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.

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