The Economist – Tech firms shell out to hire and hoard talent

LARGE technology firms used to hold on to their high-flying employees by agreeing not to poach them from each other. “If you hire a single one of these people, that means war,” Steve Jobs, Apple’s then boss, warned Sergey Brin, a founder of Google, in 2005. That was an illegal arrangement, and in 2015 Apple, Google, Adobe and Intel paid a $415m settlement to engineers whose pay had been held down as a result.

Today wage suppression in Silicon Valley is even more of a distant memory than dial-up internet and mainframe computers. Last year technology companies in America recorded expenses of more than $40bn in stock-based compensation. Exact comparisons are difficult, but to put that sum in perspective it is roughly 60% more than the bonus pool paid to the New York employees of Wall Street banks.

The money tech firms throw at employees has ballooned as competition to hire and hang on to top talent in engineering, data science, artificial intelligence and digital marketing has soared. Even entry-level engineers can easily earn $120,000 a year, more than most people their age can make on Wall Street; mid-career executives with technical expertise who choose to work at large public companies such as Apple, Google and Facebook will pocket several million, including stock grants. The boss of one startup complains that he cannot find a competent chief operating officer who will work for less than $500,000 a year.

All this is driven by a number of elements. The price of housing plays a part in pushing up salaries. The cost of living in the Bay Area is now 41% higher than the national average and 7% higher than the next most expensive place, New York City, according to Brant Shelor of Mercer, a consultancy. But the biggest spur of change is the enormous appetite for talent. Unlike the best lawyers or doctors, who can see only a limited number of people each day, those with exceptional technical expertise can transform a company because they are capable of creating products that are many times more attractive and thus a lot more lucrative, explains Marco Zappacosta of Thumbtack, a digital marketplace.

Come into my parlour
Google, Facebook and Amazon alone probably hire around 30% of all American computer-science undergraduates, reckons Roelof Botha of Sequoia, a venture-capital firm. These big public companies not only pay handsomely, but also wield a hiring advantage with the huge amount of stock they are willing to hand to promising candidates. Last year Alphabet, Google’s parent company, issued around $5.3bn in stock-based compensation, equivalent to a fifth of its gross profits. That amounts to an average of $85,000 in stock-based compensation per full-time employee.

Whereas non-tech companies in the S&P 500 give out, on average, the equivalent of less than 1% of their revenues in stock-based compensation, the norm for big technology firms is around five times that (see chart). Last year Facebook, for example, recorded stock-based compensation expenses equivalent to around 17% of its sales; Workday, a software firm, and Twitter had stock-based charges of some 20% and 31% of their revenues, respectively.

Stock-based compensation has its roots in the early days of Silicon Valley, when startups could not afford to pay employees much, if anything, and asked them instead to take a small piece of the company that might rise in value later. What is different today is that many of the Valley’s firms are mature with proven track records, so their stock is already valuable and can be used to greater effect. It is being deployed to “strategically hoard” the best talent, says Patrick Moloney of Willis Towers Watson, a consultancy. Once locked in, that talent is then assigned to important projects. This deters people from going to rivals or launching their own startups.

To maintain their grip on top employees, the tech giants use several tactics in addition to handing out stock. Some provide generous signing-on bonuses that can be clawed back if an employee leaves within three years. Amazon heavily weights stock grants to an employee’s third and fourth year with the company, as an incentive for them to stay and continue to work hard. Another common practice is to offer a “retention” bonus to make employees who are considering going elsewhere reconsider. Apple, Google and Facebook are rumoured to keep a list of companies they do not want to lose talent to, and supervisors are empowered to offer large bonuses to prevent people moving in that direction. A famous example of this occurred in 2011, when Neal Mohan, a senior Google executive, was considering leaving for Twitter. Some say he was offered a bonus of $100m in stock to stay at Google.

The top ten
“It’s gone too far,” says one venture capitalist among the many bemoaning how large public technology companies suck up so much talent with their lucrative equity packages. The munificence of the large tech firms raises the stakes for others. Word of lavish offers spreads among colleagues. As a result, the top 10% of talent are getting paid what only the top 2% would otherwise fetch, says Richard Lear of Vantage Partners, a consultancy.

Even companies that are not doing well offer financial incentives to keep people. Twitter, whose stock is languishing as it struggles to make money from its social-media platform, has seen many talented people depart. The firm is believed to be offering bonuses of up to $1m to persuade its top engineers to stay for another few years.

Not surprisingly, startups find it hard to compete in the war for talent. The best positioned are high-flying “unicorns”, Valley-speak for private companies valued over $1bn. These companies, such as Uber and Airbnb, have raised lots of money and are willing to use it lavishly to lure people out of the large public firms. They can offer high cash salaries, but also try to attract employees by suggesting their stock will look better when they finally go public. After someone has been at a unicorn for around four years, they can receive “refresher” grants of stock to give them an additional incentive to remain.

Lacking the same resources, smaller startups blame the giants for distorting the market for high-flyers. “I get the feeling that I can’t compete for objectively proven, brilliant talent,” says Mike Driscoll, the boss of Metamarkets, an analytics startup. “All I can do is hire diamonds in the rough, who will almost certainly get poached away by larger companies when they start to emerge as very talented.” Smaller fry try to find employees with a different temperament, perhaps those willing to take greater risks or others who find working at a large company dispiriting.

The rising cost of talent has also pushed up the level of funding startups need to raise. The idea that it is cheap to launch a firm is a myth, says Evan Williams, who co-founded Twitter and set up Medium, an online-publishing platform. “It’s harder and more expensive than ever to make a startup successful.” The more money young companies raise from investors to pay their employees, the harder it is for them to break even or become profitable.

The tactics employed by the large tech firms carry risks. One is to the entire ecosystem of Silicon Valley. In the future, entrepreneurs with a world-beating idea for a startup may recoil at the price of a garage to launch it in. Some startups are already moving elsewhere to hire cheaper engineers and reduce other costs. They don’t have to go very far from the Bay Area, perhaps to southern California (see article) or other states. In the long term, there is a risk that the Valley could resemble South Korea: dominated by a handful of giant chaebol-like companies that soak up all the talent and squeeze out smaller startups.

Another risk is the wrath of investors and the public. Under generally accepted accounting principles, companies are required to deduct stock-based compensation to calculate profits, but many emphasise alternative measures, and as a result plenty of shareholders have not been paying attention to the vast amounts being doled out. Spencer Rascoff, the boss of Zillow Group, an online property firm, thinks that stock-based compensation should be paid a lot more attention. “When it’s ignored by companies and investors it gives companies the opportunity to use stock compensation like funny money,” he says. “It’s not. It’s dilutive to shareholders.”

Few shareholders question expenses when firms are flying high, but the mood could change swiftly if the stockmarket plunged, or a company’s performance were to falter, as happened this year at Twitter and LinkedIn. Tech bosses may think that because they deliver products and services people like, even adore, they do not have to worry about the kind of backlash against high pay that Wall Street suffered. They shouldn’t count on it.

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