I had a discovery call with a prospective client the other day. For privacy, I’ll call him Les.
I ended up telling Les that I couldn’t, in good conscience, take him as a client.
When I first saw his application, I thought he would fit right into my specialty. I could potentially add a lot of value.
However, after talking, we both agreed that my fee would put an undue hardship on his business.
I gave him some advice on things that I felt he needed to fix immediately, but also gave him a new way of thinking about his business and his life.
His business is set up in Southeast Asia (SEA), as are his employees. Nearly all of his employees are low paid. The business is doing about $750,000 revenue, but with nearly zero profit.
So I challenged him to change his thinking:
What would it take to make this business profitable in a world-class city?
He hadn’t ever considered this before.
I shared tales of my clients in similar businesses who run them in expensive US cities and maintain 25% to 30% net profits while enjoying a market-rate wage for themselves.
He didn’t have much of a bottom line and sure didn’t have a market-rate salary.
Unfortunately, he is not alone in this problem.
There are thousands of founders who save up their money, hop on a flight to SE Asia, and start a business with next to no money. The truth is, in a lot of cases, this actually “works”.
You only have to find a few consistent customers to pay your bills. And for what anyone in the U.S. would consider a part-time venture, you can live a very comfortable lifestyle abroad—but, unfortunately, most of these businesses wouldn’t survive the overhead of the first world.
So how does he (or anyone else in a similar situation) go from barely getting by in Southeast Asia to becoming highly profitable in a world class city?
Let’s take a look at my client’s specific situation for an example of how someone would pull themselves out of the bootstrap phase and grow a company based anywhere in the world.
First: Fix Payroll
Les had no idea what percentage of revenue was going to payroll.
Not knowing key numbers like this could be a sign of a bigger problem. If you are looking at your PayPal account just to see if there is enough money to pay rent and buy street food, you definitely need more financial discipline.
My Rule of 1/3: Total company payroll cannot exceed 1/3 of revenue to maintain a healthy profit in a service business.
My prospect guessed that his payroll was way over 50%. I’ll bet after he runs his numbers, he’ll tell me that they exceed 70%.
Why do I say that?
While it is possible to maintain an acceptable profit (15%+) with payroll in a service company hitting 50% or so, it get a lot harder to manage.
To fix his margins, he has three choices:
1) Increase prices: Bumping up the cost of admission is the fastest way to increase margins. All new customers should pay the higher fees, and eventually all current accounts will get bumped to the new fees when the company can afford the risk of losing them.
2) Increase Labor Efficiency: How productive is the team (or yourself)? Setting up proper communication, getting rid of bottlenecks, and setting standards can help improve efficiency.
3) Do Both: If sales don’t slump after an increase in price and opportunity for more productivity exists—pursue both.
He has a couple of other advanced options, but in an emergency situation, those 3 are really the only ones that make sense and can increase his margins quickly.
Next, Implement True Project Management
Even if Les can get his team to work more efficiently, it is unlikely that he would maintain this efficiency over the long term without implementing a strong project management system and hiring the BEST people.
To get a team who can really handle client work well, he needs to drop the common but potentially harmful idea of hiring Southeast Asians who are inexpensive, but not necessarily good (in most cases). I’ve seen this a lot with Westerners hiring people in Southeast Asia (SEA).
While there are a lot of smart, creative people throughout Asia, you may not find the best fit for your company there. Don’t limit your hiring scope to SEA.
Hiring at the lowest cost often ends up costing a lot more because you have to have a bloated staff to achieve anything. Only hire great people – the right people for the job – and you won’t have as many headaches.
Sure it’ll cost more up front in terms of salary, but you’ll have fewer employees overall, which also means you’ll need fewer managers.
Great people will be exponentially more efficient, which will make your company significantly more profitable. Profitable enough that you could pay yourself a market-rate salary for a world class city and still have a 25% profit margin.
If you’re one of those people who can’t move to an expensive city such as London or New York because there isn’t enough money left in your business after expenses, then you need to do the same as I told this prospective client.
Let’s go into more detail.
How to Turn Around a Profitless Company (Anywhere)
I said that the first thing that needed to be addressed was payroll. Which is true.
However, I wouldn’t immediately slash payroll. That’s the old school MBA way of doing things and not entrepreneurial at all.
My thinking is that the business is already paying for these people and they are already trained. Cutting 20% of the staff would be a significant drain on the intellectual property of the company.
One of the first things I would do is sit down and figure out how well Les is utilizing the current team.
Les needs to do time-tracking on all his staff and all their projects.
The goal is two-fold:
- To find out areas of underutilization within the team.
- To learn which projects aren’t profitable.
All of my clients with poor margins should do this. I’ll bet if Les did this one thing, his business would be profitable the very next month.
One of my clients found that over 80% of the revenue from some of his projects were eaten in labor costs. That means he was actually paying to do those projects. If it wasn’t for other profitable projects, he would have been out of business quickly.
For Les, he needs to find which of his projects are profitable and which aren’t. Then he needs to determine why.
1) Staff Underutilized? Not enough work for the wage.
2) Project Fee Too Low? Too much work for the wage.
3) Combination? Could easily be a bit of both.
In Les’ case, I would say that his fees are close to market rate (based on our call).
He could probably go up as much as 50%, but I’d guess he could do 20% higher on new clients without much pushback during the sales process. Without other changes, if he replaced all his existing clients with clients paying 20% more, it would all go to profit.
While this would be a great step, low project fees is not the primary cause of his business distress.
The culprit appears to be that Les’ staff is massively underperforming, not just underutilized. What I’ve often found is that many professional service businesses have staff that are spending too much time on labor without a big impact on results for clients.
Unfortunately, the activities that have the biggest return for the clients are typically neglected.
The Nuts and Bolts: Doing an 80/20 analysis on each project and the labor activity in those projects will show just how the team is spending time on these projects.
I’m guessing from experience here (since we didn’t have the numbers), but I think his staff is around 50% to 60% utilized and they are probably spending that time on low-return activities.
Once we know what activities give the greatest results for clients, we can trim back labor on the other activities and spend that labor on the better, more profitable activities.
Les will then have a lot of people who don’t have anything to do.
Or, for the glass-half-full people, he will have doubled his capacity for new clients—with new clients paying at least 20% more for that matter.
He could go from $750,000 to $1,650,000 with his current team based on these numbers.
As he puts on more higher-paying clients, he’ll bolster the courage to raise prices on his less profitable clients.
There will still be a few unprofitable clients even after fixing labor utilization but if they refuse to pay a profitable rate, they’ll leave and open up a spot that can be filled by a more profitable client.
Doing this could turn his company into a $1.8 million business with close to $900,000 in profit (theoretically). Probably more like $600,000 in profit after he pays himself $120,000 in salary and has to pay more in software fees and one or two really solid project managers.
Again, payroll problems aren’t quickly solved by slashing jobs.
The only time I would recommend that Les cut staff is after he does all the above ,has 50% of his team idle, and only then if he can’t add new clients fast enough to cover labor costs.
If his marketing and sales are weak (I don’t know this yet), then he will have to cut as much as 25% of his team. Cutting any more would be dangerous and would eliminate most of his capacity for growth.
If you’re having profit trouble, go over the market pricing of similar products while determining your value. Next, track how projects are currently handled (your process) and do an honest 80/20 eval.
- If it’s not profitable, try to cut it.
- If staff is underperforming, reorganize and use them more efficiently.
- If your product can earn more, raise prices.
- And, in many cases, do all of the above.
Pricing Is Positioning
This particular point is not about Les’ business per se because his pricing is already in line with competitors.
However, I would be remiss if I didn’t use my standard line of “raise your prices.”
Les could probably raise his prices by 20% without too much resistance from prospects. Go above a 50% increase and he would almost assuredly need to change markets.
The types of clients who are willing to pay his current prices are not likely to be the same clients who would pay significantly more, such as double or triple his current price (there are plenty of companies like his that charge 3X what Les charges).
I have seen companies raise their prices 3X+ and stay in the same market, but those people were grossly undercharging.
This isn’t the case for Les in his market.
Since my case study falls short on tactical implementation, let’s go into some of the business theory that I use to change mindset.
What would it take to add a zero to your price?
If you charge $1000, what would it take to charge $10,000? If you charge $10,000 what would it take for you to charge $100,000?
Humans aren’t really good at exponential thinking.
What’s the saying? “We overestimate what we can accomplish in a year and underestimate what we can accomplish in 10 years.”
When I get pushback on Add A Zero, I ask, “Are there any companies that do something similar to you that charge those fees?” I’ve not found anyone who has said “no” yet.
I’m sure those people exist (theoretically), I just haven’t dealt with them.
I’ve had loads of clients in the online marketing space just like Les’ business and I know this industry really well.
I’ve had many clients say things like, “my large clients” when talking about the ones that pay them $2000 a month compared to their other clients that pay them $1000 a month.
Key Takeaway: It takes research to figure out what a “large” client is within your industry.
Example: In pay-per-click, a large client would start around $20,000 a month in fees (not including ad spend). And some agencies still wouldn’t take that client, as they get hundreds of thousands per month from their clients.
- What, in reality (not your perception), is a large client in your industry?
- What would it take for you to charge those fees in your business?
- What kind of clients would you need to attract?
- How would you position your business so that large clients would work with you?
Management Makes You Money
At the start of this article, I said that Les needed to fix his margins by dealing with payroll. Next, I extrapolated that he needed to analyze his team utilization and the time spent on tasks within client projects. Then, to go deeper for those of you in Les’ situation, I went over pricing.
What’s the thing that will keep the wheels of profit spinning?
To fix his company, Les also needs to hire top-notch project managers to keep his company running properly after he’s made the fixes. Ideally, he would get project managers to help him fix and set up his business more efficiently.
Odds are he would return to the chaos he is familiar with if he doesn’t have quality people in these PM roles – people who would also improve the company deliverables along the way.
Notice—I said project managers and not any other kind of manager.
Les is in an emergency situation so dealing with the greater operations of the company isn’t as high of a priority as stopping the bleeding in deliverables to current clients.
With companies that have a solid team on deliverables, I focus on operations management as they will get a huge return by improving in this area.
Les can’t profitably add customers until his project management is under control.
However, if Les trains his new project manager to work the way his old one did, then he will only remove a small amount of chaos.
Les has a lot of Southeast Asian employees. He said there is lower level management in place, maybe in the form of team leads. During our discovery call, we didn’t discuss this at length but I have to doubt that there is much of a management system in place due to the chaos his company is in.
Other than team leads, the next level of management for deliverables is the project manager (PM). Strong team leads would make the job of project management easier. Les needs to have a top-notch PM to train and guide strong team leaders.
If the PM has dozens of direct reports to manage, he will always be in a manic state. However, if the PM grooms 5 or 6 team leads, he will be able to oversee projects better as more of the deliverable ownership moves closer to the person doing the labor.
The team leads would do the same—efficiently move ownership of deliverables to the person responsible.
The PM’s job is to make sure that the people who are doing the deliverables have the resources, training and guidance necessary to do their jobs to the best of their ability.
If accomplished, the work processes become dramatically more efficient and the company becomes profitable.
The Real Change Is Mindset
For Les, this whole case study is really about changing mindset – how he views his business and the people in it.
He has run it as a centralized, command-and-control system from the beginning because he had the belief that the people he hired wouldn’t be able to think through problems on their own.
That became a self-fulfilling prophecy as he only hired people who could only follow a checklist of tasks to do.
That leaves all problem-solving to the one or two people at the top.
Unfortunately, those are the people furthest from the problem. This may work in the very beginning and start up of a business since the team is really small and the founder is still really close to every problem and deliverable.
But as the company gets bigger, this becomes untenable. The company first becomes scattered, then hectic and finally falls into unprofitable chaos.
Once Les begins implementing the things I advised (and outlined in this article), his business will quickly become profitable, without even adding new customers. But as he adds new customers, his business will grow rapidly and most importantly, profitably.
Take a look at your business. Do you see any similarities? If so, go through the steps I shared and begin implementing them. Even if you’re profitable now, you can implement these ideas and significantly increase your future profitability.