The takeaway is this:
Many startup founders – interestingly especially those with an engineering background – screw up the budgeting process by not applying any constraints to growth.
According to Ben Horowitz a typical budgeting process goes like this:
- Set goals that will enable us to grow
- Break the goals down so that there is clear ownership and accountability for each goal by a specific team
- Refine goals into measurable targets
- Figure out how many new people are required to hit the targets
- Estimate the cost of the effort
- Benchmark against the industry
- Make global optimizations
While this sounds reasonable at the first glimpse the problem is that by not applying any constraints or targets you’ve just implicitly created a gamified process.
The name of the game? Maximizing the size of an organization and – by consequence – the status of the manager responsible for this organization.
Even if most of your managers behave ethically and altruistically, i.e. just keeping in mind what’s best for the company instead of their own careers and status, it just takes one manager to start this game of organization bloat and everybody else is forced to follow suit.
Game theory is just beautiful …
Ben suggests to amend this flawed process by doing what engineers and designers usually are best at: Applying constraints and working within them.
The following would be useful constraints for restricting budgets in an engineering-oriented startup:
- run rate increase
- target earnings
- engineering growth rate
- ratio of engineering to other functions
Applying such constraints Ben puts forward the following steps for an improved budgeting processes.
- Take the constrained number that you created and reduce it by 10-25% to give yourself room for expansion, if necessary.
- Divide the budget created above in the ratios that you believe are appropriate across the team.
- Communicate the budgets to the team.
- Run your goal-setting exercise and encourage your managers to demonstrate their skill by achieving great things within their budgets.
- If you believe that more can legitimately be achieved in a group with more money, then allocate that manager extra budget out of the slush fund you created with the 10-25%.