In 1937, a young economist named Ronald Coase theorized that as a company grows, management becomes a bigger drag on productivity and profit. Essentially, he found that the costs of managing can escalate faster than sales and profits, steadily lowering production per person.
Coase won the Nobel Prize for this in 1991. Yet 80 years after his intial theory, the business community remains blind to the problem because it’s a little bit hard to believe. How many managers think they’re going to work every day only to make everyone less productive and the company less profitable?
From the outside, though, the problem is apparent in a measure we call the "team ratio" -- the ratio of managers to non-managers or team members. It changes dramatically as a firm grows; a phenomenon I see in small knowledge-worker enterprises like the marketing agencies, engineering and software dev houses and digital product companies I work with every day.
It goes like this -- when there are 12 people in the company, there’s usually one manager or a couple of part-time managers. When the company doubles in size, it more than triples the managers, so there are three or four managers, or full-time equivalents, managing about 25 people. And when the company grows four times it's original size, it suddenly has eight to 12 times more managers! For companies with multiple clients, products and projects, that number can be even higher.
How does this happen? Here’s an example that economists use to illustrate it. Picture the legendary castaway Robinson Crusoe stranded on his island. He starts a business -- fishing (so he can eat) and making straw hats. As the sole worker, he’s self-managing and 100 percent productive. He’s always either fishing or making hats.
Then four other castaways arrive. Crusoe organizes them, teaches them what to do and coordinates their work. It takes half of his time every day, so he is now only 50 percent productive. And the crew devotes time to coordinating with Crusoe, so their productivity is below 100 percent as well.
More castaways arrive, so now there’s a 25-person crew. Crusoe promotes two people to full-time managers. The combined productivity of Crusoe and these managers is zero. The bigger overall crew puts more pressure on food and shelter, and introduces more variability, requiring more coordination. More things to manage means more managers, and things slow down.
Before long, the management team is growing faster than the company. It’s piling on costs -- in energy, money and time -- and distorting communication. Specifically priority, understanding, empowerment and feedback are all suffering. Crusoe is too busy managing to notice this hard reality. His operation is getting too complex too fast for him to do anything but work harder. He longs for the days when he was alone on the island.
As an entrepreneur, your first challenge is growth. Your second challenge is not letting the growth kill you. Keep your eyes on your team ratio to help you keep your management rightsized, scrutinizing every challenge that beckons for another manager.
To calculate your team ratio, count the number of team members (people who produce things) and managers (people who coordinate things). Count part-time managers at two times their management time and only the remainder as productive. So, a 30 percent manager counts as 60 percent management and 40 percent productive. Now, add them up. If your ratio of team members to managers is lower than 6:1, then Coase is smiling right now.