How the End of Non-Competes Could Reshape Tech – Harvard Business School Working Knowledge

Federal restrictions of employee non-compete agreements could be in the cards for 2022, paving the way for increased worker mobility in a variety of industries. Such restrictions would have hiring and strategy implications for businesses as well, but not all of them are negative, an expert at Harvard Business School says.

As part of a sweeping executive order aimed at promoting competition in the American economy, US President Joe Biden specifically called out non-compete agreements as hurtful to innovation and workers. Issued last July, the order asks the Federal Trade Commission to consider curtailing the use of such agreements. Andy Wu, an assistant professor in the Strategy Unit at Harvard Business School, is an entrepreneur and startup advisor who now researches how technology firms organize and mobilize resources to grow and build competitive advantage.

“Technology firms will need to revisit their strategies for recruiting, managing, and retaining talent.”

We asked Wu about the implications of a ban on non-competes for firms and employees in tech and what strategic levers businesses might consider should such restrictions come to pass.

Kristen Senz: How would restrictions on non-compete agreements affect employers and professionals in technology?

Andy Wu:
A ban on non-compete agreements would be great for professionals in the technology industry, ranging from software developers to account managers. Non-compete agreements restrict departing employees from accepting jobs with competitors. They can often even prevent them from working in the same industry, especially when employers are intentionally vague in defining the competition in non-compete agreements.

As Professor Matt Marx of Cornell University and his coauthors have shown across multiple studies, non-competes hurt employees by limiting their job mobility and sending them on “career detours” where they may have to accept lower compensation than appropriate for their experience level.

More important, departing employees are often best positioned to launch entrepreneurial ventures to address opportunities that their previous employers may have failed in or overlooked. Imagine how the last year might have been for all of us if Eric Yuan—formerly an executive at Cisco WebEx—was unable to go on to launch Zoom Video Communications; we learned about Eric’s story as part of our case study on Zoom that we now teach in several classes at HBS. Fortunately for the world, California does not enforce non-compete agreements.

Senz: How might the end of non-compete agreements change the tech landscape?

Wu: First, without non-compete agreements, technology firms will need to revisit their strategies for recruiting, managing, and retaining talent. Take, for instance, the phenomenon of acqui-hires, which may become less valuable with a ban on non-competes. An acqui-hire—or a talent acquisition—is when a larger firm acquires a startup to bring the entrepreneurial talent to the larger firm. Acqui-hires are often more expensive than just making individual job offers to everyone at the startup, but they take care of the issue of outstanding non-competes. Fewer acqui-hires may increase risk for early-stage venture capital firms, who rely on acqui-hires to bail out underperforming investments.

“Why are states doing nothing, even when research shows non-competes might impair innovation?”

Second, larger technology firms may have another reason to consolidate. Technology firms use non-competes to protect intellectual property. If employees can easily move to another firm, another way of protecting IP is to acquire the other firm.

Senz: Why do you think more states haven’t restricted non-compete agreements, given the innovation that has emerged out of California?

Wu: We should think about the existence and enforcement of non-compete agreements as the status quo. Companies naturally want to include them in the contracts of new and prospective employees, and most new employees are not in a position to negotiate against the inclusion of the non-compete term. When a state government does nothing, non-competes by default are enforced by the courts.

Why are states doing nothing, even when research shows non-competes might impair innovation? The answer is likely lobbying and influence from special interests, particularly the established businesses that want to continue enforcing non-competes.

These businesses can justify non-competes for good and bad reasons. On one hand, having non-competes can protect businesses from unfair competition between an employee and her previous employer. This allows employers to fully invest in training employees with proprietary knowledge without the fear that the employee might run off and join the competition (or become the competition). On the other hand, non-competes make it hard for employees to leave, allowing these businesses to pay employees less and put less effort into retaining them.

Senz: If tech companies are forced to work harder to retain employees, what other strategies do you think they might use to do so?

Wu: I hope to see a continuation of the compensation growth and workplace improvements that we have started to see over the last few years. For instance, remote or hybrid work models appeal to many skilled workers, even if their employer would prefer them coming into the office. Employees now know the benefit of remote work, and resistant employers may have to compromise on this dimension even more if retention becomes harder.

In addition, without the threat of a non-compete to curtail more entrepreneurial and innovative employees from starting their own businesses, I hope to see established firms create more ways for those employees to be entrepreneurial without having to leave. As is obvious in the Zoom example, these employees are exactly the ones that established employers should be fighting hardest to retain. Imagine what it would have meant for Cisco if Yuan had the autonomy and resources available inside of Cisco to pursue his vision for a superior videoconferencing experience.

“If an employee inside Coca-Cola stole the recipe and used it to start a competing cola company today, could he really compete with Coca-Cola?”

Companies can empower these stars by providing opportunities for them to ideate and execute on their own independent projects. First, they need to autonomy to work creatively in areas of their own interest, for instance by intentionally allocating them free time on their own or in teams at a hackathon. Second, they need the resources to execute on these ideas, which companies can provide through a startup accelerator program or a flexible organizational structure that allows executives to rapidly shift resources toward projects led by these stars.

As these strategy examples make evident, the implication of the end of non-competes does not have to be a net negative for employers. Employers can create win-win scenarios for themselves and their employees.

Senz: Are there other strategies companies can use to protect trade secrets in the absence of non-competes?

Wu: Ongoing trends in technology and business will continue to protect trade secrets, even in the absence of non-competes, making the agreements themselves less important. Consider the classic example of a trade secret: the secret formula for the Coca-Cola soft drink. At some point, that formula might have been the key to the company’s success. But if an employee inside Coca-Cola stole the recipe and used it to start a competing cola company today, could he really compete with Coca-Cola? Assuming he could overcome the decades of accumulated brand loyalty among Coca-Cola customers, there are a lot more trade secrets he would need steal from Coca-Cola. He would need to replicate the know-how to create a global soft drink manufacturing and distribution network; that knowledge is spread out among many people at Coca-Cola. He would need access to years of data on marketing efforts, consumption patterns, etc. He would need to walk out with a hard drive—or more accurately, several data centers—a difficult feat even if non-competes were still in place.

Trade secrets are becoming harder for employees to steal. First, know-how is increasingly embedded organizationally, across employees and teams. Even ignoring all the formal patents in place, no one person is capable of building the iPhone 13. Second, advanced software algorithms and data-based artificial intelligence algorithms account for increasing amounts of trade secrets in technology. These technologies rely on massive stores of distributed computing and data built up over time that no one person can remember how to replicate. Google does not worry about one engineer replicating Google Search.

Furthermore, it would be illegal and easy to prove in court if someone transferred software and data to themselves. Financial firms like Citadel vigilantly track this risk and work with federal authorities to prosecute data theft by employees to the fullest extent permitted by law. In other words, as time passes, leading companies can worry less and less about trade secret theft in the traditional sense, and they have a path forward regardless of the future of non-competes.

[Image: iStockphoto/kentoh]


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