Outsourcing For Startups

A few weeks ago John Prendergast (founder/CEO of Blueleaf) and I gave a presentation on outsourcing at the Boston Founder Institute. The presentation was on outsourcing generally, not just software engineering and the audience was very early stage companies (some yet to be founded). We tried to provide a framework for startups to think about what activities should be outsourced and why. Anyway, the presentation went well so I wanted to share a Cliffs Note version here (the actual presentation was 2+ hours including Q&A). I’ve embedded the slides below, but they’re mostly just pretty pictures and so following is a summary of the narrative.

Basically our advice is to outsource everything. That is, you should outsource everything that is not core to your long term success (with one caveate that I’ll come back to later).

Now you might be thinking that’s absurd. What kind of startup outsources everything? Well, you’re right, most don’t, but one example of a startup that does is PlentyOfFish. Many of you have heard of PlentyOfFish. It’s a dating website that is free for users and makes money from advertising. PlentyOfFish has 11 million registered users, is the #1 dating site in the UK and Canada and the #2 in the US by audience share. But did you know that founder Markus Frind has just 3 employees for his $10MM+ revenue business? He basically outsources everything. The servers are in the cloud, his advertising sales is with Google, etc. In some strange way, a big part of his competitive advantage is that he is able to outsource everything and maintain such a low cost structure.

So it can be done.

How do you decide what to outsource though and what to do internally with your own team? The answer, as mentioned earlier, is that you should out source everything that isn’t core to your long term sustainable competitive advantage. Things that are key to, for example, building barriers to entry for competitors or barriers to exit for customers, should be done internally…they’re part of your “special sauce.” The one caveat to this rule is that, at least in the early days, you won’t truly understand what your competitive advantage is so you need to keep those things inhouse that allow you to learn fast. So the real rule is outsource everything that isn’t core and isn’t needed to learn about what is core.

Now, for very early stage companies, you may be thinking, “I don’t have any cash, so outsourcing isn’t an option.” To that I say baloney. Even without cash you have many ways to outsource. For example, you can barter for a service or you can negotiate payment terms or even equity for service. Also, outsourcing often isn’t an “all or nothing” decision. You can often pursue a hybrid solution. For example, while you may not be best best at branding/copywriting, you might decide to write a first draft of the copy for your website and have a professional copywriter edit it.

So what you want to do next is to think about all the functions in your business and where they fit in your long term success (or ability to learn) and identify as targets for outsourcing partially or in time. Since every business is slightly different the functions and whether to outsource will be different for each. Here, I’d like to run through a few of those functions and provide some thoughts / tips on outsourcing (these functions range from the obvious to highly nuanced as to whether to outsource and are in the order John and I thought of them):

  • Accounting. Almost certainly accounting is a support service and should be outsourced (unless, perhaps, you’re selling accounting software and you need to eat your own dogfood!). Pick an accountant early and set up a process, which probably means you entering transactions in Quickbooks online and your accountant handling tax filings and the like.  You might think you can do this yourself, but it’s not worth it. In the early days it’s more book keeping than accounting. As your business grows, you will likely need more and more time from your accountant and at some point you’ll hire a full time person to handle the day-to-day, likely combined with roles as office manager or finance (not to be confused with accounting).
  • Banking. Believe it or not, banking is a core part of some businesses (think PayPal or Zopa), but for most of us, it’s a basic support service to be outsourced. When you outsource…at least in the early days…it matters little wheter you pick a local bank or a global one. You should be sure to set up a separate bank account for your business as soon as possible though…mixing personal and banking transactions is a recipie for disaster.
  • Legal. Again…another nobrainer unless you’re LegalZoom. When outsourcing, remember that lawyers are like VCs…it matters less who’s name is on the front door than who you work with. Also, most startup attorneys will do deferred payment plans. In the valley or in Boston, lawyers will often *defer* up to $25K until funding in return for 0.5%-1.0% in equity. Lastly, a hybrid model makes sense for many types of agreements (NDAs, employment contracts, supplier agreements, etc.) where you can leverage some internal “low cost” time. Rember, you’ve got to run the show and set clear limits.
  • UX/Design. Unless you’re a designer you’re going to outsource the graphical design work you have, but remember, you get what you pay for.  99designs are simplistic. Guru/eLance are “transactional”. Local free lancers can offer quality but may not be available in the long run (often a tradeoff working making) and there are always firms that offer integrated services but cost money. UX, on the other hand, is another beast altogether. It’s something that you probably need to have your hands on (or find someone to join the team who will). You can find UX rockstars like Robert Hoekman who are awesome but can be very expensive. World class In-house UX is one of the most challenging hires you’ll make.
  • Branding/Copy. Content is what makes or breaks a site and strangely enough it’s usually the last thing that gets addressed, which is a mistake. Unless this is your forte, you should enlist help of experts. After friends/family, there are professionals that can make a huge difference. it’s also a good example of hybrid sourcing…you can draft and get outsourced review.
  • Engineering/QA. For the vast majority of software startups, the actual code / development process is infrequently a competitive advantage; ergo, you ought to consider outsourcing. One consideration that comes up often when outsourcing is whether to go with a local or offshore vendor. I’ve done both and in my experience picking the right offshore solution can be an advantage (freeing up time and money to deploy elsewhere). Another tip (whether outsourcing or developing in-house, make sure you follow the “2-man” rule, which means that you should have at least 2 people familiar with your code which gives you insurance in case one goes away or moves on. Having managed a lot of software development both local and offshore, this is a topic I plan to write more on.
  • Payroll. You should keep your employees as 1099s as long as possible (there are state and federal guidelines on this that your accountant will help you comply with).  When it comes time to do payroll, it’s best to outsource for quite a while (100+ employees).  Sure Payroll is a good service.
  • Customer Support. However strong the temptation to outsource customer support may be, don’t do it. The reason is not that this will become a long term competitive advantage, but rather that you won’t find a better way to learn about your product/service than to talk to your current customers.
  • Online Payments. Outsource, obviously, but don’t bother setting up a merchant account to start unless you have reason to expect heavy volume.  Paypal, Google and others have great online payments tools that have low setup costs (but relatively high variable costs) and are easy to implement.  You can set up your own merchant account later when it becomes economically viable.
  • Advertising. If you are pursuing an advertising business model, then in the early days you will almost certainly have to outsource, despite the fact that this could be a core long term advantage. The reason is that putting a sales force in the field with limited inventory is very, very expensive. Depending upon your inventory (online, mobile, etc.) you should be able to find many options for an ad sales network.  Unfortunately they will be very expensive (30-50% or more of gross revenue).  Once you have scale, you can think about building your own sales force.
  • PR/Marketing. For startups, PR firms are a waste of money.  Better to do personal outreach to blogs/local media.  Get Constant Contact or Mail Chimp and create an email newsletter for interested folks, including the press. Start a blog. In the early days no one can tell your story better than you. The best early PR is a product that people actually love plus a genuine story to tell from the founder. You can also get to know local media easily, they’re at the same events you are and generally speaking are very approachable.
  • Brokers. And by brokers, we mean people who offer to make introductions to investor and/or help with raising capital. The short answer here is that you need to keep this in house…not that it’s strategic in the long term, but because you’ll learn a lot from prospective investors. By the way, investors hate deals that come to them via brokers…there is a perceived adverse selection bias…they’re thinking, “if you can’t raise money by yourself, how are you going to build a business?” Go direct and network your way to the people you need to meet or find them directly in the local community. Plenty of people are willing to help you for free.

Conclusion

What to outsource depends upon whether it’s core to your business or not AND whether there is an economically viable 3rd party solution OR whether you stand to learn substantially about your business by doing it yourself. Cloud computing, open source and a global talent pool make outsourcing easier than ever before (even a few years ago). If you tried outsourcing something a few years ago and it didn’t work, things likely have changed. You must balance short term constraints (human, capital, etc.) with long term requirements. And remember, anything is possible with hard work and the right attitude.

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