Tragedy of the Commons: It’s (Really) Time to Ban Non-Compete Agreements

7/15/09Follow @rowe

On snowy days in certain neighborhoods of our great city it is not unusual for someone to put an old trash can in an on-street parking space that they have recently cleared. We all know there is threat implied: if you take the spot, you will regret it. Given the effort expended to clear the spot, the person who did all the work may feel justified in blocking others from taking it. But we all know that this tends to screw things up for everyone. Pretty soon cars circling looking for parking spaces clog the roads, and nobody can get home, even if they have blocked a spot.

This is a textbook example of the classic “tragedy of the commons” problem, in which following our personal self-interest eventually screws things up for everyone.

I believe the use of non-competes falls into the same category. By laying claim to our best employees, and keeping them from working for others, our economy becomes less agile, many of our best employees get tied up in what may not be the best job for them, and their only option is to move to a state that prohibits non-competes.

Don’t get me wrong. I use non-competes in my business, and nearly everyone else I know does, too. Non-competes are in our individual self-interest. The problem is just that they probably aren’t in our collective interest.

In states where non-competes are unenforceable, such as California, we know from our brethren there that employees rapidly gain experience, moving from company to company in quick succession. One of the results of this is that the best people quickly flock to the best companies as they start to show promise. This may be one reason that the world’s tech powerhouses like Google and Cisco disproportionately come from California.

While one could argue that banning non-competes hurts California companies individually, empirical evidence seems to suggest that the system benefits to society collectively outweigh this. In addition to the observation that the Googles and Ciscos of the world tend to grow more commonly in California, it also appears that investors are most happy to put their money there. Venture capital investment there has grown much faster there in the past decade than it has in Massachusetts, reaching a level now that is about three times that of Massachusetts.

This problem is not just theoretical. It is practical, and personal. Twice in the last few months, I have seen cases where great employees were prevented from working for the company that could make the best use of their talents. In one of these cases, the current employer was effectively out of business, although not yet legally dissolved, and for reportedly emotional reasons suggested it would litigate if the employee in question moved to a healthier company in the same industry. This scared off the new employer, who simply didn’t want the legal risk. The employee had to switch industries to take a new job.

Years ago, one of our executives left my employ at Cambridge Innovation Center. I was somewhat concerned that he would help others compete with us, and I reminded him of his non-compete. Not long after, I learned he had moved to California. While this may have benefitted my firm, it was clearly not good for Massachusetts.

I believe movement from company to company is a form of innovation pollination, and we should encourage it. It is time for our lawmakers to ban non-competes.

Xconomist Tim Rowe is Founder and CEO of Cambridge Innovation Center. Follow @rowe

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  • http://www.twitter.com/bostondave David

    Agreed – great article.

  • http://www.massspec.org Aaron (www.MassSpec.org)

    I agree as well. Non-competes are particularly detrimental to those who work in highly specialized industries or have highly specialized skill sets. MA is fantastic at providing that degree of high-level education, and doing away with non-competes would help keep our graduates here!

  • http://www.innoeco.com Scott Kirsner

    Bijan Sabet from Spark Capital (one of the folks who helped kick-start this discussion about non-competes) has an online petition that just went up… for those who agree with Tim:

    http://www.thepetitionsite.com/75/support-the-alliance-for-open-competition

  • http://www.marchonpartners.com Eric

    Having recently gone thru a non-compete lawsuit I agree with your article and am fundamentally against the use of non-compete’s. There are much simplier ways to protect your business. We really need to change the law!

  • Dan

    In general, Tim, I agree. A few thoughts:
    1) Companies should have some right to protect their investment in the employee: the employee does not “rapidly gain experience” at no cost to the company. A limited noncompete is thus fair.
    2) The problem is with “limited”. Often, reasonable limits are embodied in company to company law. With or without a noncompete, an engineer can’t use IP from the former company. This gets murky for “stuff in my head” and trade secrets, but I’d err along with you that the noncompete does more harm than good. It’s not unreasonable to restrict salespeople from calling on current clients for competitors though, or a VC business development person from taking term sheets/deals elsewhere). I guess the difference is between restricting a person from using skills (engineering, selling) and restricting a person from using inside info to impact current business.
    3) Note that government has had, for some time, a type of noncompete: you can’t go from being Commissioner of something to working for a company you previously regulated. This does restrict the flow of talent… a LOT… but the greater good of eliminating conflicts of interest is served.
    4) The perceived gains, say in CA, need to be put into a broader context. Sure, the best talent goes to the best companies and makes a good living. And the overall economy in CA benefits to some degree. But what of the average folks? How do they pay for their retirement? Are we assuming a government bailout for them? I’m not saying that noncompetes help or hurt here… just that a tragedy of the commons for elite workers and tech powerhouses may not necessarily be a tragedy for the common folk.

  • http://www.i-nalysis.com Drew Hession-Kunz

    @Dan- your concern for the commoners is admirable, but very few firms now, and VERY few tech firms, have retirement plans beyond 401k. If people save at each company, there is limited effect from switching. One retention tool the company has is vesting of shares, and vesting of company retirement match.

    If an employee moves and gives up remaining vesting, they have clearly decided it is more valuable to start accruing at the new place, than to try to hang on at the old one.

    Let individuals decide- this argument should probably be more about that, than about ‘society’, which is really only the statistical sum of individual benefits.

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  • http://willbrownsberger.com Will Brownsberger

    “Venture capital investment there has grown much faster there in the past decade than it has in Massachusetts, reaching a level now that is about three times that of Massachusetts.” That’s not from PWC — that data shows a slightly increased share for MA over the past 15 years. See recent posts from Amrith Kumar linked to on my site. Do you have another data source?

  • http://www.cictr.com Tim Rowe

    Hi Will. First of all, thank you for digging so deeply into this issue. This is important for our economy.

    As to your question, we are both using the same data (PricewaterhouseCoopers data).

    Amrith Kumar is correct that New England has been flat for a long time. What is striking is what has been going on elsewhere. Since 2003 Silicon Valley has been on a steep climb. During the 5-year period I analyzed, 2003-2007, we were essentially flat, and Silicon Valley went from attracting twice as much venture capital as New England to attracting three times as much capital as New England. And the next three regions after New England collectively are following a trend that looks a lot like Silicon Valley. Here is the chart, which is generated directly from raw PWC data:

    http://www.slideshare.net/rowetim/venture-capital-trends-in-us

    And here is the source of the raw data, for anyone who wants to do their own analysis:

    https://www.pwcmoneytree.com/MTPublic/ns/nav.jsp?page=historical

    Since I did this analysis last May, I didn’t yet have access to the 2008 data. That data is available now, however. I did a quick check, and found that Silicon Valley widened its lead over New England in the last year.

  • http://willbrownsberger.com Will Brownsberger

    Of course, we are smaller than California (in every way), but as a % of the total, we are holding our own and improving.

    The raw data into 2009 is at https://www.pwcmoneytree.com/MTPublic/ns/nav.jsp?page=notice&iden=B (under the title “regional aggregate data”)

    Am I missing something?

  • http://www.xconomy.com/author/bbuderi/ Robert Buderi

    Tim, thanks for getting this discussion going with a great post. And Will, thanks for kicking it off again today.

    I think it is valuable to bring the stats up to date. One thing we have been writing about on our San Diego site (SD is one of the other three regions Tim is looking at, if I read his slide right) since opening there last fall is the tremendous falloff in venture activity since 2007. Indeed, many feel the local VC industry there is in serious peril. LA actually rose in 2008 in terms of dollars invested, unlike the other regions, but then seems to have had an even more precipitous decline so far in 2009. Texas fell off a bit less on a percentage basis than New England in 2008 vs 2007, but seems to have fared worse so far in 2009 as well.

    Even Silicon Valley, which was essentially flat in 2008 vs 2007, has had a steeper decline than NE so far in 2009.

    So, as far as the past year and a half goes, it does look like New England has more than held its own, or at least improved its standing a bit vis a vis other regions. Now that is just in terms of dollars invested. Of course there is much more to be looked at to get a picture of the true state of venture health. What stages are firms investing in, who is raising new funds, and then ultimately the performance of those funds, just to name a few. And finally, even if NE is holding its own on all fronts, that doesn’t get to the real issue I think Tim is getting at: how can things be improved?

  • http://willbrownsberger.com Will Brownsberger

    Here is a response cross-posted from my site:
    Tim and I have talked and reconciled our understanding of the PriceWaterhouseCooper venture capital data. In summary, it does appear that during the period 2003 to 2007 and perhaps into 2008 and 2009, Massachusetts has lost some market share. However, from a longer term perspective — the full available time series from PWC goes back to 1995 — there is no evidence of a down trend, in fact Massachusetts may have gained slightly. From a non-compete perspective, since there has been no recent change in non-compete policy, the long-term perspective is probably the right one to adopt — it appears that there is no evidence of a long-term negative market response to non-competes. That doesn’t prove that non-competes aren’t hurting us; their effect could be a consistent drag that has kept us down in spite of other assets. And, of course, if anyone can demonstrate that there was something really big that changed about MA non-compete practice in 2003, the data could be interpreted differently.

    Regardless, the recent downtrend suggests that we should be doing everything we can to improve.

  • http://www.cictr.com Tim Rowe

    I want to thank Will for paying close attention to this. While there are doubtless other Massachusetts officials who have carefully studied venture capital trends in order to better understand our economy, Will is the first I am personally aware of who has done so.

    I agree with Will’s analysis: measured from 1995-2009, the ratio of VC investment in California to New England is almost exactly flat, and since non-compete policy didn’t change over this period, we can’t infer anything about non-competes relative to VC investment.

    Will and I agree that since 2003 the trend has been largely against us.

    Alert readers will deduce that this means that from 1995 to 2002 we gained significant ground, and this is what Will’s analysis shows.

    Why we gained so much ground then, and why we have been losing it for a while now, remain unexplained. It would be great to hear theories from our readers.

    What it does suggest in any case is that we should continue to look carefully at all ways that we can improve our competitiveness.

  • http://www.xconomy.com/author/bbuderi/ Robert Buderi

    Another round of thanks to Will and Tim for advancing the non-compete discussion. It is really interesting that, in effect, the presence or absence of non-competes has made no discernible difference in the dollars invested by VCs, at least when comparing CA to New England.

    Of course, as they both point out in different ways, this is just looking at dollars invested, not deal numbers, or numbers of firms actually formed. The real argument against non-competes is that they impede the formation of new companies, which we won’t get to by looking at VC dollars, or even VC deals done (though that would be a better metric). It could even be that the unenforceability of non-competes in California HAS led to more VC dollars being invested there, but that NE is doing something else to offset that.

    To me the real lesson here is that a deeper level of analysis is needed on the effect of non-competes before we really get to the bottom line.

    On another question raised by Tim, why has NE lost ground to CA since 2002 after gaining ground before that, first, I would point out that just investing money at a lower rate isn’t necessarily a sign of losing ground. I have heard it suggested that there were so many pseudo-VCs in CA during and right after the dotcom bubble that a ton of money was invested poorly in the early part of this decade, more so than in MA. So I’d want to look at when the biggest differences occurred and I’d like to look at NE firm performance vs CA firm performance. I also know from looking at the 2009 investment numbers earlier today, that Silicon Valley has fallen off this year at a steeper rate than has NE when comparing 2008 to 2009. So maybe we are gaining ground again.

    Finally, Bijan Sabet once shared with me his theory that when Boston VCs got into the consumer Internet during the Internet bubble, “they jumped in late and they got killed.” Many, he suggests, said ‘never again.’ That might have affected investment dollars since 2002 as well.

  • http://willbrownsberger.com Will Brownsberger

    Just a further footnote: The trend in CA/MA volume ratio is basically flat whether one is looking at dollars invested or count of deals done. Those numbers appear in the second link in the first numbered paragraph of http://willbrownsberger.com/index.php/archives/2330.

    Bottom line is that I agree that deeper analysis needed regarding non-competes. However, I fear that, as is often the case in public policy, robust data to support deeper quantitative analysis is unlikely to be available.

    So, in the absence of good data, the challenge is to sort through the reported experiences (a/k/a anecdotes) of employees, business leaders and investors and try to define legislation that seems to fairly reflect the legitimate problems and concerns that each have.

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  • http://www.linked/igprevet Isaac George Prevette

    Tim Rowe has made a very important points concerning non competition
    in allowing talented hi tech employees going to companies in
    competiton in the same technological area
    However what should the larger companies do when talent moves from
    one technology company to another &the company tries to protect their
    patents & intellectual property & have a semi monopoly on products
    A good example could be Apple iPads iPhones vs Samsung Galaxy Tablets
    & android phones. For example Apple tried to prevent Samsung from
    selling tablets in Germany. Apple lost to Samsung in court in the
    Netherlands & Samsung was allowed to sale in Holland &most of Europe
    All over Europe and in the USA Apple & Samsung are in law suites
    in courts. Steve Jobs at Apple had been against Google & Android &
    Samsung. Steve Jobs felt Samsung & Google has stolen Apple’s
    patents & Apple’s knowledge & hard work. China workers benefit most
    when Apple products are sold, USA workers receive very little benefits
    from Apple’s world wide sales. USA workers remain unemployed and
    the USA economy falls behind China & the rest of the world.China
    will be the leading technological country in the future. The USA
    can eventually loose out in every technological leadership area.
    Any suggestions about the decline of the USA? Any suggestions
    about Apple &Samsung exchanging highly skilled technological engineers
    California was mentioned as the best place for skilled technological
    employes to move around quickly from company to company.
    Should this hold true for Apple andSamsung(USA&SKorea)&other companies
    in close competition to each other?
    The problem seems almost overwhelming in many ways.
    What are some reasonable approaches to this problem?
    Life & Industry & World Leadership in Technology does not seem
    to be conflict free. China now has an aircraft carrier & produces
    3 ships for every ship the US Navy produces. Obama wishes to protect
    Taiwan & Southeast Asia from China expansion & claims. The US
    Military has new agreements with Australia,Philippines & others to
    protect us from the military expansion of China.
    How can the US protect itself from China’s technological & military
    expansion and world economic leadership? Exchange Pentagon workers?
    Thanks for your consideration of these complex problems
    Isaac George Prevette USAF Security clearance SECRET DOD NAC
    Ft Hollabird Maryland file 21-4740 9feb