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TURTLE SOUP, VENISON AND A PIECE OF THE ACTIONNotes for a Speech by Gaylen Duncan, President & CEO, ITAC
To The Canadian Institute's Conference on Employee Stock Options
September 12, 2000 – Toronto, Ontario
Good afternoon. Thank you for the opportunity to contribute to this dialogue on employee stock options.
As a luncheon speaker, I'm conscious of my role as an aid to digestion. I'll try and keep my remarks light. I won't bog you down with a lot of statistics demonstrating the value of employee stock option plans because, frankly, I don't have any.
But I would like to give you a street level perspective on the battle for talent that's going on in the IT industry and why stock option plans are so important.
To begin, I thought I'd share a couple of stories with you. The first is from Dickens' Hard Times, set in the fictional British industrial centre of Coketown. Dickens described it like this:
"Coketown was a town of red brick, or of brick that would have been red if the smoke and ashes had allowed it; but as matters stood it was a town of unnatural red and black like the painted face of a savage. It had a black canal in it and a river that ran with ill-smelling dye, and where the piston of a steam engine worked monotonously up and down like the head of an elephant in a state of melancholy madness."
Some of Dickens' most memorable characters populated Coketown - the wrong-headed educator Gradgrind, the industrialist Bounderby and the noble, troubled mill hand Stephen Blackpool. Dickens paints this picture of Stephen at work.
"Stephen bent over a loom, quiet, watchful and steady. A special contrast, as every man was in the forest of looms to the smashing, tearing piece of mechanism at which he laboured. So many hundred Hands in this mill; so many hundred horse steam power. It is known, to the force of a single pound weight, what the engine can do; but not all the calculators of the National Debt can tell me the capacity of good or evil at any single moment in the soul of one of its quiet servants with the composed faces and the regulated actions."
Blackpool was valued, up to a point, by his employer Bounderby, chiefly because he was regular in his work habits and rarely complained.
"You have never been one of the unreasonable ones," Bounderby said. "You don't expect to be set up in a coach and six, and to be fed on turtle soup and venison, with a gold spoon as many of them do."
Not only was Stephen a hard working employee, he was a man of conscience who could bring himself to join a strike against Bounderby's mill. As frequently happens to secondary characters in Dickens' novels, Stephen's great virtue is ignominiously punished. The strikers track him down, beat him savagely and hurl him into an unused mine shaft. He's retrieved just in time to die in the arms of his true love, Rachel.
It's a great book. If you're ever nostalgic for the good old days of the industrial economy, give it a read.
Now let's fast forward to modern times. The next story I have to tell is true, but the names have been changed and the details confused to save anyone from embarrassment.
The setting is a cluster of heritage buildings in the near west end of Toronto. Ironically, this scene once had a lot in common with Coketown.
It's full of cobbled alleys that lead to large smoke-stacked buildings that once housed the mills and dye vats and looms similar to the ones that crowded Stephen's workplace.
But the smoke and soot are gone. The brick has been acid-washed to its original red. Where horses and carriages were once stabled you'll find bars, restaurants and florists. The only noises you'll hear are gentle ones - birds singing, the soft thump of a hackysack hitting an instep and occasionally the hum of a Porsche 911 pulling into its parking spot.
There are literally hundreds of companies in this block, though the age, the informality and the energy of the young men and women in the area make it look more like a university campus than an office complex.
One of the buildings on the block has been completely gutted and reconditioned to meet the needs of the 200 employees of Liberation software. Liberation produces the applications that drive an array of special effects for the film and television industry.
The team at Liberation works hard. The work is captivating so it's not unusual to find a project team burning the midnight oil to solve a problem or debug a program that has to be in the client's hands by Thursday.
Nobody punches a clock, there's no foreman, there's not even an org chart but somehow the work gets done. And even the most exigent of Liberation's clients are back again and again.
So the company has grown rapidly in the three years it's been in operation. It serves clients all around the world and boasts revenues of about $35 million.
Rumour has it that last year the partners dropped two million dollars to renovate their new space in the latest post-modern industrial design.
When questioned about this by their board, the partners argued persuasively that for client impact and employee morale, ambience is important.
Ambience in this case includes a retro-looking bar in the centre of the open concept office space. Many of the people who work at Liberation aren't 19 yet, so it also dispenses freshly squeezed fruit and vegetable juices along with more conventional beverages.
The work stations that radiate from this centre are state of the art with servers and peripherals that even Scott McNealy doesn't know he makes yet.
Tucked into the corners beyond the work stations are a weight room, a meditation room and a trampoline. Inge, the office reflexologist, dispenses her services from a small studio between the fooze-ball game and the pinball arcade.
One of the first people new hires at Liberation meet is Stan the personal trainer who designs wellness plans and can recommend the right work-out to overcome code-writer's block. Closely allied with Stan is Betty the dog walker, who makes her rounds with the pets of Liberation twice a day.
True to its name, Liberation prides itself on a free, open workplace where the ideas crackle like electricity in the air. There are no rules. Only two things are explicitly forbidden... polyester and Celine Dion.
Follow me, won't you, up the spiral staircase to the partners loft tucked up under the rafters.
It's quiet here. Most of the partners are on business trips out of town. But one of the offices is occupied. We know this because we can hear soft sobbing emanating from it. We look in on Liberation's Chief Technology Officer, Ida Lovelace, who is pounding her head on her Philip Stark desk.
It's been a tough week for Ida. Three times daily a Hungarian producer, who may or may not be insane, screams abuse at her over the telephone. He's behind schedule because he's waiting for Liberation to ship him a debugged version of an application he's tried in prototype.
Ida's late getting the product out because she's been running her team at reduced capacity. She's had two openings for senior software developers that she's been unable to fill in three months.
Fifteen minutes ago she took another call from Budapest. And then Otto, Liberation's most experienced and most brilliant interface designer dropped in to see her. Otto has been with the company since it operated out of Ida's parents garage. He's a magna cum laude mathematician from MIT and is generally regarded as Liberation's resident genius. More than once Otto has meant the difference between movie magic and hysterical FX-directors.
And his inestimable worth is closely approximated. He makes more than Ida. That's his Porsche in the parking lot.
Twelve minutes ago, he let Ida know he'd be leaving to work with a set-top box start up in Palo Alto. "Nothing personal, you understand. It's been great here. I love you guys. They just have more interesting algorithms ... Oh, and Ida, they want me on the West Coast by Tuesday."
These two fables of Coketown and Liberation Software bracket about a hundred and fifty years of human history. The point I'm trying to illustrate by juxtaposing the two stories is the dramatic way the balance of power between employer and employee has shifted over that time.
The knowledge economy has turned the tables. Where workers were once dismissed as a factor of production, no more valuable than fuel, machinery or primary resources used in the process, now they are virtually the whole means of production.
It is as Peter Drucker foretold:
The single greatest challenge facing managers in the developed countries of the world is to raise the productivity of knowledge and service workers. This challenge, which will dominate the management agenda for several decades, will ultimately determine the competitive performance of companies. Even more important, it will determine the very fabric of society and the quality of life in every industrialized nation.
The first step in raising the productivity of knowledge workers is understanding the key attributes that make them different from the generations of working people that came before. Like their name suggests, knowledge workers are better educated than their industrial age forebears. They are also smart enough to have a clear sense of their own worth. This tends to make them fiercely competitive and highly mobile.
The career path for knowledge workers is generally non-lineal. Unlike their parents, they're not looking for cradle to grave employment. Sure, they have families to support and mortgages to pay but they also have another obligation to meet. They must continually refresh their supply of knowledge. They'll do this through continuous re-education throughout their careers. A key contributor to this is the learning they acquire by solving new problems and meeting new challenges on the job. Fail to provide these opportunities and you'll lose them as quickly as if you failed to come through with a promised bonus.
It's not enough that you appreciate all the qualities that distinguish knowledge workers from the generations of working people which went before. You also have to be aware of serious environmental factors. For example, in the information technology industry, not only are knowledge workers independent, mobile and expensive... they are also in very short supply.
For the past five years now, addressing the skills shortage has been a top priority for the members of ITAC. We've fought this fight in spite of the fact that, for most of that time officials in government didn't believe it was a problem. In 1996, the Software Human Resource Council estimated there were 25,000 vacancies in IT in Canada at any given time. We were so dismayed with the lack of solutions to this problem that we surveyed our own members in 1998 and they confirmed that the problem was getting worse - as many as 35,000 vacancies, especially for positions like senior and junior software developers and web designers.
You've all read enough Adam Smith to know that short supply creates a seller's market. As employers in the knowledge-based economy, we can do our utmost to create employee-centred work places that attempt to meet all the requirements to ensure that our people can give us their best work.
We can stress work and home life balance, offer retraining sabbaticals, let them write their own reviews. But we've always got to be looking over our shoulder because, sooner or later, someone's going to come along and offer a sweeter deal. I told you how the virtuous employee Stephen Blackpool was rewarded in Hard Times. Well, this is the new economy's reward for virtuous employers. A knowledge worker's loyalty is to himself and his knowledge.
This all conspires to make recruiting and retraining employees in the knowledge economy a hazardous business. It's particularly difficult if you're a small company...even worse if you're a start up.
Last week we released the results of a study exploring barriers to growth among emerging information technology companies. The study focussed on 800 executives of companies operating in our industry for less than three years.
To no one's surprise, they told us that the biggest challenge they faced, especially in their first year, was finding the capital to operate and grow their businesses.
But as the companies matured, other challenges presented themselves. Finding money is still a problem but the second biggest problem they face after two or three years in business is recruiting and retraining technical staff. The toughest recruiting challenge was not what we expected. Among start-ups and emerging companies, the mission critical jobs to fill are not necessarily in the IT or the R&D department, they're in sales.
The learning I take from this is that option plans should not be restricted to the evil geniuses who pound out the code and build the applications. Sales people, too, are knowledge workers. As the battle for their talent heats up, start-ups offering options will begin recruiting from more established firms who don't.
In many cases, the start-ups are paving the way in the deployment of options as tools for recruitment. With capital so scarce and few other bargaining chips to play, they know that their best chance is to offer recruits a piece of the action. Many employees find this attractive. Even though we know that the odds are stacked against a start up's success, the prospect of being the next Netscape is tantalizing to anyone with an ounce of entrepreneurship. There are enough well publicized success stories - like Research in Motion, and 724 Solutions - to keep the dream alive.
So what role should employee stock option plans play in your companies' recruitment and retention strategy? Well I don't want anyone to leave you with the impression that they are a silver bullet to protect you from the skills shortage and the brain drain.
At this point stock options don't represent an offensive strategy at all. You need them for defence. You need them for the same reasons you need flexible hours, tele-commuting programs, on-site day care, a fitness centre and an employee rewards program. You need them because you're in a life and death battle for talent, and everyone you're competing against has access to the same programs that you do.
The only good news is that unlike all the other programs, which are pretty much invariable, the more successful and well-managed your company is, the sweeter the option plan becomes.
There was a terrific article in Vanity Fair last year about the Microsoft Millionaires ... not Bill Gates and Paul Allen ... but the hundreds of employees - including receptionists and order shipment clerks - who were part of Microsoft's option plan when the company was getting started. Many of them have gone on to launch successful businesses of their own.
So if you can offer options and a fairly strong prospect for success, you will achieve an advantage over your competitors. Prospective employees choosing between you and a fast company whose options could crater before they're vested will generally choose wisely. If they don't, chances are you wouldn't want them anyway.
Option plans are becoming a weapon of choice in the knowledge economy battle for talent. But government policy still needs to catch up with this reality. ITAC, encouraged by Terry Matthews the founder of Newbridge Networks and 35 other successful companies, helped lead a campaign to reform the tax treatment of employee stock options. We called for an increase in the life-time capital gains exemption, a decrease in the holding time for capital gains eligibility and a change in the time when options are taxed.
We had a further opportunity to promote these ideas as part of the E-Business Opportunities Roundtable, which tabled its report earlier this year. The Roundtable Report was highly influential in the February 2000 Budget where for the first time we began to see measures acknowledging the arrival of the knowledge based economy.
Apart from a most welcome reintroduction of full indexing, a commitment to eliminate the 5% surcharge on incomes over $69,000 and a general posture of tax relief, Minister Martin also implemented one of our suggestions about employee option plans. He decided to change the timing of taxation from when the shares are vested until when the shares are sold.
This brought us in line with best practice in the United States. But competing with the US is a dynamic process.
This year's budget was a good start but we need further reforms to maintain our natural advantage in the new economy. Here's what we recommended to Minister Martin this year.
- Lower the capital gains inclusion rate again this year from the current 66% to 50% and also apply this 50% inclusion rate to income realized through the exercise of share options.
- Increase the $100,000 annual roll-over limit for tax-deferred investment of capital gains into qualifying small business to $500,000.
- Introduce a parallel rollover into a qualifying small business for gains earned through the exercise of options also with an annual limit of $500,000.
- Increase the $100,000 annual limit for tax deferral on share options to $250,000.
- Lower the general corporate income tax rate immediately to 22% to bring Canadian rates in line with the international benchmarks now set in Britain, Scandinavia and Australia.
- Eliminate the remaining "high income surtax".
- Increase RRSP contribution limits by $2000.
- Work with the provinces to eliminate all taxes on capital.
We'll keep up this fight. We believe that there's more at stake than the interests of the information industry. We believe that timely reform will make the difference between leadership and a seat on the sidelines in the knowledge economy.
I think this is a position worth fighting for. A few chapters of Dickens is all it takes to convince me.
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