I was well paid though. I received a base wage rate plus a piece-rate, where I was paid an additional amount for each binder bin that I completed. The piece-rate was set based on meticulous analysis of the manufacturing process which determined how many units I should be able to produce per hour. The full-time factory workers, who were lovingly referred to as “factory rats”, were paid under the same scheme. This scheme was intended to motivate higher output on the manufacturing line.

A couple of weeks into my first summer, I figured out that I could improve my output of binder bins, and therefore my compensation, with a couple of tweaks in the process.  During lunch, I shared with some of the factory rats what I had discovered. Their response was not what I expected. Essentially, I was told:

You don’t get it. If you improve the process, management will modify the piece-rate component of our comp scheme. We’ll have to make more units to get the same total compensation. You’ll only be here for the summer, but we’ll have to live with that change forever. Don’t do it. Don’t ruin it for us.

The factory rats didn’t want to help the Company figure out how to produce more, because they didn’t believe they would receive more compensation for identifying ways to produce more. This was my first experience with what compensation experts call “if-then” rewards. I have been skeptical of “if-then” compensation schemes ever since. If this kind of pay for performance scheme doesn’t work for a mundane repetitive task, imagine what happens when you apply “if-then” rewards to knowledge work.

Established management philosophy treats all employees like the factory rats – with carrots and sticks. That philosophy says “I can cause you to do more of what I want you to do if I pay you when you do it” and “If you don’t do what I want, I will withhold rewards or worse punish you”. This is tantamount to giving a mouse a piece of food for pushing the blue button and shocking it if you push the red one.  The only problem is we’re not mice (or rats for that matter). WE’RE HUMAN and that makes us complicated. Carrots and sticks don’t work.

The first book I read on this topic (many years ago now) was Edwards Deming’s The New Economics. Yes, that Deming, the American-borne manufacturing process guru who helped to usher in Japanese domination of manufacturing process. It turns out that Deming was also a management psychologist who was well ahead of his time. Deming believed that we should abolish performance reviews in the workplace and grades in school. He felt that those types of subjective measurements of performance wiped out the employee’s/student’s intrinsic motivation. The employee’s goal becomes to please management, rather than to do good work. The student’s motivation becomes to get a good grade, as opposed to learn. It turns out that we complicated humans like to do good work and we enjoy learning; we are intrinsically motivated beings; external rewards and punishments get in the way.

Many years later, I’m encouraged that there is finally a new management regime beginning to take hold. It is best summarized in my most recent reading on this topic. Written by Daniel Pink, Drive: The Surprising Truth About What Motivates Us gives a good overview of the roots of our antiquated management/compensation philosophy and the science (much of which has been around for many years) that shows how flawed it is. Pink also offers insight into what we can do to change. To sum it up; pay people what they are worth, give them autonomy in their work, provide them the opportunity to master their craft and create a sense of purpose in the workplace. It is not that hard.

My own experiences, my personal reaction to comp. schemes I’ve had imposed on me in the past and years of reading on this topic (Here are my favorites) make me contrary on compensation. I’m done with carrots and sticks. How about you?

Note: For a good summary of Drive, check out this RSA Animate sketch narrated by Pink.

Neither is an obscure business model that the Internet has managed to invent. And both are well studied by economists. As David Evans, a scholar and consultant I admire, and co-author of The Catalyst Code – one of the finest books on two-sided business models – highlights in a recent blog post:

Most of the kinds of business models that Anderson talks about have been around for centuries if not longer. Google’s search business model isn’t fundamentally different than yellow pages. The yellow page companies charged the advertisers and give the search mechanism away for free. The only business model that Anderson points to that is really new is open source.

Evans and his colleagues at Market Platform Dynamics get free, particularly its application in two-sided businesses better than anyone I’ve met. Not surprisingly, they work in sectors like payments and media where free is a prominently used tool. Evans goes on to say:

The two-sided literature and other economic theories emphasize that free is a special case and that it doesn’t necessarily or always lead to a profitable business.

Yes, frictionless distribution enables more companies to give something away for free in the hopes of getting someone to pay for something else. But getting someone to pay for something is the hard part and is largely ignored in “Free”. This is all too “if you build it someone will pay” for me. For my part, I’d like to know what and when someone is going to pay for before I start giving a component of my offering away for free. Anything short of that is gambling.

Some smart entrepreneurs are fighting the urge to “go free” as well. For a humorous look at making money on-line without giving something away for free, check out this video of David Heinemeier-Hanson presenting at Startup School ’08. His conclusion; don’t give what you do away for free; have a price!

While all free is not equal, free as a price has its place. But it is not an elixir for all.

As the cliche goes, every night, the most valuable assets in my investments walk out the door; the people. And the group that is responsible for managing all those people, the management team; they are not just “executives”, they are people too. Those executives need to be nurtured and developed if they are to perform. And from my perspective, psychology and “mindset” play a key role in executive development.

So how does a VC help put the entrepreneur/executive in the right mindset? Well, it starts with the VC having the right mindset to begin with. So what is the “right” mindset? Carol Dweck, a Professor of Psychology at Stanford, wrote a book on two basic mindsets she has observed and analyzed over many years, creatively called “Mindset”. It is a simple, but remarkably powerful construct for understanding how people frame their worldview and their place in the world.

According to Dweck, there are two basic mindsets that people adopt; the fixed mindset or the growth mindset. In the fixed mindset, people see their abilities and those of others as based on fundamental talent. This inherent talent is perceived to be unchangeable; fixed. A fixed mindset person would think “I am talented at math”, “I am not a good artist”, “I am a naturally gifted athlete”. In contrast, people in the growth mindset believe that talent is “developed” through hard work and that everyone has the ability to improve. They are interested in the journey, and view the result as an outcome based on many factors, including effort. Both success and failure are considered opportunities to learn and improve.

In my opinion, a venture investor with a fixed mindset is doomed and potentially dangerous. Every failure is taken as a personal affront to their talent. Rather than learning from failure, those in the fixed mindset look to blame others; the market, the management team, the “irrational” competition. They view investments that are behind plan as failing them and therefore a waste of additional time and effort. If the Company is behind its sales target, the VP of Sales and Marketing must not be talented enough. Fire him. There is no consideration given to helping the CEO, and executive team develop their skills, because they can’t be developed, their talents are fixed. Success is even more dangerous for the fixed mindset VC, because success validates the belief in their raw talent. They don’t have to work hard, their inherent “deal-sense” will carry them. In fact, working hard might cause others to question their raw talent. Those who are inherently gifted don’ t need to work hard.

More importantly, a VC with a fixed mindset can’t help a management team get into a growth mindset. They don’t view the team as people to be developed, but rather as people to be judged and kept or terminated. They take credit for others successes and blame others for their falures. This risks putting the entire company in the fixed mindset, stifling team development, creativity and the risk taking that emerging companies thrive on.

If the fixed mindset is dangerous, the growth mindset is powerful and empowering. Every challenge  is an opportunity to learn or to help someone else learn. Success is seen as the result of hard work; effort is rewarded as well as results. There is no blame, no finger pointing, only accountability. The only way to fail is to not try.

I look for growth mindset entrepreneurs. If you are an entrepreneur, look for a growth mindset VC. And if you are in a fixed mindset, fret not. Read the book; you’ll learn something. And with some hard work, you can change your mindset!

Analyzing failure is unfortunately prone to post-hoc analysis and revisionist history. As a result, Collins takes an empirical and analytical approach to the process. The companies Collins analyzes are necessarily large, public companies. Despite this, there are many key takeways from the book that are applicable to emerging growth companies; two of which I wanted to capture.

Takeaway 1: Pride Cometh Before the Fall

There is a great synergy between How the Mighty Fall and Collins’ prior works, in that failure is to some degree the mirror image of success. In Good to Great, Collins’ concludes that a single personality trait separates leaders of good companies from leaders of great companies; humility. It is no surprise then that the first “marker” of the impending decline of a great company is the replacement of “humility” with “hubris”. If your Company is growing and looks as if it will be successful, the right response is utter paranoia; of competition, of a shift in your market, of anything that can take your business off track. But most of all, you must be paranoid that hubris sets in and your team starts believing its own press. It is a surefire sign; perhaps the first sign; that your company is at risk.

Takeaway 2: The Fatal Wounds are Self-Inflicted

Decline can be reversed if caught early. Hubris can be re-replaced with the humility required for an organization to question assumptions, to come to grip with the harsh reality and with the persevering drive necessary to harness great market opportunities. But if caught, “hubris” leads to a series of bad decisions that are disconnected with the core mission of the organization. It is like an airline crash; rarely caused by a cataclysmic damage, but rather by a series of bad decisions (none of which is fatal in isolation) that compound on one another. This quote from Collins on the back cover of Why the Mighty Fall pretty much sums it up.

“Whether you prevail or fail, endure or die, depends more on what you do to yourself than on what the world does to you.”

There is no shortage of ways to fail. But to summarize Collins’ findings, the things companies do to themselves that cause them to fail include pursing growth that is undisciplined or that can’t be digested by the organization, increasing the risk profile of the business by pursuing non-core ventures, incessant restructuring and choosing to blame outside factors for failures rather than looking in the mirror. The nature of these items is noteworthy; as Collins points out, it is not complacency that kills most companies, but rather, doing too much. The good news is that the process of decline is not irreversible. So if you see hubris seeping into your emerging growth business and see your organization making decisions that are inconsistent with the organizations core, abiding values, return to your roots, look internally, assess the situation without panic and make sure you have the right people in the right seats to work your way out of it, slowly, methodically, surely. There will be no magic bullets.

Success has 1,000 fathers and failure none. But we can learn a lot from the mistakes of others. Better to learn that way than to learn by repeating others’ mistakes and wasting a lot of capital in the process.