In the hundreds of articles about building successful startups, service companies get a little short changed due to a lack of glamour and high stakes. Here is some advice on how to focus on the fundamentals to ensure a steady growth of your service business. Especially, in its formative years, given that you have identified a service need successfully.
Start with a long term vision and work backwards
This sounds a bit fuzzy wuzzy, but it important you do it on an annual basis. Lot of decisions on the target market, type of client, domain of projects, and ticket size will start becoming clearer. This will also help rest of the team understand where the company is heading, and what could be their career path in the next few years.
We kind of did anything and everything for just the bottom line. As a result, we never actually carved out a niche, and team largely felt stagnated due to repetitious nature of work. Then we put a vision of “Impacting a billion users in next 9 years.” This vision is helping us focus more on real world solutions in health care, wellness, consumer, social and commerce. While moving away from enterprise projects. The rest of the team is also excited about this direction.
Founders should pay themselves market salary from Day 1
Most founders compromise on their market worth. Which means you won’t be able to arrive at a true profitability of the company. Second, it will be very difficult to replace a founder, if something untoward was to happen. Understandably, you won’t be able to pay yourself market salary at the onset. But account for it in your balance sheet as deferred payments to keep your financial forecasting accurate. The equity in a service startup won’t be a enough to attract new talent until much later.
This was again a late realization for us. You never know if one of us finds an interesting opportunity and wants to exit. We are now building a financial transition plan in place. And the first step is to identify our market worth and get paid accordingly.
Find a mathematical basis for your pricing
Unless you achieve the holy grail of value based pricing, you will most likely start with a cost plus pricing. In other words, calculate how much an employee costs to the company – employee salary + vacation + sick leave + expected utilization + share of rent and other expenses. And then factoring in your expected profitability, you should arrive at the number of hours or person days that need to be utilized at a certain rate.
In our experience for Indian companies, the factor is usually between 2-2.5 times an employee salary, while in the US, it closer to 3. Obviously, higher the utilization rate the lower the multiplication factor.
Never discount as a rule
This is the hardest lesson to master. It is very tempting to discount in order to close a deal quickly. If you discount once, you will generally have to discount every time. And soon you will need to add a negotiation buffer in your pricing. It is a slippery slope, where you will get positioned as a commodity player rather than a true value generator.
We have a standard rate card where we offer standard discounts based only on certain parameters like duration of a project or a size of the contract. Otherwise, we sometimes throw in some freebies like free design support for 30 days, instead of an upfront discount. We indeed have lost projects due to a fixed pricing, but we have more than recovered the loss by not discounting in the longer run.
Track utilization rate maniacally
This is one of those things that is common sense but very few do it. Of course, tracking the utilization is harder. There need to be incentives for filling time sheet regularly and accurately. And then creatively figuring out on how to make use of the excess capacity, instead of forcing employees to work for 8 hours.
For instance, we discovered that just by increasing our utilization by 10% we could increase our profits by 20% by lowering our hiring requirements. We have a list of internal projects that either help in improving internal processes or help in sales and marketing.
Calculate cash flow on monthly basis
You can kick start the cash flow by charging some percentage of the project cost up front. After accounting for every expense and possible revenues from current and potential projects, you should get a good idea of actual cash in hand. A working capital loan as an overdraft from a bank helps in accounting for delayed payments. However, use it very carefully. It is very easy to get addicted to “easy money.”
We also account for things such as TDS that we won’t see for at least 2 years and Service Tax that has to be deposited on monthly basis regardless if the client pays us or not. [The Indian government does not make it easy, does it?]
You probably understand most of the points discussed here. But do you actually track them regularly and honestly. It will be hard to build a profitable service business without keeping these operational fundamentals in check. Read Greg Crabtree’s book called Simple Numbers, Straight Talk, Big Profits. It will really help organize your financial plan and put you on a path towards profitability.