Human Capital Development: Renting an Idea Factory

The past thirty years have seen a massive shift in valuation, from an emphasis on value investing based on tangible assets towards momentum investing based on intangible assets. This, in turn, has led to broad based consternation within the investment community as conventional financial and economic models are outperformed by superficially less sophisticated approaches. Empirically, though, something is going on - it doesn't seem like our current models are working and in this scenario, new theories are required.

This essay is a reflection on the oddities of human capital, the production of ideas, and the complex relationships between employees, markets and firms in the modern economies. As the economy shifts from a focus on physical goods towards a focus on more abstract intangible goods, more and more companies are de facto becoming idea factories.

However, compared to actual factories, in which labor is rented from employees to operate high-cost machinery owned by a firm, idea factories rely on high-cost labor carefully arranged in order to produce finished products (e.g. software and content). The output of this idea factory is "owned" by the firm, but the firm itself is also owned by humans, many of whom may be key employees in the firm. This fact - that individual humans play many different roles in the context of a modern idea factory (founder / factory manager / idea producer / owner / investor) - is wildly under-discussed.

Too often, valuation models focus too much on a given firm's stock of intellectual property with too little emphasis on the half-life (depreciation) of that IP - here, we attempt to reflect on the flow of intellectual property; the capacity of a firm to create novel IP, which is a function of the organization's ability to recruit, retain, and grow talent (atomic human capital) as well as the organization's ability to organize that talent productively (emergent human capital) - in other words, it's stock of human capital.

Unlike other forms of capital, atomic human capital is owned by the individual and rented by the corporation. Its productivity is wildly variable, hard to measure, and subject to power-law dynamics: the productivity of a single human within a complex idea factory varies tremendously. More importantly, though, individual humans have non-linear atomic growth. This growth, over time, increases the capacity of a given human to produce value. Perversely, though, this growth also increases the bargaining power of that human to lobby for higher wages. As such, the return on investment in human capital development is much different and complex than the return on investment in traditional capital - labor, not capital, should be able to extract some large percentage of that created value, and firms end up competing with one another for access - in some sense, the value of human capital investments accrues to the individual, not necessarily to the firm.

But aside from Substacks / Newsletters, there aren't that many great projects where the value is around the sum of the parts - most great idea factories require the management of brilliant individuals together, not to make them replaceable, as in a traditional factory, but to make them irreplaceable as in a great championship winning team.