Leadership Lessons from Netflix
Back in the 1990’s the Defense Department wanted to be more like Silicon Valley. The Pentagon felt it was no longer the “leading edge” of technological innovation, despite the many hundreds of millions of dollars it continued to spend on contractor Independent Research and Development (IR&D) costs each year. It believed it was hamstrung by onerous MILSPEC requirements, by “non value-added” administrative controls—and by a prescriptive, bureaucratic, culture adverse to risk-taking. The period from 1992 to 2000 was largely defined by broad attempts to “reinvent” government in an effort to make it “work better and cost less”—and many of those reform initiatives were aimed at (and embraced by) those in the defense acquisition field.
Since then, not so much.
The Obama Administration’s “acquisition reform” efforts (to the extent they qualify for that description) have seemed, by and large, to focus on undoing the acquisition reform efforts of the Clinton Administration. We have studied the contrasting efforts at acquisition reform, and concluded that Clinton-era reform efforts imbued Federal employees with enhanced discretion, but failed to impose commensurate levels of accountability. This failure led to well-documented abuses during the Bush Presidency; and ultimately it led to more prescriptive bureaucratic processes and controls imposed on acquisition professionals during the Obama Presidency. Failing to find accountability, the Obama Administration seemingly has chosen to limit discretion.
It’s about culture, not processes. But culture has never been the strong suit of any large bureaucracy; it’s far easier to focus on changing processes rather than changing culture. Moreover, growth seems to inevitably lead to imposition of additional processes: the larger and more complex the organization, the more it seemingly focuses on imposing control processes in order to assure its people are working toward strategic objectives. Attempts to streamline bureaucracy and reduce control process are themselves implemented via new, additional, processes. We’ve discussed this phenomenon with respect to the DOD’s Better Buying Power initiative before. We quoted J. David Patterson, Director of the National Defense Business Institute at the University of Tennessee, who stated, “Suborning people to processes results in the least-productive bureaucratic behaviors.” In other words, if you want change, you need to focus on people and culture, not processes.
Being ourselves implementers of process change and not cultural change, we’ve wondered about organizations that focus on process and ignore culture—especially those that contract with the Defense Department. We’ve noticed that the larger and more successful government contractors seem to mimic the Executive Branch’s own organization and culture—and perhaps that’s what makes them so successful.
But does it always have to be this way? Should we simply accept the onerous rules and regulations and business processes as a fact of life in the government contracting environment? Is it endemic only to the defense acquisition arena, a by-product of a multi-level hierarchy coupled with political pressure and the occasional newspaper headline? Or is it perhaps some immutable axiom of organizational behavior, a phase that all organizations grow into as they increase in size and complexity?
Is there a way out?
Well, we don’t know the answers to all of our questions, but we do know that Netflix thinks it both understands the problem and has found a solution to it. And Netflix has documented its corporate analysis in a 126-page slideshow, which we provide below.
Now we know you. You are not going to click through 126 pages of somebody telling you about their corporate culture. You don’t have the patience, and you don’t think it applies to your organization in any case. And there’s a real argument to be made that, no matter how innovative and cross-my-heart-true this cultural approach sounds, it simply could never be implemented in your organization. We get that. Which is why we are going to print selected quotes and paraphrases from the Netflix slideshow.
Consider the following as statements of cultural philosophy, as statements of intent to create and foster a unique culture. Consider how you could, in a perfect world, unfettered by your HR policies and procedures, implement them within your organization. Consider the impact. Consider what it would be like to work in such a culture.
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Actual company values, as opposed to the nice-sounding values, are shown by who gets rewarded, promoted, or let go. Actual company values are the behaviors and skills that are valued in fellow employees. At Netflix, we value nine behaviors and skills: Judgment, Communication, Impact, Curiosity, Innovation, Courage, Passion, Honesty, and Selflessness.
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Each Netflix manager uses the Keeper’s Test to evaluate employees: Which of my people, if they told me they were leaving for a similar job at a peer company, would I fight hard to keep at Netflix? The other people should get a generous severance now, so that we can open a slot to try to find a star for that role. The more talent we have, the more we can accomplish. To that end, we assist each other all the time; we help each other to be great.
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We don’t measure people by how many hours they work or how much they are in the office. We care about accomplishing great work. Sustained B-level performance, despite an “A for effort,” generates a generous severance package, with respect. Sustained A-level performance, despite minimal effort, is rewarded with more responsibility and great pay.
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We insist on high performance. In procedural work, the best are 2x better than average. But in creative/inventive work, the best are 10x better than average. There is a huge premium on creating effective teams of the best performers.
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We are looking for responsible people who thrive on freedom, and who are worthy of freedom. Responsible people are self-motivating, self-aware, self-disciplined, self-improving, act like leaders, don’t wait to be told what to do—and they pick up the trash on the floor. Great managers figure out how to get great outcomes from their people by setting the appropriate context, rather than trying to impose control. High performance people will do better work when they understand the context, the overall goals and strategies. When one of our talented people does something dumb, a great manager doesn’t blame the employee; instead, the manager asks where s/he failed in setting the context.
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The Netflix model seeks to increase employee freedom as we grow, rather than to limit it. We do that by focusing on increasing talent density as we grow. Many companies impose process controls as they grow, in order to manage increasing complexity. That’s fine: such companies may be market leaders, defined by their optimized processes that drive efficiency and permit few mistakes. But they are also defined by: minimal thinking required of their employees, a lack of curious innovators/mavericks, and a lack of flexibility. When the market shifts, those companies have trouble adapting to new conditions. But we seek to avoid that by-product of successful growth by adding more and more high performers, who have the self-discipline to thrive in an informal work environment. We increase talent density by: (1) paying top of market compensation, (2) giving our people an opportunity to make a big impact, and (3) continuing to demand high performance.
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We seek to have only outstanding employees. One outstanding employee gets more done and costs less than two “adequate” employees. We have three questions, or tests, to determine a person’s compensation: (1) What salary could this person get elsewhere? (2) How much would we have to pay for a replacement? (3) How much would we pay to keep this person if they received an offer from elsewhere? Our goal is to keep each employee at the top of the market for that person. We will pay an outstanding employee more than anybody else likely would; we will pay them as much as a replacement would cost; and we will pay them today as much as we would if they had a higher offer from elsewhere. These questions are asked of each employee every year.
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We do not have centrally administered “raise pools” or salary range percentiles. We don’t focus on internal parity or giving everybody the same flat raise; instead, we focus on what the employee is worth in the marketplace. Regardless of how well Netflix is doing, we will always pay our people top of market compensation. Think of a sports team: even if the team has a losing record, it is still paying its players the market rate.
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Formalized employee development is rarely effective, and we don’t do it. We don’t have rotations, mentorships, etc. Instead, we develop people by surrounding them with stunning colleagues, and by giving them big challenges to work on. If we would promote somebody to prevent them from leaving, we will promote that person today.
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Bad processes are in place to prevent mistakes. Our model focuses on rapid recovery rather than error prevention. For example, we don’t have a vacation policy. Further, our policy for expense reports, travel, acceptance of gifts, and entertainment consists of five words: Act in Netflix’ best interest. That’s it.
Netflix is working hard to create its own organizational culture, and it says it understands why the culture it has created fosters accomplishments of its strategic vision and goals. Can you say the same about your organization and your culture?
DOD Withdraws Proposed DFARS STEM Rule
We recently told you about a proposed DFARS rule that would “encourage contractors to develop science, technology, engineering, and mathematics (STEM) programs. STEM programs are, programs or initiatives, either formal or informal, which encourage the pursuit of education and experience in the Science, Technology, Engineering, and Mathematics disciplines.”
We also told you about a catch in the proposed rule. Buried in the language were the following phrases:
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“The Contractor shall assume the responsibility for all the costs and investments in support of the STEM disciplines.”
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“The Contractor will not be reimbursed for any costs incurred or associated with the support of the STEM disciplines. Any costs incurred for supporting the STEM disciplines are unallowable under this contract.”
Based on the catch, we concluded the following about the proposed rule—
… it is disingenuous and perhaps even contrary to Congressional intent, to both ‘encourage’ contractors to engage in STEM-related activities, while at the same time declaring that if the contractor does engage in such activities, the costs are not allowable contract costs. One is tempted to assert that the two policy positions are contrary to one another. Declaring that STEM-related costs are unallowable seems to be faint encouragement, indeed.
We asked our readers to consider submitting comments to the DAR Council. Perhaps they did so, because the DAR Council recently announced that the proposed rule was being withdrawn.
Why did the Council withdraw the rule? According to the Federal Register announcement—
DoD has determined that the proposed amendment to the Defense Federal Acquisition Regulation Supplement (DFARS) is not a necessary part of the Department's plan to implement a section of the National Defense Authorization Act for Fiscal Year 2012, that requires DoD to encourage contractors to develop science, technology, engineering, and mathematics (STEM) programs. … At this time, DoD is in the process of reassessing the most effective and efficient methods by which it can encourage contractors to develop science, technology, engineering, and mathematics (STEM) programs.
We suppose that’s as close to an acknowledgement of a misstep as we are ever going to see from current DOD rule-makers. But while we could quibble with the wording, we are quite satisfied at the outcome—as we trust our readers are. Thanks to those who submitted comments.
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Lessons from the ASBCA
The Armed Services Board of Contract Appeals (ASBCA) is one of two fora to hear appeals of Contracting Officer Final Decisions (COFDs) (the other being the U.S. Court of Federal Claims). Two recent decisions issued by ASBCA Administrative Judges offer lessons to contractors considering litigation. We thought we’d share them with you.
The first decision involves United Healthcare Partners, Inc. (ASBCA No. 58123, April 2, 2013). UHP appealed a Termination for Default (T4D0. UHP was awarded a contract by the Air Force to provide telephonic “Nurse Triage Answering Service” for personnel seeking medical attention. The contract was a firm, fixed-price type valued at $254,259, with an estimated quantity of 19,710 and a unit price of $12.90 per call. The original dispute involved the amount of supporting documentation that UHP was required to provide with its invoices. The Government was concerned that UHP’s invoiced call volume did not match governmental records, and demanded that UHP provide a “monthly clinical statistics report” that supported UHP’s invoiced call volume. For its part, UHP disputed that such a report was necessary or required by contract terms.
The government began to issue CARs (Corrective Action Requests) and refused to pay submitted invoices. When three months had passed without payment, UHP “suspended” its services. The government responded to that action by issuing a Default Termination, characterizing the T4D as a COFD, which could be appealed. UHP appealed that T4D and demanded that its past due invoices, worth about $71,000, be paid.
But while UHP was free to appeal the T4D, it could not appeal the unpaid invoices. Why? Because it had not filed a certified claim for the unpaid invoices to the Contracting Officer (CO), and it had not received a COFD. There was nothing to appeal, according to the Judge Page. She wrote—
There is no proof that UHP's demand was properly submitted to the CO for decision, and appellant cannot first assert a claim as part of its complaint. It is ‘the claim, and not the complaint, [that] determines the scope of our jurisdiction in this appeal’ as a '"CDA claim cannot properly be raised for the first time in a party's pleadings before the Board.'" [Citing American General Trading & Contracting.] ... Appellant [UHP] did not submit a $71,659.30 or other CDA claim to the CO for payment of its invoices in question and did not seek a COFD. Neither UHP's ‘Request for Fair Compensation’ attached to its complaint nor its routine invoices meet the requirements for a cognizable CDA claim.
What lessons can be learned?
First, we noticed that UHP was represented by its CEO. We have railed in the past against contractors who do not hire expert attorneys when litigating against the government. Suffice to say, we don’t think very highly of them.
Second, let’s talk about UHP’s tactics. It chose to stop work when its invoices went unpaid. It chose not to file a claim for its unpaid invoices to the Contracting Officer. We consider those choices to have been … unwise. If you have a dispute with the government, you are pretty much always going to have to keep working (and paying your staff and your overhead) while the dispute is being resolved. There may be exceptions to that general rule but they aren’t worth knowing. (Remember we are not attorneys.) If you want to get your dispute resolved, you don’t stop work; instead, you file a certified claim and get a COFD that you can appeal. The faster you do that, the faster you get paid. It’s really just about that simple. The path UHP followed was essentially the opposite of the correct course of action.
Finally, let’s look at the dispute itself. The government wanted UHP to support the amount of phone calls it was billing for. UHP said such support was not required by the contract. UHP may well have been correct that the contract was silent regarding additional reporting requirements associated with its invoices but, once again, it chose an unwise path from a contracting point of view. Another, perhaps wiser, contractor would have generated the reports—especially if it got the invoices paid faster. To the extent that there were additional costs associated with the reports, a savvy contractor could have submitted a Request for Equitable Adjustment (REA) for the cost difference. Had UHP chosen that path, it could have gotten paid and it might have been able to get its contract value increased. Instead, UHP’s course of action led to unpaid invoices, sour customer relationships … and a Termination for Default.
The second recent decision involves Servicios y Obras Isetan S.L. (ASBCA No. 57584, April 5, 2013). Servicios y Obras Isetan (SOI) also found its contract terminated, and it also represented itself in litigation. And it also claimed “funds for overhead costs and the return of retained amounts.”
The interesting thing here is the nature of the dispute. SOI’s dispute did not involve insufficient invoice support. Instead, the CO terminated the contract because SOI allegedly “submitted falsified documentation in order to secure the contract.” The allegations were substantiated by the Air Force Office of Special Investigations (AFOSI). Although the word “forgery” was used, Judge Wilson simply found that SOI “misrepresented” key facts “in order to obtain a more favorable evaluation of its proposal.”
As was the case with UHP, SOI found its claims for monetary compensation denied because the company had never submitted a certified claim to the Contracting Officer in order to receive a COFD. Further, Judge Wilson found that the contract was “void ab initio” because of SOL’s misrepresentations. The government argued that SOL’s misrepresentations amounted to “fraud in the inducement,” but Judge Wilson simply found that SOL “materially misrepresented” key facts, that the government relied on the misrepresentation when deciding to award the contract, and that the government’s reliance on the misrepresentation was reasonable. Thus, the contract was voidable and it was voided.
We have dealt before with contractors that have “enhanced” their proposals by making misleading and possibly flat-out untrue statements. It is never---ever—a good idea to make demonstrably false statements to government officials. Proposals are not an exception to that rule. We suspect that SOL was lucky to receive the outcome that it did.
Small business contractors often receive contract award opportunities not available to other contractors. However, with respect to contract compliance and contract breaches, they are held to the same standards as are the largest and most experienced contractors. These two contractors learned their lessons the hard way; we trust our readers will learn from the mistakes of UHP and SOL.
DOD IG Says DCMA Cannot Manage Performance-Based Payments
Sigh.
Reading this recent DOD IG report is like listening to a doctor diagnose a patient’s illness by listing the symptoms. The doctor tells the patient nothing new, fails to identify the illness that is the root cause of the symptoms, and then charges the patient $800 for the appointment. And to make it worse, the patient was already aware of the symptoms—because they are why s/he went to the doctor’s office in the first place.
We’re talking about the DOD IG report that evaluated the ability of DCMA Contracting Offices to negotiate and administer Performance-Based Payments (PBPs). DOD IG reported—
Contracting personnel did not properly evaluate and negotiate schedules. Specifically, they did not:
- Establish appropriate events for 1,807 events out of 2,356 total events on 57 approved performance-based payment schedules, and determine whether the event value fairly represented contract performance for 44 schedules;
- Clearly define the criteria for successful completion in 33 schedules, identify events as severable or cumulative in 23 schedules, and specify completion dates in 21 schedules; or
- Properly negotiate and verify the contractors’ need for contract financing or level of investment before authorizing performance-based payments in all 60 sample contracts.
Based on those findings, the DOD IG provided the following incisive root cause analysis—
This occurred because DoD contracting personnel did not perform adequate reviews of schedules provided by contractors and did not use expenditure data or other independent data to value events. In addition, DoD guidance did not require contracting personnel to take any performance-based payment contract financing training and DoD guidance was inadequate and inaccurate.
Yes. It was a failure of guidance that led to the systemic failures to properly administer PBPs. Thank you, DOD IG, for the value-added diagnosis. Here’s your $800.
This is not the first time DOD IG has expressed concerns with the Pentagon’s administration of PBPs. In 2003—a full decade ago—audit report number D-2003-106 found that DOD was not adequately administering contracts that used PBPs, and asserted that billions of dollars’ worth of contracts “had poorly defined event schedules … lacked performance criteria, or did not document event dependence.”
Partly in response to that 2003 IG report (as well as in response to an earlier IG report on the same topic), the Defense Procurement and Acquisition Policy (DPAP) Directorate convened a PBP Working Group to improve PBP administration. The PBP Working Group’s final report, issued March 8, 2005, can be found here. In that report, DPAP committed to revise FAR language to eliminate confusion, revise the DOD User’s Guide to Performance-Based Payments, and to revise training to address concerns and confusion about administration of PBPs.
A decade later, in its response to the 2013 DOD IG audit findings, the Director of Defense Pricing committed to take the following actions:
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Update/revise existing policy guidance
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Enhance required training
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Revise and issue the (draft) 2012 Performance-Based Payments Guide
So let’s recap the bidding.
DOD has been using PBPs for contractor financing since 2000. DOD IG has been criticizing DOD’s administration of PBPs for just about that same length of time. While some of the details have changed, in a larger sense none of the 2013 criticisms are new; they are essentially the same criticisms asserted in 2001 and 2003. Pentagon policy-makers continue to largely concur with the IG’s audit findings, and continue to commit to enhanced/revised policy guidance and enhanced/revised detailed user’s guidance, and to enhanced/revised training for DCMA personnel involved in the administration of PBPs. Not too much has changed over the past decade.
So let us offer this prediction.
Sometime in the next decade, the DOD IG will conduct an “audit” of DOD’s administration of PBPs on its fixed-priced contracts. That audit will find many failures. It will recommend enhanced policy guidance. It will recommend more detailed direction. It will recommend enhanced training. And the Pentagon policy-makers will concur, and agree to implement the recommendations.
And that cycle will continue. Forever.
The patient will continue to visit the doctor, because something’s not quite right. And the doctor will repeat the symptoms back to the patient. And the patient will go home with no more knowledge than before—and perhaps poorer by $800 for the experience.
Let us end the cycle now. Let us diagnose the problem for Pentagon policy-makers.
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Using PBPs requires a trade-off. PBPs require an upfront investment of time and effort in order to identify meaningful events that reasonably correlate to a contractor’s expenditure of funds. It requires time and effort to negotiate them and to come to an agreement. In return, “non value-added” administrative efforts are reduced during contract performance. PBPs should not be audited, and event confirmations should be a breeze. It’s a trade, but one that many Contracting Officers cannot make, because they have neither time nor schedule to invest in such pre-award negotiations. If DCMA cannot address theCO workload and pressures to put contractors on contract, then it cannot fix this problem--no matter how much the guidance is improved and how many training classes COs attend.
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Using PBPs requires education and know-how. It’s a relatively new area (even though it’s nearly 15 years old at this point.) Unfortunately, training has been perfunctory and had not addressed the real needs of the users—including Contracting Officers and CO Representatives. There aren’t a lot of gray-haired mentors around to help out young COs. If you can't create DCMA PBP SMEs, you cannot fix this problem--no matter how much the guidance is improved and how many training classes the COs attend.
Based on (1) and (2), above, there will be a high percentage of compliance failures. If you want to reduce the amount of failures, you’ve got to give the COs time (and schedule) to make the initial upfront investment. You’ve got to give them “how-to” guidance and tools—not just some pretty platitudes about “PBPs are DOD’s preferred financing solution”. You’ve got to give them detailed guidance and step-by-step instructions. And you’ve got to create a small cadre of experts who can answer questions.
Until you do all those things, you are never, ever, going to break this endless cycle of IG audit findings and empty promises to fix things.
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