By harnessing the power of the multiple, Smith, in turn, hopes to do more than merely change his business mix and fatten the firm's margins. He wants to revolutionize his business. First, because of both the appreciation in the firm's equity holdings and the above-market returns on those holdings, annual revenues per employee will rise from $200,000 to $300,000 in the next five years. In practical terms, that will free up the design staff to do more creative, speculative work because it will take fewer traditional "billable" hours from the staff to cover the firm's operating costs. (Smith calculates that if the return on the equity holdings matches his expectations—an annual return of 30%—fewer than half of the hours actually worked by the staff will have to be directly billed to clients in order to cover Lunar's yearly operating costs.) "It's a much richer mix," says Smith. Designers will be free to do more experimental work, even community service—and their compensation will go up, not down, because of the increased revenue per employee (not to mention the commensurate increase in profitability). "There's an emotional/psychological component here," says Smith. "We'll be able to keep people more interested. We won't be just tending other people's gardens, but our own." And as Lunar's designers are freed to develop some of their own ideas into real, market-meeting products, Lunar will develop an identity founded on a greater sense of authorship. Says Smith: "Wouldn't it be cool if we could show people things and say, 'We invented that'?"
Avoiding Lottery Fever
Darrel Rhea of Cheskin Research says that taking an equity approach shows a greater sophistication among service-based companies—an awareness that, in today's complex business climate, they must transcend their narrow disciplines. "I choose to work with Lunar because they have a real thirst for strategic understanding," says Rhea, who has been working on the Moonrocks initiative since its inception. "Not a lot of people in the design world think about the business implications of what they do."
Rhea notes that in the past five years "The number of opportunities to participate in this kind of activity has doubled every year." He sees the service economy following what he considers a "Hollywood" model: "You have a large network of very talented people coming together for a year or so to produce a product. No one has the expectation of working together forever. But there is something satisfying in being able to maintain your independence and focus on what you do best." He adds that ultimately this way of doing business is much richer and more satisfying than the current model because it thrusts together highly talented people for shorter periods of time‚—and holds out loftier goals and richer rewards.
Lunar is a virtual company, tapping into its "parallel universe" of specialists such as Rhea, in Redwood Shores; Ulrich, in Philadelphia; and Cantu and Bayless, in Bozeman. That, too, is by design. These consultants each pay into the pool with their expertise and draw out stock with potential future value. "This allows us to grow our company backwards," notes Smith. "We have the complete ability to make products virtually and not be in a big corporation where you end up doing the same thing every day."
But the downside of such exhilaration, cautions Ulrich, is lottery fever. "You've got to be careful with these projects." People develop an inflated sense of what an idea is really worth. Companies that freely offer equity often have little of real value. "You have to control the amount of spending you do. Don't allocate too much to this or you'll go out of business," says Ulrich. "Somebody gets passionate about an idea, diverts too many resources, and imperils the company."
In fact, Ulrich's role with Lunar is that of outsider-skeptic. One question he asks repeatedly of Lunar's management is, What business does a design firm have really being in venture capital? "An economist would say you go to venture capitalists to raise money because that is the professional service they get paid for. I'm always asking Lunar, 'Why do you think you're any better than the people up on Sand Hill Road?'"
Ulrich says that question is often not easy to answer. But, he adds, "at a gut level I believe in this model. It gets the designer to have some skin in the game, and now he has a very different motivation." As a result, he says, the client is often willing to offer more in equity than the equivalent in cash "because the [designer's] motivation and the quality of the work could be better."
By the same token, the onus is also on Lunar not to make impossible promises to its employees. Ulrich notes that Lunar has tight controls and an open-book management style. That is key, given that the firm is located in a high-cost area and because it has many young employees who need cash—not speculative equity stakes—to meet their living expenses. Thus the equity participation they have must be limited, and the risks spelled out clearly. At present, all staff members participate in the equity upside only via the bonus pool; investment losses are absorbed by Lunar's partners.
Tad Toulis, a senior industrial designer at Lunar, says, "This [model] doesn't make the design staff uneasy because of risk, because the information is widely dispersed and it's a small percentage of the whole picture." He says it's a way "to build flexibility into our work and offer a big recoup on the back end." In addition, says Toulis, in the venture-design model the designer "is more centrally located in a project. This allows us to get in touch with and work with clients in a way we otherwise might not be able to."
Another Lunar senior industrial designer, Dave Laituri, adds, "The model is robust. It seems to me it makes good, sound business practice to qualify business candidates in advance."
Ulrich says that it will remain management's responsibility to ensure that the staff—and the management itself—understands the risks in venture design. "At Lunar every designers can see the instrument panel. He knows how much has been made, what goes into the bonus pool, and how much goes into the speculative stuff." But ultimately, Ulrich says, the Lunar experience is "less about getting rich. The kinds of bets being placed here create an environment that's exciting for people. And that's a competitive advantage for Lunar."
