People Don't Scale: Tech Investors' Blind Spot?

For all that talk about from bankers, venture capitalists and angel investors about how they invest in people, not ideas, products or services, the harsh reality is that, well, as The Doors once sang, 'people are strange.'

People get moody. They can be demanding about money and other things that investors think are rightfully theirs to dispense - or not. They also make mistakes, have big egos, unfathomable neuroses and are otherwise generally inefficient, even when they are not just annoying. Finally, people are not all that scalable. They are not like software, which they really ought to think about if they want the big bucks.

So when entrepreneurs are thinking about their next big thing, presenting an idea that relies for success on hiring a lot of people as opposed to say, an additional server farm, they should be prepared for a chilly reception.

This is, as the following article explains, an only-slightly exaggerated description of the venture world today. But, as so often happens, this is also an opportunity. Because as anyone who has followed tech investing for the past 24 years will tell you, that industry is not - brace yourselves - infallible. That the number of 2013 IPOs is about to reach about half of what it was in 1996 - the highest it has gotten since that date 18 years ago - is indicative of the larger issue. So looking for businesses that effectively identify, train, deploy and manage actual human people may be a very smart move, especially when they are enabled with some of that new-ish soft and hardware to make them force multipliers. Scalable, if you will. JL

Farhad Manjoo comments in the Wall Street Journal:

To tech investors, companies that depend on such people are old-fashioned. People are unpredictable and hard to manage. They are costly to hire and train, and their path to success is difficult to set into an algorithm. People don't scale.

"I used to think I was this made man," says entrepreneur Glenn Kelman. "That's what they tell you after you take a company public."

In 1996 Mr. Kelman co-founded Plumtree, a business-software firm that went public in 2002. After that, he assumed that his next idea was as good as paid for.

"Whatever I thought of, they'd fund it," he says.

Then, in 2006, Mr. Kelman became chief executive of a real-estate startup, Redfin Corp.

Redfin sounds like it would be catnip for technology investors. The company aims to overhaul how people buy and sell houses, using software and data to improve real-estate agents' customer service. Real estate is an opaque, expensive insider's game—exactly the kind of business that is ripe for getting blown up by a less-expensive, more-convenient Web-powered service.

"We wanted to change the whole thing in the consumers' favor," Mr. Kelman says, his voice straining with a revolutionary's passion. "We wanted you to have an agent who was on your side, who used technology the whole way through the process and who charged half the price."

But whenever Mr. Kelman shopped his plan in Silicon Valley, venture capitalists looked at him funny. He raised millions of dollars, but the money came fitfully, often at lower valuations than he expected.

Eventually Mr. Kelman realized the problem. Like Soylent Green, Redfin is made of people—sales staff and customer-service representatives.

Yet Redfin is one of a handful of startups showing that people can make a big difference. Mr. Kelman believes that improving the real-estate business takes more than just better code. It takes better people, specifically, better real-estate agents. Consequently, Redfin has hired hundreds of agents on staff, people to whom it pays salaries, benefits and on whose work the company depends.

After years of slow growth, Redfin is poised to hit it big. It's on track to book $100 million in revenue—and turn a profit—next year.

And its path suggests that businesses that try to improve workers—and not just code—can be better for customers and, in the long run, better for the bottom line.

Like Zillow Inc.  TRLA in Your Value Your Change Short position Redfin is partly a website that helps you find houses for sale. But unlike those companies, which make money through ads placed by traditional brokers, Redfin is a full-service brokerage. After you find your dream house on its site, Redfin makes money when you sign up with one of its agents to guide you through the home-buying process. (Its agents sell houses, too.)

Mr. Kelman says Redfin's unusual setup offers several advantages over traditional brokerages.

First, it improves service. If you're touring a neighborhood and see a house for sale, you can order up a Redfin agent to drive over to show you the property quickly. In the company's most-established markets, Seattle, for instance, the agent can be at your service within an hour. (It takes longer in Redfin's newer markets, like Dallas). This works thanks to a blend of technology and management. Just as the Uber online ride service maps its drivers, Redfin keeps track of its agents' calendars and real-time locations. Unlike a traditional real-estate brokerage—in which agents essentially are contractors of a brand, not employees—Redfin's agents are salaried workers. The company can tell them where to go and what to do.

Redfin helps soothe other home-buying frustrations as well. Redfin compiles detailed histories on competing brokerages' pricing strategies, strengthening Redfin agents' negotiating prowess. Redfin also conducts most of the home-buying process online, reducing paperwork. And if you're selling your house, Redfin can test offer prices on the Web, helping you to home in on the optimal price.

The biggest opportunity is price. Mr. Kelman says the incentives of traditional real-estate agents are misaligned with those of customers. If you're selling your house, your agent, who gets paid on commission, will prefer that you take a lowball offer over no offer. If you're buying, your agent will want you to bid higher than you might otherwise want—or need—to pay. Economists call this the Principal-Agent Problem, and it has proved stubbornly intractable in real estate.

Mr. Kelman says Redfin has a solution. About half a typical Redfin agent's pay comes through salary. The rest comes through commissions. But crucially, commissions are linked to detailed reviews that Redfin customers complete after sales. The reviews are posted online and affect each agent's future business. Your agent always has an incentive to please you. If pushing a client to close a deal will produce a bad review, the agent would rather not close.

Redfin is still tiny. In its most-established locations, it has about 3% or 4% of the market. In bigger, newer markets, it seems nearly nonexistent.

Mr. Kelman concedes that his people-dependent model has slowed Redfin's growth. But he sees the prospect of long-term returns. "After we hit a certain threshold in the market, our share begins to accelerate," he says. In other words, over time, better service begins to pay off.

Redfin last month said it raised $50 million from T. Rowe Price  TROW in Your Value Your Change Short position Group Inc. and Tiger Global Management LLC. Compared with tech-focused venture capitalists, Mr. Kelman says, these investors didn't care that Redfin might take several more years to realize its mission of revolutionizing real estate. They were willing to wait, he says.

"Most of Silicon Valley isn't that patient."