Show Me The Incentive

Charlie Munger, is Warren Buffet’s partner in Berkshire Hathaway. He’s famous for saying, “Show me the incentive and I’ll show you the outcome.”

Society and government alike have been conditioned to think of regulation as the path to controlling market behaviour, to eliminate so-called “bad behaviour”.

The internet is the great equalizer that has broken many business assumptions. We live in a physical world. People live in houses. They eat real food (mostly). The doctor cures the physical ailments. Governments pave the streets so you can travel with ease from your house to your destination.

Local, state and provincial governments tax their residents in order to pay for these items. The local governments try to control what happens in the local communities through regulation.

The recent runup in share price for Tesla has increased Elon Musk’s paper net worth to the point where he is now the second wealthiest person on the planet. This week he announced that he moved from Silicon Valley in California to Austin Texas. In May of this year he announced that he was selling all of his properties in California. He clearly cut all ties to California to make it abundantly clear that he is no longer a California resident. Apart from needing to raise a bunch of cash to exercise his stock options this year, his nearly $1B in stock option compensation, which become exercisable this year would bring a whopping tax bill.

Texas of course has no state income tax, compared with California’s new proposed 16.8% top marginal tax rate. So if Elon Musk cashes in on $1B in stock option profits, he could conceivably save $168M in tax just by moving to Austin. Would I accept $168M in cash in order to move to Austin? I suspect that virtually anyone would.

On the first of December, Hewlett Packard Enterprise announced it was moving its corporate headquarters from San Jose to the Houston suburb of Spring. Spring is located in the NW of Houston, very close to where HP had it’s enterprise server and storage division.

HP has said that it is listening to its employees who want greater choice on where to locate. They want a place where there is a lower tax rate, a lower cost of living, and more ability to spread out without the congestion of traffic in Silicon Valley. Hewlett Packard split into two companies in 2015, with the more profitable server and IT services business forming HPE, and the consumer computer and printer business remained as HP Inc and is still based in Cupertino near the original HP headquarters.

Here again, we have a company that is a fixture in Silicon Valley, one of the Silicon Valley originals, making the move to a lower cost, lower tax, lower regulation environment.

I hired engineers in both Silicon Valley and in Texas in my hi-tech career. I can tell you from first hand experience, that equally talented people cost 25% more in Silicon Valley, simply because the cost of living in that area is so much higher.

I used to hire organizations from India and relocate portions of the team to North America to facilitate the communication. The bulk of the team remained in Bangalore. Today, that model is gone. I regularly hire top talent in India even today. Not only do I save money, the main reason I do it is for speed and quality. North Americans culturally tend to work in isolation. My team in India will throw 4-6 people at solving a design problem and deliver a high-quality result in a quarter of the time and at a fraction of the cost of a comparable North American team.  In my case, the incentives are cost, quality and time. Those are strong incentives. 

If there are local regulations that make work here locally more expensive, or more cumbersome, we’re not obligated to conduct business or invest in a particular geography.

We will invest where the numbers make sense. As Charlie Munger says, Show me the incentive and I’ll show you the outcome.