Labor arbitrage is when you tap into offshore talent at a lower cost than your home country to provide the same services. This continues to be used extensively in the IT world for myriad software applications. The economics are shrinking with wage growth and it is difficult to measure real productivity gains since they can be masked with volume and though the term “labor” was upgraded to “talent”, in my view it isn’t really arbitrage.
I propose a broader and different use of the term. It applies beyond technical talent to executive positions and all industries. If your company attracts and happily retains talent in a similar pay scale location at a lower total compensation package than your competition you have achieved talent arbitrage.
In the financial markets arbitrage is when you get something that has intrinsically more value to it than the rest of the market sees. It is when there is an imbalance in the price. In the world of mergers and acquisitions, you might buy a company at 6x multiple of earnings and merge it with two other companies that you purchased at 6x earnings. The combined roll up, even without making any improvements to it, is now worth 8x or even 10x.
That 2x to 4x differential is multiple arbitrage. The merger effort alone created this arbitrage. Buyers with a different value proposition are now interested in acquiring the combined company. You can turn right around and sell the companies you purchased for a handsome profit. Or you can just keep the company, make some improvements and enjoy the free cash flow. It's a positive thing.
With talent, I’m not suggesting you flip them, nor am I suggesting that you pay your team below market. I am proposing that you create a culture that contains within it, real value above the compensation. If you're just attracting and retaining talent with compensation, you'll be in a never-ending upward spiral of increased costs and margin squeeze.
Is it really that simple? To attract and retain talent over your head you need a superior company culture – something that provides your team with a purpose beyond themselves. For example, when my co-founder and I started Master Solutions in 1997, we needed to attract the world's best architects, developers and engineers to win our part of the first billion-dollar software contract with the Air Force, helping to upgrade NORAD’s radar and satellite systems. We won in 2000 because of our people. But, in 1997, all I had to offer them was my start-up company with no customers. Somehow, we were able to convince these rock stars that we would build a great culture. (My first book, Customer Success, was produced six months after hiring them, but I was able to point to the philosophy in practice in another business of mine.) Without them we would not have convinced one of the largest customers in the world to buy services from us. After we won the contract, they helped us recruit more top talent and twelve years later we sold that business to the NASA Hubble Telescope contractor delivering to investors a triple digit compound return on investment.
We did provide stock, so everyone came out a winner financially, but the overriding culture was not just based on "what's in it for me". It touched that part of most people that wants to impact things for the better. While my team was architecting the upgrade to NORAD, I was doing the same with our company culture. I’ve done that in six different sectors – and it always paid off.
Just chasing talent with compensation and benefits leads to a mercenary culture. This type of talent will respond to compensation improvements alone. He is maximizing his financial utility.
But, providing an exceptional environment where people are respected, where their contribution is honored, where there are clear objectives, where they can trust one another and where destructive politics are not permitted and where the language of the day is inspired by a transcendent customer purpose creates a culture that is missional. And that missional component creates value that is real and that is talent arbitrage.