Inventing the Talent Asset Pricing Model

We know that economic productivity comes from 3 primary drivers: Land, Capital and Talent (usually called Labour).

We know that economic productivity comes from 3 primary drivers: Land, Capital and Talent (usually called Labour).

For decades, the ability to do business has revolved around access to Capital. Yet today, Capital is cheaper and more abundant than ever before. In the past six years, the amount of cash in the world has increased by 140% from $7.2 Trillion to $12.3 Trillion. Companies have over $5 Trillion of it on their balance sheets. Global interest rates are at historic lows and €1.5 Trillion of bonds have a negative yield.

Meanwhile, businesses the world over are experiencing a worrying shortage of Talent. In a PwC survey, 63% of CEOs called Talent shortage a serious concern, up from 58% last year and 53% two years ago. In Silicon Valley, Marc Andreessen recently stated: “Our companies are dying for talent. They’re like lying on the beach gasping because they can’t get enough talented people in for these jobs.”

With Capital at the center of attention in global economics, there has long been a certain primacy to the Capital Asset Pricing Model (“CAPM”). CAPM holds that any investment project should be ranked according to the cashflow it will generate over a certain period of time, discounted by a variety of inputs such as risk and time – a Discounted Cashflow. Arguably, it is CAPM that drives Wall Street’s strong focus on corporate earnings and the P/E ratios that guide companies’ market values.

Yet in practical terms, I have rarely been able to use CAPM as a clear explanation of actual value. As an investment banking analyst for example, I learned that Discounted Cashflow analyses are much more a Prop to guide valuation discussions than a steadfast measuring stick (especially as the output can swing wildly based on small adjustments to the inputs). Later, as a venture capital investor in technology, it was unthinkable to try to use a DCF analysis to value an early-stage company. There was simply no way to predict the cashflows with any confidence.

Despite it’s limitations, the reason CAPM is so hard to challenge is that it is internally consistent. It says that what starts with Capital should end with Capital. And if we are deciding to invest Capital, we should be asking how much Capital will we get out in the future. That’s just the bottom line and it makes sense.

But Capital is becoming less important, because it is so abundant. Looking at Talent, nothing could be further from the truth. The Talent that can successfully drive results in today’s markets, whether it’s developing software at a disruptive startup, or managing an established organisation in sharply changing conditions, feels incredibly scarce.

So our hypothesis is that in today’s economy, seemingly dominated by an ethos of “Innovate or Die”, business outcomes are being driven more by availability of Talent than Capital. And therefore CAPM is not the most relevant model with which to project returns and make decisions.** The problem is, we don’t have any really robust ways of evaluating, modelling and driving Talent-related decisions. There is no equivalent of CAPM for Talent.

I was discussing this with our friend and advisor Juan Pablo Vazquez Sampere, professor at IE business school in Madrid, and he had an inspiring response: “It is only a matter of time. 500 years ago there was no established model for money either. Money was about how many bushels of wheat would you give for how many grams of gold. Today we have a clear understanding of how the internal combustion engine works, but 100 years ago there were many competing models.”

So perhaps we are at the beginning of our journey of understanding how to measure and deploy Talent optimally around the world, and can develop a model as robust as CAPM. Maybe it would be called TAPM: the Talent Asset Pricing Model.

We’re working to develop this model and if you have thoughts on what it should contain, please connect with us in the comments or on twitter @craftdotco

** The caveat to this is that people don’t run on jelly-beans. You need capital to pay people to work, so capital is still a key driver.

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