Bootstrapping Part 1 – Outsourcing

Not everyone agrees that bootstrapping a startup is the best way to go (I do). But the economy has recently made you a bootstrapper, whether you like it or not. Mark has already posted a great article about bootstrapping which I encourage everyone to (re)read.

One good way to achieve bootstrap success is to ask yourself what needs to be inside your startup. Most entrepreneurs don’t ask themselves what really needs to be inside vs. outside because they fall prey to the following myths:

1. Contractors are always more expensive – Most people compare the high hourly rates contractors charge with a computed hourly rate taken from a person’s salary. Usually there’s no competition: salaries are cheaper by the hour. But you have to factor in hiring costs, overhead, benefits, and management time as well. Be realistic about these costs, especially the opportunity cost of your time, and you’ll probably find that contractors are efficient. Try not to think about the fact that some of your hires won’t work out…

2. I can’t outsource THAT function, it’s too important
– That’s usually the wrong question. The real question is whether outsourcing a key function might actually give you superior results. E.g. you might not be able to attract the best CFO to work with your little company but you could probably get that person to help you with a specific project, e.g. fundraising.

3. We need to retain knowledge – Find good people, write good contracts and give contractors a reason to work with you long-term. Don’t forget that most startups don’t have any formal knowledge management tools anyways. Plus key people regularly walk out the door. The point is you don’t automatically get knowledge retention just because you have payroll.

4. But we’re a software company, we need to have developers!
– Whether you run a software company or a funeral home (a great recession-proof business

by the way), the goal of your company is still to make money. If you can build a better product with less money by contracting out you’ll have more money leftover to re-invest in making your customers happy. I work with a San Francisco-based company whose products are used in some of the largest hotel chains in the world. They’re profitable but still have no HQ. Their R&D is in Montreal, their VP Operations is in Chicago, and their CEO is in San Francisco.

5. We can’t give up control
– You’re probably assuming, incorrectly, that a) you have more control over employees than contractors and b) more control = more performance. First of all, most control you have over employees is coercive, i.e. “do it or you’re fired.” The problem is, the more you use this control the less people will like you and want to work for you. Contractors, on the other hand, are used to being paid for performance, especially for fixed-bid contracts. They often have more incentive for doing a good job. Sure you can bonus employees for good performance but you can’t cut their salary if they underperform. Sometimes giving up some control gives you a better end result. If you’re not a developer yourself it’s almost always better to outsource to someone more experienced. Hire a great external team and they’ll save you from yourself.

So in summary, ask yourself the hard question of what really needs to be inside your firm. Don’t forget that employees imply a lot of overhead costs and risks, including the risk of sitting idle if things don’t work out as planned. If you’re a first-time entrepreneur outsourcing the headaches of building and managing a staff for the first time will pay off in spades as you focus on your products and your customers. There are risks in outsourcing too, so be diligent and get good references. But when things get tough don’t forget that “supplier credit”, i.e. slowing down your payments to suppliers, is a source of short-term cash flow. I wouldn’t try doing that with employees…