So you're rocking along, doing some pretty good dollar consulting, and you build a small product, internal use only, to help you get your fixed price projects done more quickly.  And now you're really pulling in some bucks.

Disaster Strikes

A junior consultant you just hired from Compsci-U gets drunk at TGIF with the client and spills the beans about your groovy-o tool.  The client, who is billing $100K/month with you, demands a demo.  Upon seeing the (very rough) demo he wants to drop down to $10K/month in consulting and $25k/month in tool charges.

You want to fire Mr. Junior Consultant-man but you do the math:

$100K/month @ 25% (gross) margin = $25K/month (gross) profit

versus:

$10K/month @ 25% gross margin = $2.5K/month (gross) profit

$25K/month tool use at 100% (gross) margin = $25K/month

Total (gross) profit: $27.5K.

Total (gross) upside: $2.5K

Hmmm, up $2.5K plus you have fewer heads on sticks to worry about getting drunk and telling the client what is really going on.

Brief break for the hula dance of victory.  With some Walk Like An Egyptian dancing thrown in.

Money Left on the Table

Hey, wait, all those RFP's and client requests you couldn't fill?  Now you have people.  Time to start dialing!

Revenues go up, bench time stays low.

What is a Tool?

I am using it in a generic sense. It might be an actual tool that takes input and produces output, like WordFinder.  It might be data, like D&B records.  It might be a newsletter, like ValueLine.  Heck, the Yellow Pages is a product.  There are different kinds of products: Shrink Wrap, Custom Off The Shelf (COTS), Consumables (newsletters), etc.....  You'll know which category you're in, and they have different sales characteristics, but at the end of the day, they all fall in the tool bucket and the discussion below applies.

Defensible Business

Consulting is a human resource constrained business so growth is hard.  Suddenly you see how you can sell maybe a quarter of your customers this tool and double your top and bottom lines with the same resource base.  You're rich.  Well, you do have to start investing in resources to improve, grow, and bullet-proof your tool.  So maybe you're just doing better and not well. Still, it's easier money in many ways.

Plus you are suddenly holding a defensible business with a 99% margine.  Before a competitor could come in, offer to do the same job at 80% your rate, and boot you out.  How would the client know the difference?  But now there is this cool tool where the client can pay 35% what they were paying before and get the same benefit.  It's a win-win because they won't be able to get the service cheaper and you can't come under much (if any) price pressure.

Business Fundamentals: Cost / Payment Cycle

When you first start a consulting business you can finance it by floating your expenses on your credit card while you wait for clients to actually, you know, pay.  After a while you learn to build up a bank account so that you don't have to use your home equity line or pay big Amex penalties while you wait for your client's AP department to cut and mail a check.

If you're pretty smart you prepare a bigger reserve before you hire your first non 10-99 employee so that you can pay their salary and expenses too.  If you're like me, well, you're just glad that you put 20% down on your house 15 years ago.  Eventually, though, you learn to keep a tempting pile of cash around (business reserves) relative to

• Employee headcount
• New employees costs and ramp time
• Bench time - expected (occasional) and sudden (client driven)

Costs Start to Rise

If you're really really smart you got ahead of the cost cycle, otherwise you eventually figure it out in time.  (Else you're reading this post from a post-Dilbert cubicle slapping your head!)  But what is probably surprising you is the rising costs of maintaining your cool new tool.

See, the tool got built by the guys on the bench because they need to do something wihle they're not working.  And you figured, hey, if my guys are only spending 10% as much time at client sites then....

But it doesn't work that way over time. Consultants are the king of the one-off – each client gets a customized solution.  It’s very hard to step back from that and introduce release cycles, source control, Q/A,  and a one size fits all mentality.  In fact, your consultants probably can’t do that and you’ll need to hire dedicated product staff and not just guys on the bench.

Regardless, the product gets more complex so you need dedicated resources.  But you have better margin, revenue, and gross dollars to pay for them, so on you plunge. 

And then you need bigger office space.  And you need support staff.  And so on and so forth.  Suddenly you're spending a LOT of money building in features that will be required for future sales.  And now you have a product manager - how did that happen?

The Sales Revolution

Suddenly you have a sales guy.  Or you realize  you need one.  Maybe at first your senior consultants were making the sales for you, but as costs of building and maintaining the tool rise you realize that you need to convert more and more of your customer base to tool users.  And you need to poach, er, convert your competitors customers, which is a much more sophisticated and complex sales cycle.

So now you have a salesguy absolutely eating money as he travels around and does the needful making sales.

Industry Conferences

Got a spare $50K to $100K lying around?  Because now you feel you need to go to the industry conferences.  If not for leads, then certainly for branding (whatever that means for you).  Good luck keeping it down to one or two conferences!

Revolution In The Ranks

Back when your consultants ruled the roost they were busy and happy and well bonused. Now they're carrying water for the product guys, there is some strife, and you're having higher turnover.  Oh, and consultants are paid bonuses based on utilization.  With shorter engagements and because you're spreading them across customers suddenly you have to bonus people for bringing in less money.

Remember your Reserve?

Before, with a staff of a dozen people, you were keeping $75K to $125K in the bank to cover salaries, float, bench, and expenses.  Now you have thirty or forty people and only a dozen of them are pulling in steady and predictable monthly revenue.  So what's your reserve now?  Maybe $350K?  Oh, wait, you've signed up for two conferences so you need another $50K set aside for that.

Hmmm, by now you're at the beginning of the turnover cycle for install base customers, but since new customers are signing up it's all gravy.  Except that now revenues are growing at a slower rate.

Inflection

Andy Grove, the most paranoid and brilliant man in the semiconductor business, describes an inflection point as where a business fundamentally changes from catepillar to moth.  You're just noticing that your consulting model is necessary to your product sales model, but that your company is built around a product model.  You've reached an inflection point.  He also noted that capital is the grease that rides you over the bump.

A Little Planning Meeting Discovery

Usually on a Saturday, usually right after a tight payroll, usually after the cash reserves go down two months in a row, usually this is the discovery:

We need capital to get past this inflection point

You briefly consider using your reserve but then remember that many of your staff own guns.   So you think that maybe the partners can go lite on salary, but they're already only pulling down $40K/year, or less than half the company average, so not much blood left in that rock.

But you've run the numbers, and while you can keep going like this for at least a year, you're going to have to either go back to being primarily consulting or somehow find $1M to just push through the wall.

Enter the VC

To Be Continued....