Could Talent Drought Dry Up Software Innovation?

Not long ago, the barriers to growth for software companies may have been about chip speed and other hardware hurdles. Today, their biggest obstacle is human: A shortage of programmers, engineers, sales and service personnel, particularly in the US and Europe, that could slow innovation, revenue, and development.

In a recent report, “Software and Services: The Valuation of Human Capital," Morgan Stanley Research's Sustainable and Responsible Investing team examines the rising cost and struggle to find, hire and retain the industry's best minds. Limited human capital may be the hardest ceiling for the industry to break through.

That constraint could worsen in the short term because many other sectors and industries are also competing for the same finite pool of top talent. Which is why companies and investors both need to focus more on recruitment and retention programs, turnover and training, as well as productivity tied to engaged employees, and how overall wage inflation affect operating costs and valuations.

It's a good time to be a great coder. Not only can they have their pick of software names, but also Internet giants in Silicon Valley and promising startups all over the world. Demand is also strong among old-school manufacturers exploring the Internet of Things, Big Data upstarts trying to extract meaning from the flood of information, or Wall Street firms exploring how financial technology can give them an edge.

It's not just coding. The sales side is also struggling to hire top quality in enough quantities. “Many companies note constraints in their ability to attract and retain top level salespeople capable of good account management who have the ability to bring in the bigger deals," says Jessica Alsford, head of the Sustainable and Responsible research team. As a result, they may also struggle to hit their revenue and growth targets.

What accounts for the dearth of skills? One reason is simply the delayed consequence of an educational gap. For example, U.S. National Center for Education Statistics data show a decline in undergraduates with computer science degrees and related skill sets between 2003 and 2010—perhaps not a coincidence following the burst Internet bubble in 2000. Looking ahead, demand will continue to grow, but supply remains constrained.

Another culprit: the “upgrade cycle.” Rapid changes in technology and required skill sets in software means that “skills that graduates might acquire at university seem unlikely to remain directly relevant for long in the workplace,” says Eva Zlotnicka, Morgan Stanley's US-based Sustainable and Responsible analyst. Those who can adjust and learn new skills are in heavy demand. Those who fall behind may end up in niche roles with a limited lifecycle.

To help offset the imbalance, some software companies may opt to literally acquire the talent they need. In this low interest rate environment, the financing needed to buy a competitor could be less expensive and time-consuming than finding the right talent to develop new products, generate sales, and drive growth.

Meanwhile, more IT services companies are relying on outsourcing. To cut costs and scale up, they are tapping talent in less expensive labor markets around the world. This trend has become so pronounced, especially in Europe in recent years, that personnel costs have actually begun to fall.

Companies with the right talent aren't exempt from anxiety. Their focus, however, is on raising employee satisfaction to retain and attract more top talent. Strategies include better stock-based compensation packages, as well as perks, such as onsite dry cleaning and free meals.

“Silicon Valley companies, in particular, are well known for their perks, which represent another vector along which firms compete for top talent," Zlotnicka says.

What if great pay, benefits and perks aren't enough? Particularly among the top talent in software, the draw may be the intangible edginess of a startup. In that spirit, some companies have gone so far as to carve out special projects within their own organizations that have the entrepreneurial culture of a startup.

Overall, software and IT companies may find that, the more creative they get with their retention methods, the more innovative their own workers can become.

“Employees who are more engaged are likely to be more motivated and productive, potentially leading to more innovative work, less absenteeism and greater focus," says Alsford. “This may result in higher revenue and profit per head."

Explore more Ideas and Research, or contact your Morgan Stanley representative for the full report, “Software and Services: The Valuation of Human Capital" (Apr 30, 2015). Find a Financial Advisor to discuss your investment goals and strategy.