Organizational Debt Kills ☠️
70%+ of costs for the typical software company are people related, so act like it!
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Annual Planning
We are in the thick of annual planning season for next year and as usual the conversations are centered around:
How do we accelerate growth?
How do we become more efficient?
Headcount related costs have historically accounted for ~70%+ of total costs for cloud companies. While headcount costs can be high, an even more important factor is the impact great people/teams/culture can have on the growth of a company.
While scrutiny on headcount has certainly increased over the past few years, the majority of companies still fail to appropriately manage it. And it is slowly killing them…
Headcount planning often goes something like this:
Finance: Hey VP of Engineering, you spent $35M last year in R&D. We are forecasting revenue of $120M in 2025 and based on the benchmarks you have $4M of additional budget for next year. What do you need to add based on the company goals?
VP Eng: Well the benchmarks say I can add 20 more headcount, so let’s do that. And I need to hire them asap! Let’s chat again next year.
There are a few things wrong with this, but the biggest issue is that we are just incrementally adding more spend rather than re-evaluating all the existing people, spend, and team structure. We often heavily scrutinize the additional $4M, but we completely ignore the existing $35M.
Organizational Debt
The above example is one way for organizational debt to start accumulating.
Startups blitzscale to capture big opportunities and grow revenue as fast as they can, but that speed comes with trade-offs, which is organizational debt.
The concept is very similar to tech debt, which most folks in the tech industry are familiar with:
Tech debt: The consequence of prioritizing speed over designing the optimal code and software infrastructure. This means making decisions that you know will need to be fixed in the future.
Organizational debt is basically the same thing, but with how the organization is built.
Organizational debt: The consequence of prioritizing speed over making optimal people, culture and organizational structure decisions.
Everyone talks about tech debt and understands it. Good R&D teams make sure to eventually refactor their code when the time is right and before it eventually slows them down.
We allow tech debt so engineering teams can move fast, but if not properly managed then the opposite will eventually happen - engineering teams will be so preoccupied with band-aid solutions that they will be slowed down.
Companies often forget that refactoring may also be required because of their organizational debt.
We might be scrutinizing new hires a lot more closely but we neglect the significantly larger amount of organizational debt already accumulated.
Fixing Organizational Debt
The organizational debt is created because of the need to move fast, but eventually the debt piles to a point where it is actually slowing the company down.
Zero-based budgeting is critical in fast changing environments and during technological shifts. If your company doesn’t do zero-based budgeting, then now might be a good time to start.
Zero-based budgeting = This is an approach that involves developing a new budget from scratch every year, versus starting with the previous period’s budget and incrementally adding to it.
Leaders should define what needs to be accomplished and what they require to accomplish those things.
This is not necessarily about forcing leaders to do layoffs (although many orgs still have a lot of fat to cut). But rather it is to force leaders to really understand their needs based on next year’s goals before incrementally adding more spend based on benchmarks.
Zero-based budgeting takes longer, but when done right it can enable companies to move faster. Organizational debt can sneakily build much faster than most companies realize. And it can be much less obvious than tech debt.
Questions to ask:
Is the team structure optimal for our current stage?
Has the company outgrown any of its people? (leaders were great startup people but maybe not growth stage people)
Are B/C players making things inefficient? Would just one A player be enough?
Are reporting structures slowing us down?
Has technology changed our needs (👋 AI)?
Do we have roles we never should have hired for?
What bucket does this role/team fall into? (increase revenue, drive innovation, mission critical, candy) - The “candy” roles are nice-to-haves and should be evaluated - see this post.
Concluding Thoughts
Try zero-based budgeting and have honest conversations with your leadership teams.
What do you need in your business today based on your current stage and environment? Things have probably changed….
Organizational debt can still build even if you hired amazing people originally.
Don’t let organizational debt sneakily slow you down and kill your company.
Footnotes:
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Dynamite post and timely. This is a great example of why finance leaders need to stop sending Excel templates during budget season and instead have a conversation with their leaders in a small group or 1:1 setting with these sorts of questions, take notes, and then turn those notes into a spreadsheet.
Well-written, and it’s an important topic. A few thoughts:
1. For every organization that has the debt you describe, another has the opposite problem: People, structures, and processes stretched so thin/eliminated in the name of EBITDA that the multiple on those earnings is impaired, and you have little hope of knowing the damage until you bring the company to market and land at (or below) the bottom of the range.
2. You’ll struggle to align on a zero-based budget without first aligning on a better operating model and then sizing organization and the budget to run that model. The budget is a dependent rather than an independent variable. It’s the output of the process, not its driver.
3. Rewriting an operating model from scratch is really hard. Incremental annual budget increases are mindless and lead to the organizational debt you describe. Maybe there’s a middle ground: Hold the functional leaders responsible for the majority of people costs accountable for *increasing returns to scale*. Let them figure out the people, structure, process details. They’ll need a strong HR business partner who understands strategy, finance, and org design. And if these leaders can’t do that, you’ve found the problem.