Checking Costs

by on November 29, 2008 · 10 comments

Another great essay from Paul Graham:

Checks on purchases [at large companies] will always be expensive, because the harder it is to sell something to you, the more it has to cost. And not merely linearly, either. If you’re hard enough to sell to, the people who are best at making things don’t want to bother. The only people who will sell to you are companies that specialize in selling to you. Then you’ve sunk to a whole new level of inefficiency. Market mechanisms no longer protect you, because the good suppliers are no longer in the market.

Such things happen constantly to the biggest organizations of all, governments. But checks instituted by governments can cause much worse problems than merely overpaying. Checks instituted by governments can cripple a country’s whole economy. Up till about 1400, China was richer and more technologically advanced than Europe. One reason Europe pulled ahead was that the Chinese government restricted long trading voyages. So it was left to the Europeans to explore and eventually to dominate the rest of the world, including China.

In more recent times, Sarbanes-Oxley has practically destroyed the US IPO market. That wasn’t the intention of the legislators who wrote it. They just wanted to add a few more checks on public companies. But they forgot to consider the cost. They forgot that companies about to go public are usually rather stretched, and that the weight of a few extra checks that might be easy for General Electric to bear are enough to prevent younger companies from being public at all.

One of the most challenging things about this kind of institutional bloat is that it’s extremely hard to articulate to those in positions of authority precisely how damaging this kind of institutional overhead can be. I’ve been involved in at least one organization (which shall remain nameless) that had created elaborate processes for reviewing and double-checking moderately expensive purchases. And the phenomenon Graham described applied with a vengeance in those cases. The minor cost was the dozens of hours devoted to making the case to the relevant decision-makers for our preferred option. But the more important, but harder to articulate, cost was the way the approval requirements distorted the decision-making process. Since we’d have to defend our choices to decision-makers who didn’t know very much about the options, we tended to overweight factors that could be clearly and easily explained to the decision makers (“This supplier is the market share leader,” “this candidate has a PhD”) and underweight more important but harder-to-articulate qualities of the various options. And because we had to gather a lot of mostly useless information about the options to present to the decision-makers, the most qualified suppliers would often opt out of dealing with us, because they could get business with a lot less hassle elsewhere.

And this organization was not especially large, in the grand scheme of things. These problems tend to get worse as an institution gets larger and older. I was just talking to a friend who works with a firm that provides services to large banks, and she was complaining about the large amounts of money large companies waste on this kind of overhead. And the condition is almost terminal in one of America’s largest and oldest institutions—the federal government. The reason we have $600 toilet seats isn’t that the people buying them are corrupt or incompetent. It’s that selling a toilet seat to the federal government costs $50 to manufacture the toilet seat and $550 to fill out the relevant paperwork.

  • http://zgp.org/~dmarti/ Don Marti

    Maybe the problem with selling software at a price between $1000 and $50,000 why open source software is so successful in the markets for development tools, web servers, and small server OSs. Proprietary alternatives for Linux or Apache would have to cost more than $1000 but are clearly worth less than $50,000.

  • MikeRT

    You're not kidding, Tim, about the state of the federal government. Anyone who has worked as a government contractor at some point has experienced this first hand. In fact, one of the things that people don't tend to understand is how much worse things like affirmative action are in the federal government than they are in the private sector. One of the reasons why there are so many contractors is because government managers cannot fire employees who are pathologically lazy and insubordinate in most cases. A corporation could literally not operate if it had to run its affairs according to the way that the federal government is forced to work.

  • http://srynas.blogspot.com/ Steve R.

    A corporation could literally not operate if it had to run its affairs according to the way that the federal government is forced to work.. Incompetence is really an EEO employer and not limited to the government.

    Have you read the news lately?. Currently the list of private companies that cannot operate because of self-serving management is exploding. Regretfully, none of these executives seem to be being held accountable for running their corporations into the ground. Few CEOs are even making an attempt to appear remorseful by giving up their so-called bonuses, They are essentially milking their companies dry.

    What is distressing is that that these executives, to maximize their compensation,have been oblivious to the fact that they are destroying our economic system. I don't think the free-market is supposed to operate that way.

  • http://srynas.blogspot.com/ Steve R.

    A corporation could literally not operate if it had to run its affairs according to the way that the federal government is forced to work.. Incompetence is really an EEO employer and not limited to the government.

    Have you read the news lately?. Currently the list of private companies that cannot operate because of self-serving management is exploding. Regretfully, none of these executives seem to be being held accountable for running their corporations into the ground. Few CEOs are even making an attempt to appear remorseful by giving up their so-called bonuses, They are essentially milking their companies dry.

    What is distressing is that that these executives, to maximize their compensation,have been oblivious to the fact that they are destroying our economic system. I don't think the free-market is supposed to operate that way.

  • http://srynas.blogspot.com/ Steve R.

    A corporation could literally not operate if it had to run its affairs according to the way that the federal government is forced to work.. Incompetence is really an EEO employer and not limited to the government.

    Have you read the news lately?. Currently the list of private companies that cannot operate because of self-serving management is exploding. Regretfully, none of these executives seem to be being held accountable for running their corporations into the ground. Few CEOs are even making an attempt to appear remorseful by giving up their so-called bonuses, They are essentially milking their companies dry.

    What is distressing is that that these executives, to maximize their compensation,have been oblivious to the fact that they are destroying our economic system. I don't think the free-market is supposed to operate that way.

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