Hyperleveraged companies

Created

Jan 19, 2023 8:01 PM

Hiring and leverage

Hiring and growing employee headcount are traditionally seen as a form of success. Many founders are quick to hire new talent, many managers at companies want to grow the size of the teams they manage and many VCs often screen LinkedIn for companies with the fastest headcount growth to identify promising companies.

But customers don’t care how many employees were involved in something. They care about the quality of the product or service they get relative to the price they pay. Keeping quality constant, being able to deliver that quality with fewer people is better.

Now, onto leverage. I like the way Carta thinks about leverage and hiring:

The goal for employees is to maximize leverage i.e., maximize the impact they have for a given amount of effort, rather than efficiency, i.e., minimizing effort for a given amount of impact
If the existing employees failed to create enough leverage to grow the company themselves, then the company needs additional help, and so hires additional people.

So in short, companies should seek to create as much leverage as possible so that they can do the most given their resources. If that wasn’t enough to execute on what they needed to execute on, they need to turn to the labor markets for help.

The perfect business is a computer plugged into the internet. Starting with me, every human thereafter is overhead. And we are increasing overhead by 50%. I want to repeat this point. We are increasing overhead by 50% because we failed to execute. It is not something to be proud of. – Carta on hiring

Hyperleveraged companies

It is quite extraordinary that Among Us needs just 1 employee per over 100M users.

And guess what? They’re not even a complete outlier. Over the last decade or so, there have been several examples of companies that had an outsized impact with relatively small teams.

When Instagram was acquired by Facebook in 2012 for $1B, it had a total of 13 employees, including the two founders. At ~30M users at the time and a value of $1B, that’s roughly 2.5M users per employee and $75M EV/employees
When WhatsApp was acquired by Facebook in 20 for $19B, it had a total of 55 employees. The 55 employees supported ~400M monthly active users, over 7M users per employee. And the $19B in value represents roughly ~$350M in enterprise value per employee.
The Swedish firm Mojang developed the game Minecraft which had over 100M users and brought in more than $100M in profit each year. It was acquired by Microsoft for $2.5B when it had ~40 employees. That’s 2.5M users per employee and $62.5M in enterprise value per employee.
Craigslist makes over $1B in revenue each year and has ~100M users globally. It operates with just 50 employees. That’s 20M in revenue per year per employee, and 2M users served per employee.

The Drivers of Hyperleverage

So what enables these hyperleveraged companies to exist?

But before we get into those, let’s consider a general company. Broadly, companies do two things: make things and sell things. Making things involves a set of activities to produce a product or service. Selling things encapsulates activities including marketing, distribution, sales, etc to get the product or service in the hands of the customer.

With that in mind, let’s consider the factors enabling hyperleverage.

Software is infinitely reproducible: In old economy companies, most products had to be made over and over again to be sold to new people. However, software and code are essentially infinitely reproducible with ~0 marginal costs. A piece of software can be written once and distributed over and over, while a physical good has to be produced over and over. This essentially increases the leverage on the “making things”.
The rise of “supply chains” in software: Just as physical goods manufacturers used a network of suppliers to outsource parts or production processes too, in recent years there has been a proliferation of APIs and infrastructure providers which function as the supply chain for software companies. These further increase the leverage on “making things” within software since companies can focus on the key areas they add value and create more software with fewer people. Examples of these suppliers include Twilio, Stripe, AWS.
Distribution is consolidated: Today, any developer can reach a potential ~3B mobile phone users just by having an app on the App Store and Play Store. And it can be distributed infinitely to those people. Similarly, the potential TAM for any website on the internet is 5B people. This reduces the amount of effort needed to distribute things, allowing for higher leverage. Similar
Network effects and virality/word of mouth: Two separate concepts, but both help in that they increase the leverage on selling things by reducing the effort needed in selling them. Distribution might be easy, but companies still need to find and reach customers. Companies with network efforts and/or word of mouth end up having higher leverage on marketing or sales because in some sense the product sells itself (network effects), or customers of the product sell the product to their friends/colleagues (virality).
Reduced transaction costs: Ronald Coase, in his essay “The Nature of the Firm” explained that while markets were good at directing resources, sometimes due to transaction costs that arose, it was more effective to coordinate through a firm. As the internet has grown, search and information costs, a key type of transaction cost has gone down, which has reduced the need for certain activities that might have typically been done within a firm to need to happen within that firm. With the rise of freelancer platforms and other services, it is now easier for small companies to tap the labor markets for one-off or recurring projects as needed rather than to bring someone in-house to perform that function. We see this with more and more companies using agencies for marketing or hiring specialized help on a project basis. Many functions that a decade ago would have had to be done in-house can now be done “outsourced” because the transaction costs associated with turning to the outside world is lower.

These factors above are evident in the examples listed. All of them (Instagram, WhatsApp, Craigslist, Among Us, Mojang) made software products with strong network effects and virality. They relied on the internet or a small set of app stores for distribution (Google, Apple, Xbox store). They used infrastructure to maximize their leverage when building (Whatsapp used Twilio, Among Us used Unity, Instagram used AWS among others).

Closing Thoughts

Note that the goal of companies shouldn’t be to maximize users served or enterprise value created per employee. Instead, it should be to identify their core competencies and focus on those and seek to gain as much leverage on their talent as possible. They should leverage the outside world for things that it doesn’t make sense to do in-house.

Margaret Mead once wrote:

“Never doubt that a small group of thoughtful, committed, citizens can change the world. Indeed, it is the only thing that ever has.”

We’ve never needed a smaller group of people to build great companies that can change the world.

It’s only a matter of time before we see a solo-founder or co-founder duo taking a company from 0 to $1B or 500M users. They will be standing on the shoulders of giants, but they would also have mastered the art of leverage.

Hyperleveraged companies

Hiring and leverage

Hyperleveraged companies

The Drivers of Hyperleverage

Closing Thoughts

Further Reading