus hours per week at the expense of friendships and social life? Why would free agents work endlessly for an institution for which they have little or no feeling? They won’t. They’re there because of the money or the network- and résumé-building — not because they care about the company or its customers, products and services. As soon as the money is earned or appears unlikely to materialize, they leave.

More fundamentally, there is a confused notion that being productive is the same thing as working long hours. It isn’t. As Jim Goodnight, the wise co-founder and CEO of SAS Institute, has said, “If you’ve put in a full day, by 6 o’clock, you shouldn’t have anything left, so go home.” Amazingly for the software industry, SAS thrives on a 35-hour work week. Long hours also are partly responsible for the defect-filled products we have come to expect and accept. People who work when they are exhausted make mistakes. And as the quality movement taught us, it is more expensive to find and correct errors than it is to prevent them.

Silicon Valley’s success has not repealed the basic rules of business. Your profits come from loyal customers who do business with you for reasons other than just price. Customer loyalty is a consequence of loyalty from employees who produce great products and offer great service. In the short run, with enough venture money and enough product demand, any business model may appear feasible. In the long run, those companies that actually run their businesses efficiently and produce sustainable results will be the ones you keep reading about.