I recently became a partner with a start-up design agency as an investor/advisor.
The guys I partnered with are smart. They make incredible website designs that convert substantially better than other designers. However, they’re young, and inexperienced in business. They’re both 22 years old, with lots of great ideas, but struggle to accomplish big goals because of the way they work.
They were struggling to bring in very much revenue, so I dug into the business to figure out why they weren’t making any money.
Turns out some very simple fixes will help them bring in 5-10x as much money.
I decided to write a post about it, because a lot of smart entrepreneurs are BLEEDING money the same way, by not being able to mathematically calculate where their inefficiencies are. Once you figure out where they are, it’s often relatively easy to plug them. Once fixed, the money stops leaking out and you can start piling up money.
Here is the conversation that led to these discoveries:
Me: How’s the ‘XYZ’ deal going?
Mason: It’s good, I think we’ll close it, but we already have three projects for January. Should we try to book them for January, then just figure out a way to outsource some stuff?
Wooahhh, something’s wrong here, I thought. How the heck could we be booked up for January when the only jobs we have lined up are small jobs, that have already been going on for a while.
I was a bit frustrated, I’d already spent five figures on this company and we were barely bringing in any revenue! The numbers didn’t make any sense for them to be booked up. We clearly weren’t at the stage where outsourcing made sense. All outsourcing meant was me spending more money writing checks. That wasn’t the solution. We needed to get this thing on the right track.
I try to be as hands off as possible when it comes to management. I don’t want to tell people how to do their job, but something was off and needed to be fixed. My job is to make sure these guys make a lot of money. That’s why I’m involved in the deal. Other than that, my job is to stay out of the way, write some checks, and give advice whenever needed.
This was a time I needed to step in and figure out what was wrong, and break down a plan to fix what was going on before things went down the wrong road.
Me: Guys, send me the bids you’ve quoted people at so far. Let me know the specifics of why you priced the deals the way you did. Tell me exactly how you came up with the quotes.
Me: It’ll make everything clear and should be an easy fix.
Mike (when explaining how they priced it): I don’t want to base it off of an hourly rate because I think that’s ridiculous. Hourly rewards shitty work. I work fast, so each project is generally going to be less hours.
Me: While it’s fine not to base things off hourly for a client, in this type of business you have to know internally exactly what your hourly rate is, or you could be pricing horribly wrong. If you were working faster than you were quoting, and pricing the jobs right, we’d be in the opposite position—We’d be swimming in money, and/or we wouldn’t have enough work. That’s obviously not what’s happening.
I told them I was going to review the quotes, and we’d hop on a call in a little bit.
When we got on the call I told them I wanted to go line by line through their quotes.
I asked them what their goal was to charge hourly. They were persistent that they didn’t want to make decisions based on hourly rates. I told them just to humor me.
“$100/hr”, they said.
This sounded reasonable for firms I’ve hired in the past.
The first quote was a very small job, for $1.5k. Yet, this job had already been going on for close to a month.
Me: So, ideally this job would have just taken you guys 15 hours. How is this job running into January and one of three small jobs that would keep us from being able to take on new projects without outsourcing?
I ran through some specific questions with them from their quotes:
How long did the wireframe mockup take?
How long did the full mockup take?
How long did the web design section run?
What was the transfer time on this job?
When we broke down the hours on the job, they estimated that once completed it might take them a total of 46 hours.
I asked them if they realized they were working on that job at a rate of $32.61/hour. They seemed taken aback— that got their attention.
Now that we had an idea of how many hours it took, we could dive deeper and figure out what was happening.
Me: Why will this job take 46 hours but you quoted them for 15?
They both agreed they guestimated very low on the hours, so ending up pricing much lower than they should have. Once they calculated the hours out, they realized they should have charged at least double. They also said some tasks they thought would be simple on the job turned out to be harder than they thought, which added additional time.
They realized how important it was to take extra time upfront to correctly estimate the hours on projects.
We agreed that even if we didn’t quote clients out per hour, that we should absolutely know internally what the estimated hourly rate we’re charging will be. This will help us not only be able to bill correctly, but to plan efficiently when taking on work and making it possible to outsource.
It’d be extremely hard to outsource if we just charged any random price and then paid the contractor their hourly rate for however long it took them to finish. We’d never even know if we’d make a profit. That’s insanity.
So, we knew that was a hole we could plug. We set a system in place to review all bids in the near future together to make sure we didn’t run into that same problem again.
The problem seemed deeper than just some mispricing though. The numbers would help tell me if I was correct.
We went through each of the 3 individual jobs they had booked in January. They were all very small deals: $1.5k, $2.5k and $3k
“$7,000 in jobs, that doesn’t seem too bad for a business that just started.”
Well, not so fast.
A lot of people would have just assumed they plugged the hole with a pricing fix. That’s why it’s always important to do full due diligence, and run the full math.
They had already been working on some of these jobs for a bit, so they weren’t doing the full $7k worth of work in that month.
I asked them to tell me the percentage of each job they had left to complete in January. They discussed it a bit, gave me the estimates, and I calculated out the estimated remaining billable dollar amount.
$2.5k(100%) = $2,500
$3k(50%) = $1,500
So, they had $4,450 worth of work booked up in January.
Me: Okay, there’s two of you. That means each of you is only billing $2,225 in work for the entire month of January, and you’re saying you’re going to be too booked up to do more work. If you were billing at $100/hour, you’d only be working about 5 hours/week.
We had already established the pricing needed to be corrected, but there was clearly still WAYYY too big of a gap for that to be the only issue. Something else was drastically wrong.
After going line-by-line through their quotes with them, there was a total of 154 estimated hours on the three jobs. I took the percentage left to complete that they estimated and calculated out how much time they had left on each remaining job.
It ended up breaking down like this:
$1.5k: 46 hours(30%)= 13.8 hours left
$2.5k: 62 hours(100%)= 62 hours left
$3k: 46 hours(50%)= 23 hours left
So in total, they had 98.8 hours left.
Me: That’s an average of less than 50 hours for each of you in the month of January.
I pulled up my calendar on my phone
Me: There’s five weeks in that month. So, if you guys are saying you’re booked up for January, you’re telling me you plan on working less than 10 hours/week.
They quickly realized they weren’t being very efficient with their time, and agreed to work with me on mapping out a plan to become more efficient.
I just happened to be working on a new post on that subject.
They now use the PDF from this post to help set/achieve goals: https://foreverjobless.com/the-definitive-guide-to-accomplishing-your-goals/
It’s helping them be more efficient. (Most specifically the priority goal, mind mapping and task order sections of the PDF)
They are going to dedicate X hours per week strictly on design work so we can do more billable work and grow the business.
A lot of times people get caught up doing the ‘other stuff’ that seems like work, but really doesn’t accomplish anything. Reading lots of blogs or articles and ‘networking’, while beneficial, can often be a time suck and is usually a substantially worse use of time than doing actual work. Yet, if you aren’t tracking it, you won’t even realize you’re only doing 10 hours of real work per week. You’ll feel ‘busy’, but be doing everything BUT the things that make you money.
In a long month like January there are five full weeks. Assuming a full 40 hours worth of billing each week, each guy should have been able to bill for 200 hours. So two guys, that’s 400 hours. At $100/hour, that’s $40,000 billable at 100% efficiency.
So in January we were literally leaving $35,500 on the table!
Even in a short month like February there’s still four full work weeks, so $32,000 in billable at 100% efficiency.
Clearly there’s a lot of variables that have to be working to get to 100% efficiency, but we’ll talk about that in a minute.
Right now these guys only had $4,450 billable and wanted to outsource! We needed to get efficient before anything else.
Even if we were at 50% efficiency, we should have $16,000-$20,000 billable. That’s just at 50%!
We made a target goal of 75% efficiency for February. A lot of things had to come together to make this happen.
We were at 24.7% ‘time efficiency’ (if we wanted to do 40 hours per week in billable work).
We were at 11.1% overall efficiency right now (because of pricing and potentially other issues).
It may have seemed like we were miles away from February’s target, but a lot of these were relatively simple fixes we could put systems in place to solve.
Note: Even with just corrected pricing(2x), and working just 2x as much (20 hours per week), revenue would already increase to $17,800/month. $4,450 x 2 = $8,900 x 2 = $17,800. That’s without even improving anything else! (assuming we kept getting leads, which we had no problem doing)
We set up their weeks so they were 100% focused on design work at least 7 1/2 hours/day, a minimum of 4 days a week. This would achieve their target goal of 75% efficiency.
If they only worked 30 hours on the actual billable work, we’d start bringing in $6,000/week instead of the currently projected $890/week.
The rest of the time they could get other tasks done, follow up with clients, browse the internet, and do whatever the hell it was they were doing with all of their time.
“What if they don’t have enough work to fill up the 30 hours?”
That’s fine, then we focus on plugging that hole.
Getting client work wasn’t the problem. Not yet anyways. We had just barely turned on minimal marketing efforts and were getting deals closed, so we could always ramp that up if we needed to.
Obtaining client work when the product or service is high value is not difficult. The company has a great service, so acquiring more customers should not be a difficult task.
As I explained in a previous post, I have a very simple formula for businesses: https://foreverjobless.com/how-to-create-a-business-that-prints-money/
It’s just two steps:
Step 1: Create a product or service that’s higher value than what’s on the market.
Step 2: Figure out exactly how you can reach your potential audience.
These steps were solved.
“So you should have a cash cow right?”
Well, yes. It’s just that unless there’s hours being billed in a service business like this, you don’t bring in money.
“Can’t you optimize the current revenue and decrease expenses like customer acquisition costs?”
You can’t really optimize to increase profitability based on what we’re bringing in because there has to be real revenue to optimize revenue. You can’t optimize 10 hours/week very well, it’d take a LONG time. If you worked a year at that efficiency, you’d only do a few months of actual work. It’d take an enormous amount of time to improve efficiencies within the business if your sample size took that long to grow.
It’d be too much of an incremental change to try to increase margin on 4k/month in revenue. That’s not how you create a cash cow. That’s how broke people try to make money.
“Why are you only focused on time efficiency? Can’t you be working on efficiency, while also scaling traffic/leads, then outsourcing any overflow?”
While you could outsource, it’s a pretty ‘risky/lazy’ move to outsource when you haven’t even figured out how to run the business efficiently yet. If you’re running so inefficient you’re doing less than 10 hours/week of work, it’s unrealistic to assume we’re going to contract work out, and be able to efficiently manage other people to do efficient work. It’s just not going to happen.
We’d end up with disgruntled customers, and some of the leads we’d originally closed would unhappily be requesting refunds, so it’d be silly to try to acquire tons of traffic/new deals if we weren’t efficient yet.
We’re not even making money on our own jobs right now. You don’t unprofitably scale by outsourcing, and expect to miraculously be in the black.
We have to fix the efficiency hole first. If we had all the deals in the world we still couldn’t make money/scale if hours were just vanishing and not going towards the work.
“What if these aren’t the only issues?”
That’s fine. Here are the issues that could potentially give us problems in this type of business:
- Not getting enough leads— not an issue yet as we can’t fulfill what we have.
- Not closing enough of the leads we were getting— too small of a sample size to know our conversion rate, plus similar to the reasoning above, we can’t fulfill what we have in a timely manner, so it’s not relevant yet.
- Pricing deals too low— found this was a problem and implemented fix.
- Not getting enough work done— clearly the gap we need to fill.
Click image for larger version
“So if getting the actual work done is by far the biggest issue, what else are you implementing to fix it?”
Well, besides creating specific schedules of time to work solely on billable work, I’m having Mike and Mason each send me their daily schedule the night before individually to avoid what I think was another timesuck. I think a lot of times people in service businesses are working on the same things together, but not getting twice as much work done. In other words, there are blocks of time while even if dedicated strictly to billable work, that are unintentionally getting charged at half the rate.
Often too much ‘brainstorming’ and looking over each other’s shoulders. It’s obviously great to exchange ideas and check out each other’s work, but if not careful, both guys are spending time “working”, but two guys will be doing one guy’s work.
“But I don’t understand. If you already found these problems, and set plans to fix them, why not start generating a lot more traffic right now and just outsource any overflow?”
If the systems we’re putting in place solve our current issues, then we’d move our focus to getting more deals. If we did so great at finishing jobs quick that we didn’t have enough work, that’d be a good problem to have.
Our sole focus right now needs to be plugging our bottlenecks.
The main bottleneck with this business is the amount of billable design work being done.
Every time we work on a non-bottleneck (anything but design hours) we’ll cost the business $100/hr.
We can’t get that money back.
“An hour lost on the bottleneck is an hour lost on the business forever.” – Eliyahu M. Goldratt
To understand more about how bottlenecks affect companies, I recommend reading The Goal.
Let’s pretend a consultant did hourly calls at $100/hour. If he was only doing 2 calls/day because he was “busy” doing other random things, he’d be spewing $100 down the drain every time he was doing busywork instead of income-producing work. It’d be very easy to see that he was costing himself a ton of money by not doing more than 2 hours/day of income producing work.
In businesses that don’t charge an hourly rate, the same is true, but it’s a lot harder for people to realize how much money they’re actually throwing away, since they can’t directly tie their time to a dollar amount. This increases the amount of ‘busywork’, which confuses people into thinking they’re actually doing income producing work.
I believe we have systems that will improve the business, but time will tell how effective they are. If efficiencies don’t improve, we’ll re-analyze and continue until we fix the bottleneck.
I’m sure these guys will figure it out. I’m betting a lot of time and money that says they will.
We’ve talked about a number of different ideas for this company, and there’s a lot of interesting directions we may take it. If you’re interested in hearing more about this company’s progress, leave me a comment below and let me know. If you’d enjoy more stories in this style from businesses I’m involved in, let me know that as well. I write based on what I feel like people are wanting to read, so your comments count as ‘votes’ for me to decide what I’ll be writing on.
Do you know of a service business that wants to improve their business and would benefit from reading this post? Please share this with them.
Lastly, if you subscribe today, I’ll send you the Money Leak Finder PDF, to show where you’re losing money in your business: