Hidden Costs and Cultural Debt

In software, we have the concept of technical debt. Developers under a deadline to build a product, take shortcuts. Over time those shortcuts lead to other problems which have to be fixed. Those problems are the interest on the technical debt, and the effort required to fix them are the way in which the debt is repaid.

I think something similar happens to companies as they grow. Early shortcuts and patterns lead to long-term problems. This is a form of cultural debt.

I have been working on this theory for a while, and I wanted to put in writing. This is not something time-sensitive, but rather something I will likely refer back to in the future.

Put simply, I think that with time all companies build up costs that disappear in plain sight. As companies get older and bigger, these costs become a tax on the company, and in extreme cases can even lead to the downfall of the company.

For many people reading this, especially those working for companies that are less than four years old, this topic may not matter much. But if you are building a company, and want it to become something big or meaningful someday, then these issues start to matter for long-term thinking.

Let me give an example to make this tangible.

A while ago, I became very familiar with a company. The company was new enough to be small, but old enough to have pivoted at least once in its history. They were very smart people, building some of the best products in their segment, but they had gross margins that were much lower than their competitors. Lower gross margins eventually meant they had less money to allocate to R&D. This eventually became a problem as they lost their technical edge against the competition.

The disconcerting part was that there was no intrinsic reason why their gross margins should lag the competition. They all used the same raw materials and components. In fact, their products were so much better than the competition that they could charge higher prices, which should have given them superior gross margins.

In the end, it turned out that in one of its previous incarnations, the company had taken on a big operations team. As their model pivoted, they really did not need as big an operations team anymore. But no one noticed. The company’s accounting procedures allocated the operations team’s headcount to gross margins. This was a big fixed cost, but relegated to an accounting category that everyone assumed was an entirely variable cost. And everyone had just gotten so used to the big operations team that they did not think to question how it affected the company’s total costs.

To put it more simply, the company was investing in a luxury (a big ops team) that they did not need.

I think this kind of thing takes place at every company and in every conceivable way. Some companies invest too much in lawyers, or marketers, or a particular subset of customers, or family members of the founder. Whatever the case, as companies get older these problems start to limit strategic flexibility. The cultural debt becomes too big, until eventually the company loses its way in the marketplace or gets forced into some sort of painful restructuring.

There is probably no solution to this, and definitely no easy one. All companies carry the seeds of their ultimate vulnerabilities. The best management teams can do is to make sure they are aware of the source and true cost of the debt, and to be prepared to someday pay a painful price to fix the matter, or at least pay down the debt a little bit.

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