Why Valve? - Yanis Varoufakis

Valve’s survival manual for new employees. You have read Michael Abrash’s wonderful account of working at Valve. Now read my political economy analysis of Valve’s management model; one in which there are no bosses, no delegation, no commands, no attempt by anyone to tell someone what to do. Can useful lessons be drawn about not only Valve’s inner workings but, importantly, regarding the future of the corporate world?

1. Introduction: Firms as market-free zones

Every social order, including that of ants and bees, must allocate its scarce resources between different productive activities and processes, as well as establish patterns of distribution among individuals and groups of output collectively produced.

While all societies featured markets (even primitive ones), market-societies emerged only very recently (around three centuries ago). The difference between a society-with-markets from a market-society is that in market-societies the factors of production are commodities (e.g. land, labour and tools) and, therefore, their employment is regulated through some market mechanism (e.g. the labour market). In this sense, market societies (which emerged during the past three centuries) have the distinctive feature that the allocation of resources, as well as the distribution of the produce, is based on a decentralised mechanism functioning by means of price signals: the activities, goods and services, and processes whose associated price rises attract more ‘attention’, and are invested with more resources (e.g. land and labour), while those whose prices decline repel producers.1

Market-societies, or capitalism, emerged when, some time in the 18th century, the expulsion of peasants from their ancestral lands (the so-called Enclosures in Britain), and their replacement with sheep (whose wool had become an internationally traded commodity), gave rise to the gradual commodification of land (with each acre acquiring a value reflecting the value of wool that could ‘grow’ on it) and, then, of labour (as the, now, landless peasants were eager to sell their labour time for a loaf of bread, money, anything of exchange value). Once land and labour became commodities that were traded in open markets, markets began to spread their influence in every direction. Thus, societies-with-markets begat market-societies.

Interestingly, however, there is one last bastion of economic activity that proved remarkably resistant to the triumph of the market: firms, companies and, later, corporations. Think about it: market-societies, or capitalism, are synonymous with firms, companies, corporations. And yet, quite paradoxically, firms can be thought of as market-free zones. Within their realm, firms (like societies) allocate scarce resources (between different productive activities and processes). Nevertheless they do so by means of some non-price, more often than not hierarchical, mechanism!

The firm, in this view, operates outside the market; as an island within the market archipelago. Effectively, firms can be seen as oases of planning and command within the vast expanse of the market. In another sense, they are the last remaining vestiges of pre-capitalist organisation within… capitalism. In this context, the management structure that typifies Valve represents an interesting departure from this reality. As I shall be arguing below, Valve is trying to become a vestige of post-capitalist organisation within… capitalism. Is this a bridge too far? Perhaps. But the enterprise has already produced important insights that transcend the limits of the video game market.

2. The wheels of change: Valve’s ultimate symbol of an alternative ‘spontaneous order’

If I were asked my opinion of what Valve’s symbol should be, I would recommend a depiction of a wheel, like those which every desk at Valve comes equipped with so as to enable us to move about the company at will, to join whichever working group we want, to form new ones spontaneously and without seeking anyone’s permission. The said wheel, at least in my eyes, symbolises Valve’s attempt to create, within the company, a successful ‘spontaneous order’ based not on price signals but, rather, on decentralised, individuated, time allocations.

Many enlightened corporations do a song and dance about their readiness to let employees allocate 10% or even 20% of their working time on projects of their choosing. Valve differs in that it insists that its employees allocate 100% of their time on projects of their choosing. 100% is a radical number! It means that Valve operates without a system of command. In other words, it seeks to achieve order not via fiat, command or hierarchy but, instead, spontaneously.

The idea of spontaneous order comes from the Scottish Enlightenment, and in particular David Hume who, famously, argued against Thomas Hobbes’ assumption that, without some Leviathan ruling over us (keeping us “all in awe”), we would end up in a hideous State of Nature in which life would be “nasty, brutish and short”. Hume’s counter-argument was that, in the absence of a system of centralised command, conventions emerge that minimise conflict and organise social activities (including production) in a manner that is most conducive to the Good Life. Steadily, these conventions acquire a moral dimension (i.e. there is a transition from the belief that others will follow the established conventions to the belief that others ought to follow them), they become more evolutionarily stable and, in the end, function as the glue that allows society to be ordered and efficient albeit without any centralised, formal, hierarchy. In short, spontaneous order emerges in the absence of authoritarian hierarchies.

Hume’s views influenced one young man in particular: Adam Smith, the economists’ patron saint. Indeed, Smith’s ‘invisible hand’ is no more than an application, and extension, of Hume’s spontaneous order to market-societies. Smith’s argument, in case we have forgotten, is that markets are an example of spontaneous order, where price movements (in reaction to market forces) coordinate individual efforts in a manner that, as if by the help of some invisible hand operating behind our backs, promotes the public good (much better than any ruler who strives to promote it).

While the concept of a ‘spontaneous order’ harks back to Hume and Smith, it was Friedrich von Hayek, the doyen of modern day libertarians, you coined the term. Taking his cue from Adam Smith, Hayek used the ‘spontenous order’ idea as a stick with which to beat into submission all ideas in favour of economic planning (socialist planning in particular) and all arguments in favour of an activist state.

Hayek’s argument was predicated upon the premise that knowledge is always ‘local’ and all attempts to aggregate it are bound to fail. The world, in his eyes, is too complex for its essence to be distilled in some central node; e.g. the state. If we hardly understand our own preferences and capabilities, how on earth can we hope to aggregate the knowledge of what people want and what societies can produce within some central agency; however well meaning that agency might be? All attempts to centralise this infinite, and unknowable, quantity of knowledge will, inevitably, end up in serfdom.

The miracle of the market, according to Hayek, was that it managed to signal to each what activity is best for herself and for society as a whole without first aggregating all the disparate and local pieces of knowledge that lived in the minds and subconscious of each consumer, each designer, each producer. How does this signalling happen? Hayek’s answer (borrowed from Smith) was devastatingly simple: through the movement of prices. E.g. whenever the price of balloons goes up, this signals to balloon makers that ‘society’ wants more balloons. Thus they produce more, without any agency or ministry telling them to do so; without any need to concentrate in some building or server all information about people’s balloon preferences, or about the technology of producing balloons. As for Hayek’s intense dislike of the state, trades unions, municipalities, indeed any collective agency, the reason is that he believed that (a) such bodies interfere with the price signals (e.g. through ‘distorting’ taxes) that are society’s only chance to coordinate its activities well and efficiently; and (b) aggregating profoundly local knowledge was the first step toward collectivising decision making for the benefit of the decision makers and at great cost to everyone else.

Be that as it may, there is a twofold problem with Smith’s and Hayek’s ‘spontaneous order’: First, it restricts too heavily the scope of Hume’s original notion of an order that evolves spontaneously. Hume thought that humans are prone to all sorts of incommensurable passions (e.g. the passion for a video game, the passion for chocolate, the passion for social justice) the pursuit of which leads to many different types of conventions that, eventually, make up our jointly produced spontaneous order. In contrast, Smith and Hayek concentrate their analysis on a single passion: the passion for profit-making. Moreover, Hume also believed in a variety of signals, as opposed to Hayek’s exclusive reliance on price signalling. Secondly, Hayek’s argument that markets protect us from serfdom (i.e. from authoritarian hierarchies) is weakened substantially by the fact that he has precious little to say about corporate serfdom; about the hierarchies that millions must submit to (when working for Wal-Mart or Microsoft for instance) in order to make a living or to get a chance to unfold their talents.2

In a section below I argue that Valve’s wheel is pertinent because it symbolises an attempt to create another form of spontaneous order (closer in spirit to Hume than to Hayek) within a corporation. One which, instead of price signals, is based on the signals Valve employees emit to one another by selecting how to allocate their labour time, a decision that is bound up with where to wheel their tables to (i.e. whom to work with and on what). But before we get there, let us take a closer look at what corporations are for, at least according to four important thinkers.

3. What are corporations for?

Before we try to shed analytical light on Valve’s internal workings and management structure, let us recount what four key political economists had to say about the role and function of firms. This is how they answer the basic question: What are firms for?

Adam Smith
Smith begins his Wealth of Nations (1776) with an account of how a pin-making firm manages to produce so many pins, i.e. efficiently, via the utilisation of a clever division of labour. Clearly, for Smith, firms are the locus of the division of labour. Firms are good for the purpose of creating economies of scale and thus of making it possible to reduce costs inexorably while boosting output geometrically. However, firms sees a threat to the Good Society because an inordinate success of one firm poses a threat to competition, the solvent of market (or monopoly) power that constantly undermines the invisible hand. For that reason, Smith was adamantly opposed to the idea of limited liability, to corporations in other words. In short, firms were essential as loci of divided and synchronised labour but their ultimate contribution to society was predicated upon being kept small, free of the division between ownership and control that is the feature of modern corporations and, lastly, engaged in constant, cut-throat competition with one another.

Karl Marx
Marx posed a simple question: Where do firm profits come from? If Smith’s beloved competition works well, prices will crash to the level of per unit costs and profits will wither. So, is profit only possible when the market is insufficiently competitive? His answer was in the negative. He believed that firms can profit even when competition is as cut-throat as Smith had wanted. The key to his theory was the dual nature of labour: Employers hire labour time from selected employees (and pay a competitive wage for it – a standard price for labour time that is determined at the labour market) but, once production begins, firms receive from workers another kind of labour: the employees’ energy, work, ideas etc. Notice the ‘gap’: employers they pay for ‘labour time’, for which there is an established market and a market-determined price (the wage), but receive something different – labour’s fruits, which can and, indeed, must have a value in excess of that of the ‘labour time’ firms pay for. That difference, between the value of the type of labour received and the type of labour paid for, is the source of profit (and is known in the ‘trade’ as surplus value). In short, for Marx, firms operate as profit machines, through the generation of surplus value. Pure exchanges cannot sustainably generate profits since arbitrage is bound to eat into the latter. Firms are the realms of extractive power. It is where surplus is generated, before turning into rent and interest payments, with the residual equalling the firm’s profit.

Joseph Schumpeter
Unlike Smith, Schumpeter thought that progress and social well-being could not result from cut-throat competition between small firms that squeezes their profits to zero. He thought, instead, that corporations wielding monopoly (or oligopoly) power were the true agents of progress. For if long term improvement, and ultimately much lower costs, require expensive R&D, only monopoly-oligopoly profits can finance it. Adopting an evolutionary perspective (one that he admits to having borrowed from Marx – even though the two men were politically at odds), he conceived of large corporations as dinosaurs struggling to survive. Most become extinct, victims of upstarts with brighter ideas, better management structures and fresher products. In turn, these upstarts grow large and unwieldy and are, in time, undermined by hungrier, leaner, more innovative competitors. And so on. In short, Schumpeter emphasised the importance of the corporations’ monopoly-oilogopoly power from the perspective of cost-destroying innovations. Firms, corporations in particular, are seen as case studies of central planning in a see of competitive markets. While Schumpeter would say that companies like GM or Microsoft were not much different to Soviet style planning operations, he hoped that the marketplace within which they functioned would impose upon them Darwinian pressures that would, eventually, push them into the list of extinct outfits, giving space for newer, fresher corporations. Then again, in his famous Capitalism, Socialism and Democracy, Schumpeter expressed grave doubts about a society whose future depends on a corporate culture that functions in hierarchical terms that are not so much different from the logic of the former Soviet Union’s Gosplan (the central planning agency).

Ronald Coase
Coase was the first economist to pose unequivocally the question that my title paraphrases: Why firms? What are they good for? Why should an entrepreneur want to hire employees rather than subcontract an activity or service to someone else? While both Marx and Schumpeter had already given interesting answers to this question, Coase’s own answer is interesting also. He pointed out simply and convincingly that the cost of subcontracting a good or service, through some market, may be much larger than the cost of producing that good or service internally. He attributed this difference to transactions costs and explained that they were due to the costs of bargaining (with contractors), of enforcing incomplete contracts (whose incompleteness is due to the fact that some activities and qualities cannot be fully described in a written contract), of imperfect monitoring and asymmetrically distributed information, of keeping trade secrets… secret, etc. In short, contractual obligations can never be perfectly stipulated or enforced, especially when information is scarce and unequally distributed, and this gives rise to transaction costs which can become debilitating unless joint production takes place within the hierarchically structured firm. Optimal corporation size corresponds, in Coase’s scheme of things, to a ‘point’ where the net marginal cost of contracting out a service or good (including transaction costs) tends to zero

4. Spontaneous order via time allocation and team formation: Valve’s way

A corporation that tries to function as a type of ‘spontaneous order’ (i.e. without an internal system of command/hierarchy) seems like a contradiction in terms. Smith’s and Hayek’s spontaneous orders turn on price signals. As Coase et al explained in the previous section, the whole point about a corporation is that its internal organisation cannot turn on price signals (for if it could, it would not exist as a corporation but would, instead, contract out all the goods and services internally produced). So, if Valve’s own spontaneous order does not turn on price signals, what does it turn on?

The answer is: on time and team allocations. Each employee chooses (a) her partners (or team with which she wants to work) and (b) how much time she wants to devote to various competing projects. In making this decision, each Valve employee takes into account not only the attractiveness of projects and teams competing for their time but, also, the decisions of others. The reason is that, especially when insufficiently informed about projects and teams (e.g. when an employee has recently joined Valve), an employee can gather much useful information about projects and teams simple by observing how popular different projects and teams are (a) with others in general, (b) with others whose interests/talents are closer to their own.

Just like in a marketplace, everything in Valve is in flux. People move about (making use of their desk’s wheels), new teams are formed, new projects are concocted. All this information is observable by the naked eye (one notices an empty spot where David’s desk used to be, and then finds out that David moved to the 4th floor to work with Tom, Dick and Harriet), on the company’s intranet, in cross-team meetings where teams inform each other on what they are working on). People learn constantly, both by observing and by doing, the value to them of different projects and teams. These subjective values keep changing, as the time and team formation signals that are emitted by everyone else are updated.

The idea here is that, through this ever-evolving process, people’s capacities, talents and ideas are given the best chance possible to develop and produce synergies that promote the Common Good. It is as if an invisible hand guides Valve’s individual members to decisions that both unleash each person’s potential and serve the company’s collective interest (which does not necessarily coincide with profit maximisation).

5. Valve in the historical context of self-managed co-ops

There are two kinds of non-capitalist firms: (a) Mutual, co-op like, firms whose ownership is formally dispersed among members (who may be customers, employees or both); and (b) Valve (or similar companies) where management is completely horizontal (i.e. the company is boss-less) even if ownership is held in the hands of a selected few.

Valve is, at least in one way, more radical than a traditional co-operative firm. Co-ops are companies whose ownership is shared equally among its members. Nonetheless, co-ops are usually hierarchical organisations. Democratic perhaps, but hierarchical nonetheless. Managers may be selected through some democratic or consultative process involving members but, once selected, they delegate and command their ‘underlings’ in a manner not at all dissimilar to a standard corporation. At Valve, by contrast, each person manages herself while teams operate on the basis of voluntarism, with collective activities regulated and coordinated spontaneously via the operations of the time allocation-based spontaneous order mechanism described above.

Regarding remuneration, both the co-op model and the Valve model differ substantially from conventional capitalist corporations. Capitalist firms is organised along the principle that the owner is the residual claimant once factors of production are paid their market-determined prices. E.g. shareholders are assumed to retain dividends that equal total revenue minus fixed costs, minus labour costs, minus interest on capital borrowed, minus planned investment, minus all other variable costs. Employees thus receive income that is determined by the conditions of the labour market at large and which is a reward for their labour time (estimated at the market determined price of it). Bonuses blur the distinction between profit and wage income but, to the extent that they constitute a stable proportion of one’s wages (and are incapable, courtesy of imperfect monitoring, of being properly tied to individual marginal or average productivity), they can be thought of as part of wage income (except for CEOs and the like whose position of power over the shareholders creates the well known tensions resulting from the ‘managerial revolution’, which saw ownership separate from hierarchical control). In contrast, co-ops and Valve feature peer-based systems for determining the distribution of a firm’s surplus among employees. [Before writing more in this, especially regarding Valve, I shall need to become better acquainted with the peer-review based process of determining bonuses. Watch this space!]

The standard arguments against co-ops, by the opponents of such ‘socialist’ experiments, are centred upon the spectre of malfeasance, the substandard access to the capital markets (as investors are wary of co-ops), lack of scalability etc.3 Some of these, one imagines, carry over to Valve’s model of horizontal management. Let’s see which do:

(a) Malfeasance
Without a boss overlooking one’s work, what stops a Valve employee from dosing off? The answer is: a combination of social conventions (recall Hume’s point about their ‘utilιty’ as coordinating devices within a spontaneous social order), of the fact that Valve employees (by definition and design) only work on projects that interest them, and (last but not least) a very careful screening process the purpose of which is to ensure that Valve admits to its ranks self-motivated people who prefer to do something exciting than to be idle.

(b) Substandard access to capital markets
Valve is admittedly a special case, in that it does not depend on access to capital markets courtesy of a healthy bottom line which allows the company to source its investment, quite adequately, in its own revenue pool. Having said that, I see no reason why a company with this structure would not be able to tap into financial capital. Given that its ownership is not dispersed, unlike that of a mutual firm or co-op, investors should only be concerned about company earnings which, in turn, depend on the success that Valve employees have in procuring the alternative spontaneous order that I mentioned before.

(c) Scalability
Hayek’s large claim for the market mechanism as the precursor of a socially benevolent spontaneous order was that it was, unlike planning/planned mechanisms, infinitely scalable. Is Valve’s corporate model infinitely scalable?

From what I gather, Valve’s leading lights thought (and may still maintain this view) that the answer is no. That Valve would reach an optimal size and then hit problems with its boss-less, horizontal, anarcho-syndicalist structure. Be that as it may, the current size of Valve (pushing 400 souls) has exceeded expectations of what that optimal size might me without any evidence that it has actually been reached. Could it be that that optimal size will not be reached for a long while, as long as the social conventions of its community of employees are preserved? Could it be that Valve’s alternative ‘spontaneous order’ is scalable if not infinitely at least indefinitely?

Only time will tell. However, as long as the free allocation of individual time to various projects and teams functions reasonable well, as a mechanism for signalling to Valve employees how to make decisions about what to work on in a manner that promotes the production of a decent experience for Valve’s community and customer base, there is, at least in principle, no reason to expect that the Valve model is limited to certain size and scale confines.

6. Conclusion: What Valve signals for the future

Having spent a few months working at Valve, I can testify to the truth of its own self-image as a boss-less corporation. As a political economist who spent a great deal of time debating alternatives to capitalist corporations, working at Valve is affording me a valuable opportunity to watch one such alternative corporation in action. In this post, I attempted to place Valve’s quirky management structure in the context of time-honoured debates and perspectives. Central to my narrative of ‘Valve’s way’ was the notion of an ‘alternative spontaneous order’: one that emerges within a corporation (as opposed to within a market-society) on the basis of individual time allocations (as opposed to price signals). The tantalising thought arose, during my musings, that this organisational structure may be as scalable as a market mechanism (assuming that the right technologies are in hand, ensuring transparency and low communications’ costs within the company).

There is one important aspect of Valve that I did not focus on: the link between its horizontal management structure and its ‘vertical’ ownership structure. Valve is a private company owned mostly by few individuals. In that sense, it is an enlightened oligarchy: an oligarchy in that it is owned by a few and enlightened in that those few are not using their property rights to boss people around. The question arises: what happens to the alternative spontaneous order within Valve if some or all of the owners decide to sell up? Granted that Valve’s owners do not intend to do this, the question remains, at least at the theoretical level.

One possibility is that Valve will divide and multiply into a number of different Valve-like companies, as its talented employees leave for greener pastures and, possibly, with the intend of re-creating the horizontal management structure that they grew happily familiar with. Another possibility is that the owners may actually sell their stake to Valve employees, thus combining the features of a co-op with the Valve management system.

Whatever the future of Valve turns out like, one thing is for certain – and it so happens that it constitutes the reason why I am personally excited to be part of Valve: The current system of corporate governance is bunk. Capitalist corporations are on the way to certain extinction. Replete with hierarchies that are exceedingly wasteful of human talent and energies, intertwined with toxic finance, co-dependent with political structures that are losing democratic legitimacy fast, a form of post-capitalist, decentralised corporation will, sooner or later, emerge. The eradication of distribution and marginal costs, the capacity of producers to have direct access to billions of customers instantaneously, the advances of open source communities and mentalities, all these fascinating developments are bound to turn the autocratic Soviet-like megaliths of today into curiosities that students of political economy, business studies et al will marvel at in the future, just like school children marvel at dinosaur skeletons at the Natural History museum. I trust that Valve’s organisation will become, if not a central chapter, at the very least an important footnote in this historical turn.

Originally posted at the Valve Economics blog.

• 1In sharp contrast, under regimes like feudalism (a form of society-with-markets) labour was not a commodity but the property of the landlord. Indeed, labour had no price (i.e. no wage was paid) and its activities were commanded, or commandeered, by the person who had inherited the right to do so.
• 2Hayek was clearly unwilling to come to terms with the fact that markets breed powerful corporations that operate like planning agencies internally. And even when acknowledging their existence, he is happier to blame them on the… state than to engage with the problem they present to his theoretical perspective. For instance, he wrote: “My main doubt is whether it really is the corporate law which has given rise to corporations bigger than they would become under the . . . free market, or whether it is not largely the greater influence on the political machine, which the great corporation exerts, which has favoured its growth.” [Letter to Walter Lippman, 1937]
• 3Note that these objections are not dissimilar to Stalinist rebuttals of the co-op system of, say, Yugoslavia…