In the last couple of weeks I have been converted to a world of imperfection. Flatteringly considering myself an economist, I have an obsession with efficiency. Anyone with an equilibrium named after them is a natural hero.
The revelation has come in the value of keeping things simple. This principle has been reinforced to me in deal structuring and price setting. Whilst I have never actively sought to overcomplicate things (some of my colleagues and professional acquaintances may disagree), I have simply focussed on making sure that things were structured in such a way to provide people with the correct incentives.
Consequently, when it comes to partnerships I have preferred tiered revenue targets with rising shares; corporate transactions earnouts with a mix of targets to manage behaviour; and even to pricing that truly reflects value delivered.
My hope has always been to create the right balance of incentives with protection for both sides. Whilst simplicity would have always been an ideal, for me it now becomes as important as incentive and protection. Would it even help to have a diagram? (it’s been a long train journey)
The reality being that these three items are not always consistent. I would now push the importance of keeping things easy to understand, and importantly (in the corporate world) easy to communicate. One of my failings would be that when in “deal mode”, I live the deal and iterations of the structure seem completely rational. However, all parties need to share the same understanding of the deal, and this can be undermined if it has strayed from simplicity.
It is also difficult to resist the temptation to add complexity once parties have agreed buy-in on a simple basis. One of the partners we are dealing with has a great ability to continually make things simpler and consequently the partnership will be stronger – we are both clear on each other’s roles in the relationship.
This did slightly jar with my pretence of being an economist until I remembered the theory of the second best. I am bound to get it wrong (pretty sure I did in my finals), but I enjoyed the way it pulled at the core of pareto economics to say that by taking a wider view on things the right result might be in general more efficient than a series of individual efficient situations. (I defer to Wikipedia)
I have seen the value of simplicity play out in a partnership we are exploring and also in investigating pricing options (through a fascinating focus group held expertly by Rafe Offer). In both cases, the need to balance risks and incentives were fully understood, but instead of contracting for them, both our partner and dealers recognised that these could be solved in easier ways – simply by assessing whether it is working or not. And the key to solving this is closer communication. Incredibly simple, but allows us to reduce the need for contracts and focus on our relationships.
Oh crap – I’ve already over complicated it. In my head it sounded simple…
