You are no longer on an island
Fading away are the days where tech salaries were structurally 20–25% lower outside of the major tech hubs than they are in the hubs (e.g. SF/NYC). We see it everywhere, in and out of our portfolio. Companies outside of the major hubs didn’t really compete with the FAANGS of the world or the larger VC-funded companies — the vast majority of these heavy-weights would hire in geographies where they had offices. Work from home was the exception, not the norm.
Almost over night, the water drained from between these metaphorical islands of talent. Companies, whether they liked it or not, were suddenly competing on a Pangea.
It felt liberating at first — companies in cities like Nashville and Portland could pick from a talent pool 100x the size for that new FP&A Director. But over the next year, we started to see some cracks… Employee turnover started to pick up, competition on salary/benefits began to rise.
Part of this we can attribute to cheapness of capital, independent of geography. Monetary stimulus and software optimism has flooded cash onto tech companies’ balance sheets, giving them even more ammo to acquire their #1 input to production, people (engineers, salespeople, etc.). This has broadly inflated salaries of technology workers — we see new hires making ~10% more for the same positions vs a year ago. This then dribbles into adjacent industries—bankers get paid more, lawyers are working harder than ever. At least one white-shoe NYC law firm I know is paying $250k signing bonuses for new associates. Point being, cheap capital has put tech employees on the right side human capital supply/demand imbalance. Inflation of course being a byproduct of the market trying to rebalance.
Cheap capital disclaimer laid out, let’s revisit the talent Pangea with a quote:
“Talent is equally distributed, opportunity is not.” — Unknown, Pre-COVID
Post-COVID, this has become much less accurate. Opportunity is now more equally distributed, matching the talent distribution. You no longer need to be in a tier-1 city to get a job with a tier-1 company — if you’re good, it increasingly doesn’t matter where you are. Said differently, now that talent and opportunity are equally distributed, it’s only a matter of time before the market begins to correct the imbalances of compensation.
The tactical, short-term remedies
- Saddle up — you ain’t in Kansas anymore. Or maybe you are, but as far as your candidate is concerned, you aren’t. Put your local compensation comps in the trash and pick some up from a tier-1 market. That’s likely closer to what you’re competing against. Or don’t and watch your churn rise. Adjust your forecast model accordingly — several of our companies are at their headcount plans, but above on payroll. Closing your eyes and hoping it doesn’t happen isn’t going to change reality; you may even end up needing to play catch-up as people leave.
- Make it your advantage. US talent is 2–4x as expensive as talent in South America, India, and Eastern Europe. If you can effectively leverage talent in these geographies, it’s a massive competitive advantage. Maybe there are some points of friction with e.g. language and time zone, but net net, you’ll get 1.5–2x the ROI on a dollar. Become that organization that knows how to effectively leverage remote talent. Implement the collaboration tools, performance tracking systems, etc. Whatever you need, put it in place, and master it.
Hypotheses on macro implications
- If small companies can no longer “hide” in tier-2/3 markets, the large incumbents have an advantage. There are many puts and takes here, but net net, you’d be hard-pressed to argue for the small companies. Software is a build it once, sell it many times business, so the larger companies with larger annuity streams should be able to pay higher salaries. Not to mention of course, they have armies of recruiters running mega-machines to acquire and retain talent.
- It’s easier than ever to start a company, and harder then ever to scale it. Yes, it’s never been easier to raise money for a company, but markets love balance; markets make sure credits always come with debits. Per the inflation discussion above, more capital availability = more competition for talent.
- The newfound pressure on small companies may create a barbell effect. Take the above two points together — if it’s easy to start companies and mid-sized companies are suddenly forced to compete with mega-incumbents for talent, you may end up with a barbell effect. Lots of small company formation solving small problems (vertical-market software, niche tools, etc.), the mid-market feeling pressure, and lots of big incumbents. It is a bit odd that the middle-market private equity bread and butter software companies have managed to hire enough engineers into these middle-America, $250M-TEV opportunities for so long. Maybe these people just don’t care to make more money at the big tech cos, or early-stage venture cos with more upside? Location may have been a factor historically, but much less so now.
- Companies have an addiction to capital, and withdrawal is more damaging than ever. Look at the top 25 non-FAANG software names in the public market. With few exceptions, between 2019, 2020, and 2021, companies’ magic #’s have come down. Because capital is so cheap, companies are willing to take lower IRRs on their investments in customers, in an effort to boost growth. In a practical sense, this lower IRR comes in the form of higher salaries & benefits. The challenge being, if this cheap capital dries up, companies may be left in the lurch for a period of time, with structurally higher salaries keeping IRR on new customer investments low, while the cost of capital rises. The ultimate ROE squeeze.