Jolly's Volley: The Compensation Conundrum…

13 October, 2011

Last week, I happened to be in Boston speaking at the inaugural MIT India conference (since Wharton and HBS have been hosting a similar event for a few years, MIT did not want to be left behind). As an MIT alumnus, I was honoured to have been invited to speak. The event was clearly a success, but the highlight was a fireside chat between Desh Deshpande and Narayana Murthy (who are married to sisters, by the way).

Every time I see Narayana Murthy, I am inspired by the trailblazing spirit that he embodies and the benchmark he set for Infosys. But not in the way that most people might think vis-à-vis creating a phenomenal IT services company from a revenue and profitability standpoint. What’s more important is the out-of-the-box thinking that he and his colleagues brought to the field of HR management. I am speaking specifically of employee compensation and retention. By the way, I did tell the Sloan School of Management crowd that the one course that is most often ignored in business schools is actually the one that is most needed, especially in India – Human Resources Management. The fact of the matter is that I spend considerable time helping portfolio companies recruit, retain and sometimes let go of employees.

I mention Narayana Murthy because Infosys is perhaps the only large company in India that shared the wealth post-IPO with a broad swath of its employees. As a matter of fact, close to one-third of the market cap of the company has been distributed to the employees via options, leading to the creation of virtually hundreds (if not more) of millionaires in India. Interestingly enough, even after years of Infosys success, the thought of wealth creation through options is still a largely foreign concept in India. Clearly, with the MakeMyTrip IPO and other successes (at least on paper for the time being) such as Flipkart, InMobi and several heavily funded, highly valued e-commerce companies, I am hopeful that the tide is changing in favour of employees understanding and appreciating the value of stock options as a compensation and wealth-creation mechanism.

Having said that, cash is still king, even for early-stage start-ups, who simply don’t have the balance sheet to compete with other well-funded or larger companies going after that same talent pool. As such, capital itself has become a key competitive advantage, not only from a marketing muscle/customer acquisition standpoint, but by enabling companies to acquire talent, at virtually any price.

Clearly, the bar is being set very high by companies like Google, Facebook, Yahoo! and others who provide extremely attractive cash compensation. But every single VC will tell you that there are companies within their respective portfolios who are on both sides of the table – those who are poaching others with attractive packages and those who are being poached by others. That song and dance will continue for some time to come (it is my guess) as long as the talent pool, especially for the upper end of the technology spectrum, is fairly small.

The problem is exacerbated by the fact that the notion of ‘bonus’ in India, for large and small companies alike, is considered a guarantee rather than truly optional or performance-based. I had an interesting conversation with someone not too long ago, asking him what a typical increment ought to be in a start-up. The response (albeit fairly generalised) was: “Well, if the company is not performing, it should be around 15-20 per cent, but if it is performing, then it should be 30 per cent or more.” I tried to contain my shock and awe at that time (I refer to it as ‘what the fudge factor’ moment). But think about that statement for a minute. If it is truly a broadly held belief (I would love to get some comments from readers on that notion), what that might mean for the Indian start-up community as a whole. I was less concerned about the 30 per cent bit, but absolutely shocked by the “if the company doesn’t perform…” portion. What it implies is that for a company to remain relevant and competitive, it needs to keep adding to the compensation per employee irrespective of the company’s financial performance. And in India, where headcount is a significant expense on the P&L, that level of sustained expected increment could be catastrophic. That’s perhaps why some companies actually consider VC funding as ‘revenue.’ Unfortunately, the belief that everyone is owed an increment is held by CXO and individual contributors alike. Because, the “fat, dumb and happy” syndrome (see my previous post on banks and telcos not caring about customer retention at this time) is pervasive among employees, with the thought that if they don’t get an increment, they can simply move on to another gig, because companies in general are talent-starved (I am speaking purely from a technology perspective).

An amazing exception to the above is a company like Canvera (admittedly biased opinion, given that it is a DFJ portfolio company). But I am going to use Canvera to highlight a very different model that somewhat capital-constrained companies ought to utilise in their overall HR policies. What is amazing about Canvera is the fact that there has been zero attrition among the top 40-50 people in the company (it has a headcount of more than 500), which is unheard of in India. Additionally, the company has a very high bar when recruiting, where people are hired not only for the capabilities but almost as importantly for their mindset and belief in a long-term upside rather than short-term pay-out (I call it a multi-vitamin for longer, healthier life, rather than a short-term steroid hit to bulk up now). Instead of hefty compensation packages, the promoters have been able to define and embed throughout the company a culture of pride, purpose, ownership and focus on employee education and improvement (personally and professionally), along the lines of perhaps what Infosys did many years ago.

What’s strange is that Canvera is truly an exception where it should really be the norm. But definitely, with the funnel of interesting exits developing, and therefore, further wealth-creation possibilities for employees at those respective companies, combined with a better understanding and acceptance of stock options as a real long-term compensation mechanism, I am very hopeful that “if the company is not performing…” notion of guaranteed increments will change. If that change does not happen, start-ups will become more capital-intensive, less competitive, leading to short-term gain perhaps for employees, but long-term pain with more capital requirement, longer time to profitability, exits and interesting enterprise values.

I am also a big believer in the notion that the CEO of a company does not necessarily need to be the most highly compensated person. I feel very strongly about a combination of fixed and variable compensation, and actually making the variable portion a bigger chunk. There is no reason that if a sales team or another team hits a chakka, like my five-year-old calls a home run, then they should not be more than adequately compensated. Typically, my advice to start-ups is twofold. First, make sure that there are quantifiable KRAs against which a bonus is allocated (usually a combination of company and either individual or team performance). Secondly, there should be no bonus if the individual/team doesn’t hit at least 70 per cent of the target; make it linear from there till 100 per cent and actually pay over 100 per cent of the bonus (from a special pool) if the target is exceeded. If the company performs, everyone wins including, of course, the CEO, who more often than not will have a significantly bigger chunk of the company as ownership than the individual contributor who is being rewarded for exceeding his/her sales quota.

Bottom line: Indian start-up environment is still far too cash-centric and unless that changes fairly quickly, the Indian cost/efficiency advantage will erode significantly with far greater repercussions in the start-up ecosystem than people realise today.


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Jolly's Volley: The Compensation Conundrum…

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