Roger Martin is a professor at the Rotman School of Management at the University of Toronto, where he was Dean from 1998 to 2013. He’s been a strong advocate of the need to transform business education, in particular that students need to learn how to think holistically and creatively, to better prepare them to deal with the complex problems they will encounter throughout their careers. Professor Martin is also a prolific writer, having published a number of books and articles over the years.
About a year ago he co-authored a very interesting short article, Capital vs Talent: the Battle that’s Reshaping Business, with his Toronto colleague Mihnea Moldoveanu. Their basic thesis is that in our emerging digital economy, talent has become the key competitive asset for companies.
Until early in the 20th century, most companies were organized around their physical assets, such as land, minerals or oil. Later in the century, the key competitive assets shifted from natural resources to plants and equipment, sales and distribution, and finance. These capital assets enabled companies like IBM, GM and Eastman Kodak to achieve the necessary scale to compete across the country and around the world.
Then late in the 20th century the terms of competition changed again, with physical and capital assets no longer being the keys to success. “By 2000, many of the world’s top 15 firms by market capitalization began with little or no physical or financial assets - including Microsoft, Cisco, Intel, and Wal-Mart,” notes the article. “The vast majority depended on superior human assets for their advantage - great research scientists, inspired code writers, distribution geniuses, product innovators - and knowledge assets - patents, brands, know-how, experience. In short, in increasing numbers, leading companies were depending on talent.”
It should not be a surprise that talent has become the critical competitive asset in our information- and knowledge-based economy. Economists like MIT’s David Autor have been writing about the increasing polarization of the US labor market. For the past few decades, the demands for high-skill jobs have significantly expanded, with the earnings of the college educated workers needed to fill such jobs rising steadily. Low-skill jobs have also been expanding, but their wage growth has been flat to negative. And, especially since 2000, job opportunities and earnings have been declining for mid-skill workers.
The IT revolution and globalization are radically changing the business environment, note Martin and Moldoveanu, “sparking a battle between talent and capital for the profits from the knowledge-based economy - and there’s no end in sight.” Low- and mid-skill labor is losing out in this battle between capital and talent.
With capital now abundant and generic, talent has become the linchpin asset of the knowledge economy, making capital highly dependent on talented experts to navigate our increasingly complex business environment. This is driving the high levels of senior executive compensation, - especially CEOs, - as well as the compensation of high skilled professionals in industries like finance, entertainment, software and strategy consulting.
Martin expanded on the subject with the recent publication of The Rise (and Likely Fall) of the Talent Economy in the October, 2014 issue of the Harvard Business Review. The article starts out with a few facts illustrating the rise of the talent economy over the past few decades.
Creative jobs, - i.e., positions requiring substantial independent judgement and decisions making, - were 16% of all jobs in 1960, doubling to 33% by 2010. 50 years ago, almost three quarter of the top 50 US companies by market cap were primarily involved with natural resources. This all began to change with the rise of a new breed of companies like IBM, Eastman Kodak, Procter & Gamble and RCA, whose key competitive advantage was their talented employees in creative jobs like research, engineering, marketing, sales, and finance.
“By 2013 more than half of the top 50 companies were talent-based, including three of the four biggest: Apple, Microsoft, and Google. (The other was ExxonMobil.) Only 10 owed their position on the list to the ownership of resources. Over the past 50 years the U.S. economy has shifted decisively from financing the exploitation of natural resources to making the most of human talent.”
Moreover, two additional factors have contributed to the increased compensation of talent. One is the shifting tax policy. The top marginal tax rate went from 70% in 1981 to 28% in 1988; it later rose to 39.6% in 1993, fell to 35% in 2003, and it’s been back to 39.6% since 2013. The second factor is the rise of stock-based compensation, which was put in place to better align the interests of management and key professionals with those of shareholders.
“It’s no surprise that talent got much richer after it was recognized as the linchpin asset in the modern economy,” writes Martin. “It’s also unsurprising that ordinary employees have long accepted this rebalancing of income - after all, it fits the American Dream, in which hard work and the cultivation of talent deserve rewards. People don’t mind your being rich if you made the money yourself; what they don’t like is your inheriting wealth. And the evidence is clear that the vast majority of Forbes billionaires are self-made.”
But, the article warns that this talent economy may be headed for a fall. The reason is rising inequality, “with the top 1% of the income distribution taking in as much as 80% (estimates vary) of the growth in GDP over the past 30 years.”
Little of the value created by this well compensated class is trickling down to the general population. “Real wages for the 62% of the U.S. workforce classified as production and nonsupervisory workers have declined since the mid-1970s.” Nor is the situation better for investors. “Across the economy, the return on invested capital, which had been stable for the prior 10 years at about 5%, peaked in 1979 and has been on a steady decline ever since. It is currently below 2% and still dropping, as the minders of that capital, whether corporate executives or investment managers, extract ever more for their services.”
In addition, our economy has become much more volatile. As Martin notes in a related HBR blog, there are actually two different economies, the real economy and the capital markets. “The real economy is the one in which real companies, individuals and governments buy and sell real things for real prices… The capital markets, however, are not the real economy. The value of stocks and bonds are not directly determined by economic actions or events. They are driven by expectations of future economic actions and events”
In 2000, the Forbes 400 list of the riches people in America included 4 hedge fund managers; it’s 26 in the latest 2014 Forbes list. A recent paper noted that in 2010, the top 25 hedge fund managers made four times the earnings of all the CEOs of the Fortune 500 combined.
Hedge funds make their money through frequent trades and sophisticated algorithms. Unlike long term investors, traders generally hold their positions for seconds, minutes or days rather than years. “In fact, hedge fund managers don’t care whether companies in their portfolios do well or badly - they just want stock prices to be volatile. What’s more, they want volatility to be extreme: The more prices move, up or down, the greater the earning potential on their carried interest. They aren’t like their investment management predecessors, long-term investors who wanted companies to succeed.”
Furthermore, Martin worries that since executive talent is primarily rewarded with stock-based compensation, their incentives may be more aligned with shaping and manipulating the market’s expectations for their stock, rather than enhancing the real performance of their companies by creating products, services, and jobs.
“The income gap between creativity-intensive talent and routine-intensive labor is bad for social cohesion. The move from building value to trading value is bad for economic growth and performance. The increased stock market volatility is bad for retirement accounts and pension funds. So although it’s great that the proportion of creativity-intensive jobs is now nearly three times what it was a century ago, and terrific that the economy is so richly endowed with talent, that talent is being channeled into unproductive activities and egregious behaviors.”
“In a democratic capitalist country, it is not sustainable to leave the members of the largest voting bloc out of the economic equation,” he warns and proposes three key actions:
- Talent must show self-restraint by scaling back their financial demands;
- Investors must prioritize value creation, particularly the large pension funds and sovereign wealth funds; and
- The government must intervene early, and rein the excessive compensations of the top 1% before a more radical anti-talent agenda seriously compromises America’s entrepreneurial capabilities.
His proposed actions may appear unrealistic given our present political environment. But, the future is highly unpredictable, especially in an economic environment where a generation of workers is facing underemployment and stagnant pay. “Unless the key players work together to correct what’s causing the current imbalance, the 99% will vote in a rebalancing that is radically in their favor.”