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Noncompete Agreements Are The DRM Of Human Capital

from the bad-news-all-around dept

Over the weekend, venture capitalist Bijan Sabet kicked off an interesting discussion by saying that he doesn't believe in noncompete agreements and suggesting, anecdotally, why he thinks that they do more harm than good. Venture capitalist Fred Wilson responded by disagreeing and suggesting that noncompetes do more good than harm. This is a topic that I've become deeply familiar with recently, for some research I've been working on. My interest in the specifics of noncompetes was kicked off by a small part of David Levine and Michele Boldrin's book Against Intellectual Monopoly, where they discuss how the lack of noncompetes helped Silicon Valley grow. This lead me to a lot of research on the topic, some of which I thought it would be worth bringing up, as the discussion has become so heated -- with almost all of it focused on anecdotal points, rather than actual research. Some of this research was for a separate project I am working on, but with so much interest in the topic, I thought it would be worth a detailed post.

Much of this discussion kicked off with AnnaLee Saxenian's 1994 book Regional Advantage that tries to understand why Silicon Valley developed into the high tech hub it is today, while Boston's Route 128 failed to follow the same path -- even though both were considered at about the same level in the 1970s. Saxenian finds that the single biggest difference in the two regions was the ability of employees to move from firm to firm in Silicon Valley. That factor, ahead of many others, caused Silicon Valley to take off, while the lack of mobility in Boston caused its tech companies to stagnate and make them unable to compete against more nimble Silicon Valley firms. Saxenian claims that the difference in mobility was simply due to "cultural" differences between the east coast and the west coast. However, the impact was massive. The frequent job changes helped speed up the process of innovation, as ideas flowed more freely, allowing ideas to quickly change and grow and build upon other ideas leading to faster and better innovation. In contrast, employees in Boston stuck with their firms. The firms grew bigger, but slowly, and new ideas didn't flow nearly as easily. There was less direct competition from firm to firm, so firms were able to rest on their laurels rather than increasing their own pace of innovation.

Ronald Gilson found this to be interesting, and followed it up with his own research suggesting that that it had much less to do with cultural reasons and much more to do with the legal differences between the two places, specifically: California does not enforce noncompetes, while Massachusetts does. Gilson looks at a few of the other possible explanations for the difference and shows how they're all lacking, leaving the difference in noncompetes as being the key difference between the two regions in terms of the flow of information and ideas leading to new innovations. He also explains the history of non-enforcement in California, showing that it was mostly an accident of history more than anything done on purpose.

The problem with all of this research was that none of it really showed how much more mobile employees were in California than elsewhere, so that job fell to some researchers from the Federal Reserve and the National Bureau of Economic Research, who produced some data to back up the findings of Saxenian and Gilson in their report Job Hopping in Silicon Valley. Their data showed that, indeed, there was much greater mobility in Silicon Valley than elsewhere. Their research further backed up Gilson's suggestion that it was noncompetes that made the difference by showing that other high tech communities in California outside of Silicon Valley also showed greater job mobility -- suggesting it was a California-wide phenomenon.

Finally, to make the case even more compelling, some researchers from Harvard Business School put out some research earlier this year that not only compared the situation in Silicon Valley to Boston, but added a third natural experiment in Michigan. You see, Michigan used to not enforce noncompetes, but in 1985, Michigan inadvertently began allowing noncompetes to be enforced again. The research showed that immediately following the change, mobility of inventors in Michigan decreased noticeably, slowing the spread of certain ideas. Their research found that "The networks of small companies so crucial to Silicon Valley's growth would be less likely to develop in regions that enforce noncompetes."

Noncompetes Are The DRM Of Human Capital

In order to understand how this makes sense, just think of noncompetes as the "DRM" of human capital. Just as DRM tries to restrict the spread of content, a noncompete seeks to restrict the spread of a human's ideas for a particular industry within the labor arena. Both concepts are based on the faulty assumption that doing so "protects" the original creator or company -- but in both cases this is incorrect. What it actually does is set up an artificial barrier, limiting the overall potential of a market. It may not be easy to see that from the position of the content creator or company management (or investors). It's natural to want to "protect," but it's actually quite damaging.

We're already seeing this in the recording industry, of course. The desire to protect has actually limited the market size of other avenues for the music industry to make money. It's held back the ability to use music as a promotional good to build up the overall market for other tangible goods. In the same way, noncompetes limit the market size of the industry where those noncompetes are enforced. It holds back the ability of firms to innovate. Innovation is an ongoing process -- and the fuel of that process is the continual spread of ideas that allows multiple parties to build on those ideas, try different approaches and seek better solutions. While it may seem scary to a firm that supposedly "risks" losing some of its top employees to direct competitors, that's not necessarily the best way to look at this. What it does is force companies to keep on innovating and keep trying to come up with newer, better solutions to top those competitors. At the same time, that free flow of ideas means that the companies in the space have more fuel with which to attack the problem, rather than quarantining those ideas off in separate bins that can't be connected.

While it may seem easier to "protect" your ideas and your people, what you really end up doing is blocking off your own access to many of the ideas that you need to continue to innovate. You limit the vital mix of ideas to build not just decent products, but great products. Just as DRM has helped to destroy the record labels when competing against more nimble, more open technology -- noncompetes destroy businesses when competing against more nimble, more open technology clusters.


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  1.  
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    chris (profile), Dec 5th, 2007 @ 10:58am

    i've seen it happen first hand

    when the VC's for the dotcom i worked for in seattle pulled their funding and the firm went under, one idea was to for the developers to re-locate to california and start over, since our non-compete agreements were no good there.

    there are a number of reasons for a band of refugees from a failed dotcom to NOT relocate to cali and try to re-create their failed product (reason #1: it's already failed once!) but non-competes certainly isn't one of them.

     

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    Joe Smith, Dec 5th, 2007 @ 11:19am

    Clusters

    Economic development frequently occurs in "clusters" where an industry eco-system builds up in a particular area with the suppliers, competitors and skilled workforce (think Detroit for automobiles and Wall St for investing). The consequences of the enforceability of non-competes has to be seen in the broader context of the importance of clusers. Non-competes would impede the development of clusters by restricting the mobility of certain types of employees in certain types of industries.

     

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    Alaric, Dec 5th, 2007 @ 12:27pm

    Frequently Abused

    non compete are abused more often than not. Dishonest employers pull a lot tricks:

    1) Give the employee the non compete after he/she has quit other job.

    2) Don't allow employ to bring non-compete to an attorney

    3) Define the non-compete very broadly in geographic scope, topic, time period.

    4) Fail to give the employee anything for signing the non-compete

    5) "Ask" existing employee to "voluntarily" sign non-compete.

    There are legit uses for a non-compete but lets face my experience with it is that it is employed to intimidate and control employees more often than not.

    I was personally sued for one of these. The employer did most of what i mentioned above and the judge in may case laughed the man out of court but my former employer continued to use it to scare his employees.

     

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    bijan sabet, Dec 5th, 2007 @ 12:33pm

    great post

    Thanks for sharing this info. Very helpful and interesting.

     

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    Max Powers, Dec 5th, 2007 @ 12:39pm

    Psychology 101

    The point is that if they get you to sign such a document, you are probably of the thought that you can't do anything about it and must obey it. Only those with a brain can see through this and take it further if they decide to do so.

     

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    TheDock22, Dec 5th, 2007 @ 3:02pm

    Sign them

    Companies can make you sign these silly non-competes all they want, but in the end it employers can not really stop you from going to a competitor. Non-competes are always trumped by "right to live" laws which basically say you have the right to make a living doing anything legal.

     

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    Anonymous Coward, Dec 5th, 2007 @ 5:56pm

    On my last job I had to sign a 14 page non-compete agreement. I honestly looked at the personnel officer when I was handed that and said ," Is it a condition of employment that I sign this ?" And she replied yes. So without reading it I signed it, she looked at me a little amazed. I told her look, it is a condition of employment I sign it right ? She said yes. SO what difference did it make if I read it or not ? We both know its value. Nada. None.

    This was in Maryland, and I was fresh back from Cali, where I had been told point blank by an attorney, that non-competes in California didn't mean piddly. But in Maryland I don't know. Might have been a mistake, thinking back on it, to assume all states treat the manipulative "voluntary" document in the same way.

     

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    Nick (profile), Dec 5th, 2007 @ 8:27pm

    Great post, Mike.

    Another example to look at is countries that follow eachothers' IP laws vs. countries that do not. For example, China vs. U.S. or the developing U.S. of the 1700's vs. Britain.

    China is innovating faster that the U.S. becuase China is ignoring IP laws that the U.S. obeys which impedes U.S. innovation. IP law (patnets, copyright, ect) is pretty much the same as noncompete agreements, and has the same innovation stifling effect.

     

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    Simon Cast, Dec 6th, 2007 @ 5:55am

    Non-competes are anti-competitive

    From a purely market view non-competes are an anti-competitive tool. They act to depress the market price for a person's labour. Whether broad or narrow this is what happens. It also provides an unfair negotiation advantage to an employer during salary negotiations. Particularly, if the negotiations are brought on by an approach from another company.

    I know Fred Wilson's portfolio companies pay the person to site in the club house for six months, they don't make up the money that the employee would otherwise be getting in the new job. I do wonder if non-competes would be used as much if it was required that the old company had to pay the employee at the new salary for the period of the non-compete.

     

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    Misery, Dec 6th, 2007 @ 7:02am

    Re: Nick @ 8

    Nick - can you provide details of how China is innovating?

     

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    chained, Dec 6th, 2007 @ 7:38am

    Re: Frequently Abused

    Was the company named Midwest Technology Consulting?
    Their non-compete is horrendous and the company treats all of its employees as they were slaves not even worth paying.
    It's scary

     

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    Jeff Price, Dec 6th, 2007 @ 7:57am

    I agree whole heartedly with Simon. If you don't have to worry about an employee jumping ship to a competitor, are you really going to pay them their true value to your company?

     

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    A H, Dec 6th, 2007 @ 8:23am

    noncompete vs nondisclosure

    A lot of this discussion sounds like it covers NDAs (non-disclosure agreements) also. Are NDAs and NCAs (non-compete) considered the same? Are NDAs as toothless as NCAs?

    I am interested in this issue because I work in a research environment, and the team I work with generates ideas faster than we can possibly implement them.

     

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    Alsee, Dec 6th, 2007 @ 8:26am

    Inflow outflow

    In terms of companies supporting or opposing non-compete law in their state, I thought of a great way to put it. Explain it in terms of "inflow" and "outflow". Companies often WANT the law to enforce non-competes because they reasonably desire to cut off any "outflow" from their company that might harm the company. The issue is that the law cuts both ways. If the law enforces non-competes in regards to your outgoing employees and outflow of value then it also inherently enforces them in regards to your inflow of employees and inflow of value. To the extent that such a law *does* enable you to cut off outflow of ideas and value and know-how and competitiveness, it also inherently cuts off inflow of those same things.

    It is often painful to see and to agonize over every smallest negative impact to the company from any particular issue of "outflow", and it is often difficult to consciously notice the general "our business is going well" benefits that happen to come along with any inflow, but the point is that the benefits of inflow will generally exceed any negative from outflow. Any effects from outflow are diffuse, spreading like a fog in various directions to various other companies that your former employees happen to go to. And while a "plus" for some other company may be a negative for your company, it is generally a much smaller negative for you than it is a plus for them. The effect on any inflow is going to cut sharp on inflow, cutting off exactly your company's first choice in experienced skilled most valuable employees that can exactly solve your most pressing problems and most contribute the skills and knowledge and innovation that you most need.

    It is not a zero sum game. An employee that leaves to some other company can be a +10 in the success of that company and a -5 (or even zero effect at all) to you because of that other company's success, and some other employee coming in to your company being a +10 in exactly what you need and only a -5 (or even a zero effect) to the company that that employee left. Overall it it is a +5 to +10 effect for your company, AND a +5 to +10 effect for some other company.

    So while it's natural to desire a state to legally enforce non-competes so that your company can cut off any negative effect from outflow, it also means cutting off a bigger positive effect from inflow. If you do enact or preserve legal enforcement of non-compete in your state, companies in states without non-compete will benefit in their inflow and you won't. Companies in those other states are going to have an advantage over you in the same way Silicon Valley trounced Boston's Route 128.

    I think tying together outflow of value and inflow of value like that is a good way to explain it for companies that push for or defend state enforcement of non-competes.

     

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    Dataland, Dec 6th, 2007 @ 8:46am

    The Greater Good

    I agree with the overall message: non-complete agreements inhibit the flow of ideas. This compartmentalization of ideas ideally benefits small groups (companies) at the expense of the greater good (cities, states... society), which ironically causes more harm back on the small groups (companies). And this discussion really is closely tied to Intellectual Property, and Patents. I think companies have become far greedy with the acquisition of patents. Unfortunately, this explosion of patents also inhibits ideas from producing the greater good for society, and thusly for companies. What's really twisted is when a company frivolously acquires many many patents (i.e. Microsoft). These companies typically say something like "hey, everyone doing it and we don't want to get left out". These companies then use these patents as more leverage against other companies, rather than using the patents as catalysts for their own innovation. So, I'm gradually becoming disenfranchised with how we, as a society, doll out both NDAs and Patents.

     

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    perlchild, Dec 6th, 2007 @ 9:46am

    'to protect'

    Usually when companies talk of 'protecting' in non-competes, what they really mean is punish. Most non-competes are just legal recourse when an employee jumps ship(and fear-creating legalese). I wonder just how effective they are at preventing people who want it bad enough from jumping ship(if a competitor really wants an employee, it's not that far fetched to think they'd foot the legal bill)

     

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    David Mackintosh, Dec 6th, 2007 @ 10:07am

    Inventors vs. Market at large

    I disagree with your statement:

    Both concepts are based on the faulty assumption that doing so "protects" the original creator or company [...]

    While NCs and DRM very probably inhibit the potential growth of the market for the relevant idea at large, they do not necessarily fail to protect the original inventor or company. These are separate conditions.

    If I have a protected monopoly on some idea (which is what DRM, copyright, or NCs provide me) it protects me from competition which might take the idea, improve on it, and drive me out of business. Note that it does NOT protect me from my own incompetence, which is the problem afflicting the recording companies.

    So while the potential of the idea (and the potential usability of the idea in the market at large) are stifled, the inventor is protected from competition.

    The question is: is this a good thing? Are protections for the inventor as incentive to invent worth the loss in potential for the market? Michigan says yes; California says no (at least in the human capital market).

     

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    Lamaherder, Dec 6th, 2007 @ 10:54am

    think bigger

    very interesting and important discussion indeed. consider the tenets of the arguement on a country economy scale, specifically asia. my own personal experience in india and philippines is that noncompetes are non existant and the exponential speed that the economies are moving at is boderline unreal. psychology is a piece of it too in that high performers seek out environments with the most important and difficult challenges; i would argue this is the primary driver, before $$ even. companies retention strategies then become aligned with the business strategy of being leading edge, higher margin, best in class...imagine that. rentention strategies in the US are often at conflict with the BS, i.e. raise costs to maintain parity performance.

     

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    J, Dec 6th, 2007 @ 2:39pm

    Re: NC

    Non-competes in Cali are illegal. In Maryland, they may actually be enforceable. In many states there is usually case law that defines the parameters by which a non-compete may be upheld. Generally, these include:
    • First, whether the employee is a skilled employee whose services are unique.
    • Second, whether there is unfair solicitation or exploitation of contacts, or there is a "close relationship" or "personal contact" between the employee and the customer,
    • Third, whether enforcement would pose an unfair hardship on the employee or would disregard the public interest.

    Florida law is similar, as provided in §542.335(1)(a), Fla. Stat. (2001)

    The key element, in most cases, is whether the non-compete provides protection for the legitimate business interests of the Employer of it is oversteps reasonably limitations. Protection from some competition is permitted within the marketplace, but an overbroad and ambiguous agreement that basically enslaves the employee is frowned upon by most states, including Maryland.

    I'd highly recommend hiring a lawyer to review the merits of a 14-page NC. They should also be able to help determine whether you can negotiate out of it or if you'll have to work through the courts.

     

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    bijan sabet, Dec 6th, 2007 @ 5:18pm

    Re: noncompete vs nondisclosure

    If you read my original post that started this current discussion you will notice that I draw a clear distinction between non-competes and NDAs. They are quite different.

    I'm against non-competes but I support NDAs.

     

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    Herbie Robinson, Dec 7th, 2007 @ 4:24am

    Non Compete shows there is no trust

    My company was just bought by Venture Capitalist. One of the first things that they did was come up with a ridiculous non-compete agreement tied to your bonus. Only about 60% of the employees signed. It has been a Mass Exodous of the very valuable employees. I didn't think that a Company could be destroyed from within in such a short period of time - wrong. Give me special training, etc. and I would consider signing an agreement to stay for some period, but I will look very hard before ever signing a non-compete agreement. Companies do not care about employees as a person. They now treat employees as livestock and employers look as these agreements as a way to keep them in their pasture until time to slaughter.

     

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    Glen Peterson, Dec 7th, 2007 @ 5:32am

    non-compete

    I like your article on the non-compete issue and I understand how they can be good and bad for technology advancement. I ran across a non-compete in my previous job. I joined the firm in 2003, signing a 1 year restrictive non-compete (I did not realize how restrictive until I wanted to leave). The company made a decision to sell in 2005. I did not like the idea since it would extend my non-compete from a 1 year to a 3 year non-compete. I asked to be released from this and allow me to move on and continue to provide for my family. They refused to release me and stated that they would engage in a lawsuit with me if I worked in any part of the computer industry. Over the next year, while I still worked for them,, I methodically reducing my billable hours until they wanted to end the stalemate. They released me and allowed me to perform one item within the non-compete. I ended up finding a job that was outside of that item 5 months after leaving the company. I negotiated with my previous company and settled by paying them 25% of my salary for the remaining 7 months of the non-compete. Also, many companies I interviewed with did not want to deal with the liability associated with the non-compete. I was lucky to find one that did. My advice, sign a non-compete that restricts you from working with a company's customers but not with your livelihood.

     

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    Wizard Prang, Dec 7th, 2007 @ 9:47am

    Depends on the non-compete...

    Like many here, I work in consultancy. I appreciate that my employer expends effort and resources finding and cultivating contacts and business relationships, and they don't want to see that wasted by my jumping ship after a couple of months and going to work direct for the client.

    Having said that, I have seen many unreasonable Non-Competes; including one that said that I could not work for any if their clients; but when I asked for a client list they refused. Could have been the Yellow Pages, for all they would tell me. Another said that I could not work in this field within 250 miles of the client's office, which meant that if I quit I would have to move.

    Such agreements are almost certainly legally unenforceable, but since I have not the time or money to challenge them in court, I have always refused to sign such agreements. Without exception they have always rewritten the agreement in a form that is acceptable to both of us.

    To sum up,I have no problem with a reasonable Non-Compete, but have found that few are. My advice: Don't sign something that you cannot live with. Oh, and if the company won't work with you _before_ you join, ask yourself if you really want to work there...

     

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    Wizard Prang, Dec 7th, 2007 @ 9:53am

    Just so you know...

    There is no such thing as "Intellectual Property". Patents and Copyrights are limited by definition, and are best described as "loaned, not owned"

    Also, last time I looked, US Copyright and Patent law did not apply in China.

    If US law is "impeding innovation in the US", then perhaps the law needs to be revisited.

     

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    Anders Chydenius, Dec 7th, 2007 @ 11:31am

    Re: Re: Nick @ 8

    @10 : Nick - can you provide details of how China is innovating?

    A quick search of BBC News turns up:

    "'Sharp rise' in Chinese patents"

    and

    "China launches first Moon orbiter"

     

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    Charles Evans, Dec 7th, 2007 @ 11:48am

    Re: Just so you know...

    Wizard Prang says, "There is no such thing as 'Intellectual Property'."

    I couldn't agree more. In fact, I have a working paper on just this topic, based on legal and economic research, called "Pseudo-Intellectual Property."

    Information fails the most basic test of property: scarcity. Property exists, in order to allocate scarce resources. Information is what economists call a public good, by which is meant a) a good that does not diminish by others' use and b) cannot be metered. Think sunsets, the wind, and a view of a pretty mountain.

    The decision to regulate information based on property legislation was a fundamental error. It would have been better to use contract law as the basis, since, as Wizard Prang points out, contracts, like patents and copyrights, have set terms.

    Thank you,

    Charles Evans
    Executive Director
    Free Curricula Center

     

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    IAAL, Dec 7th, 2007 @ 1:10pm

    You can't just assume that a non-compete agreement won't be enforced. Some states won't enforce them at all, but most states enforce them with varying restrictions and varying degrees of scrutiny. Most courts will want to see some indication that the non-complete agreement is there to protect against competitors gaining an unfair advantage (as opposed to just being there to make it hard for employees to quit).

    Non-disclosure agreements are more likely to be enforced, but even with them there has to be a legitimate interest being protected.

    I have seen a few nondisclosure agreements from large companies that say "If you can't find a job because of these restrictions, we'll continue your old salary for (say) one year." This is a pretty good way to show the company is serious about protecting secrets and not just trying to intimidate employees.

     

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    Anonymous Coward, Dec 8th, 2007 @ 1:19pm

    You can't just assume that a non-compete agreement won't be enforced. Some states won't enforce them at all, but most states enforce them with varying restrictions and varying degrees of scrutiny.

    According to TheDock22, you're wrong. TheDock22 says they can't be enforced at all (see above).

     

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    TechNoFear (profile), Jul 4th, 2010 @ 10:25pm

    I am restricted by a NC

    I can not work in the rail industry for another 12 months, an industry in which I have a decade of experience with the specialised systems, locations and equipment (trackside and rollingstock).

    I know that the 2 year NC agreement would not stand up in court.

    BUT the companies in the local rail sphere all know each other and are not willing to risk annoying my previous boss (in case he then refuses to do all those 'extra' little customer service tasks for free).

    Most annoying is that I did most of those 'extras'....

     

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    willbates (profile), Nov 12th, 2010 @ 2:59am

    This is really interesting stuff and makes complete sense. The notion of idea transfer fits in very well with the 'standing on shoulders' model of economic growth, have a look.

     

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    James Ryan, Nov 19th, 2010 @ 11:28am

    Re: Psychology 101

    I agree, it should be implemented and obeyed because what's the use of the document if it wont be used. Hard drive data recovery

     

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    anthony h, Nov 21st, 2010 @ 12:10am

    There are some very great sources here and thank you for being so kind to post them here. So we can read them and give our opinion on hemorrhoid subject.

     

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    Anonymous Coward, Dec 14th, 2010 @ 2:30am

    Great post, I really like how you represent the information in your blog. Post more! I will repost this one on Bookwormlab.

     

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    Ramona, Dec 14th, 2010 @ 2:30am

    Great post, I really like how you represent the information in your blog. Post more! I will repost this one on Bookwormlab.

     

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    Annie Smith, Dec 24th, 2010 @ 8:16pm

    I work in a remote computer repair company and so far the "bad" side of Noncompete Agreements don't affect me much but I still believe that reviews and revisions should be done to obtain fair benefits to both employers and employees.

     

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  36.  
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    web design, Jul 30th, 2011 @ 11:59pm

    web hosting

    If you want to see the mind blowing article with real facts and figures, this has really tremendous impacts on readers.

     

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    Switch (profile), Apr 13th, 2012 @ 8:38am

    Re: i've seen it happen first hand

    Exactly!

     

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    sprearson81 (profile), Jun 8th, 2012 @ 6:22pm

    Exactly?

     

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    fodder99 (profile), Jun 19th, 2012 @ 10:27am

    Re: web hosting

    I totally agree !

     

    reply to this | link to this | view in thread ]

  40.  
    icon
    fodder99 (profile), Jun 19th, 2012 @ 10:27am

    Re: web hosting

    I totally agree !

     

    reply to this | link to this | view in thread ]

  41.  
    identicon
    Kamagra, Jan 12th, 2013 @ 4:09am

    very interesting and important discussion indeed. consider the tenets of the arguement on a country economy scale, specifically asia. my own personal experience in india and philippines is that noncompetes are non existant and the exponential speed that the economies are moving at is boderline unreal. psychology is a piece of it too in that high performers seek out environments with the most important and difficult challenges; i would argue this is the primary driver, before $$ even. companies retention strategies then become aligned with the business strategy of being leading edge, higher margin, best in class...imagine that. rentention strategies in the US are often at conflict with the BS, i.e. raise costs to maintain parity performance.

     

    reply to this | link to this | view in thread ]

  42.  
    identicon
    Diogo, Jan 12th, 2013 @ 4:10am

    Economic development frequently occurs in "clusters" where an industry eco-system builds up in a particular area with the suppliers, competitors and skilled workforce (think Detroit for automobiles and Wall St for investing). The consequences of the enforceability of non-competes has to be seen in the broader context of the importance of clusers. Non-competes would impede the development of clusters by restricting the mobility of certain types of employees in certain types of industries.

     

    reply to this | link to this | view in thread ]


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