Outsourcing product development would seem to offer many benefits to a startup: lower cost, faster time to market and no fixed cost eating up runway every week. Product development companies that specialize in startups have reference designs and procedures that can significantly lower the number of hours needed to complete a project. They also have specialists that avoid the “learning on your dime” issue with generalists. Because they charge by the hour, they can be turned off in times where you need to extend the runway (the length of time before you run out of money)—unlike employees who need to be paid even if there is nothing constructive to do.
Is it really that simple? If so, why don’t more startups use outsourcing? What are the pitfalls to outsourcing? Should I outsource everything? When should I start outsourcing? Before we answer these questions, it’s important to understand the environment in which a startup operates.
The Startup Environment
First, let’s define a startup as pre-Series A money—that is, from day one, to the point that they land the big multi-million dollar investment from a VC. In this environment, there is very little money, employees, processes, sales, customers, prospects, etc. The primary goal is to figure out how to make money; that is, what problem can we solve and for whom, and in what way will that result in making a profit? Until the startup is able to provide empirical evidence, not just theories, it is unlikely they will raise enough money to scale the Series A investment (but can raise seed or 3Fs money).
In this environment, change is continuous. You start with a theory about what will make money. Then you design an experiment that will test this theory. The results from the experiment are used to expand and change the theory. A new experiment is then designed to test this new theory. This is repeated until you have the necessary data to support your theory.
Note, this is very different than the common belief that the idea is complete on day one. Money is raised on an idea (a theory) only, and millions of dollars are spent putting an unproven product into the market. Even if you personally had the millions, don’t scale any idea until it has been proven to work, regardless of how certain you are that the idea will work. Scaling means developing all the processes and hiring all the employees to provide the product or service that you now know will generate a profit. Scaling is expensive, and if you’re wrong about its ability to generate a profit, a lot of time and money can be wasted.
In this early stage startup environment, one of the keys to success is the ability to manage change quickly and efficiently. That is, to run these experiments for very little money and very little time AND have enough resources to complete them all without much visibility of what the next experiment will involve – that is, don’t use up all the runway until your certain the plane will actually lift off the ground. To continue the analogy, we need to generate enough speed to know if we can lift off, but not so much speed that if we do not, we can stop and fix things before we use up too much runway—a tricky balance.
Factors to consider
Of course, no company should outsource everything and every company should outsource some things. Even large established companies outsource some tasks—although for very different reasons. The idea that any company can be world class at everything is just not realistic, and likely a sign of too much ego. It is also not realistic to outsource everything. There must be at least one thing, the company’s core, that it can do better than anyone else—otherwise, how could the company add any unique value?
The question is; what should I outsource and what should I do in house? Factors to consider when deciding to outsource include:
- How often will I be conducting this task?
- What is the availability of outsourcing resources for the task?
- What are the costs of outsourcing vs. insourcing?
- What is the risk of pivoting away from this skill?
- What degree of specialization is necessary to efficiently complete the task?
There may also be special circumstances where outsourcing should not be used, such as:
- Protecting trade secrets
- Excess Capacity
- It’s Our Core
Rent vs. Buy
If you must travel 10 miles to work every day, pick the kids up from school and take them to soccer practice, drop off the dry cleaning, etc., then you’re going to need to buy a car. If you’re in town for a couple of business meetings, then renting a car makes a lot more sense—or, better yet, an Uber.
If you need to design an electronic PCB for your next MVP, and you’re not positive what will happen next, then renting a team makes a lot more sense than buying (full time employees) a team.
Acquiring a team is costly. You need to hire them, train them, set up processes and procedures, get them to work as a team, buy them the technology they need to work efficiently, and provide them with space. This takes time and money. Unless you are certain you will be able to put this investment to use for a long period of time, it makes little sense to make this investment.
Of course, this assumes there are is an adequate alternative choice and you do not have excess capacity in the organization. Also, designing an electronic PCB is a very complex job requiring many areas of specialization. Acquiring this skill sets is no easy task and is likely to take years. If the task is simpler, the decision may be different.
Availability of Outsourcing Resources
Outsourcing only works if there is a company to which to outsource . Not just any company, but one that is a good fit for your needs. The wrong fit will end up costing more than trying to do it yourself; and when it comes to the needs of a startup, there are not a lot of good fits out there.
Most PSFs (Professional Services Firms) say they work for anyone—which means they will work for anyone who pays them. However, since the majority of PSFs are very narrow, but deep, in their area of specialization, they are primarily a fit for companies that have scale. A PSF that specializes in product cost reduction maybe the best in the world at what they do. They save 5% more than the nearest competitor while producing a better product—a great achievement and differentiator. However, a 5% cost reduction on manufacturing ten MVPs for a startup is not going to be enough scale to pay for their services. They are truly world class, but they are not a fit for a startup.
Our own experience is that there are few PSFs that are fits for startups. Most PSFs are designed for big companies that have the scale necessary to pay for their narrow but deep specialization. Startups primarily need broad, but shallow resources—just the opposite of what most PSFs provide. Big companies already have these broad, but shallow skill sets.
Keep in mind; if you’re a hammer, everything looks like a nail. Most PSFs truly believe they can help startups. After all, if it’s good enough for Ginormous, Inc., then it must be good for a startup. The reality is they do not have the necessary systems and skills sets to help startups, and they always assign the weakest people in the organization to the smaller customers.
On the other end of the spectrum is the “low cost” PSFs—including the solo consultant. These resources often have a low hourly rate and/or bid on project for a lot less than a World Class PSF firm would. There are a lot of reasons these resource are a bad fit for a startup, including the scaling issue mentioned above. In addition, some are simply incompetent (that’s why they need to charge a low rate), some are fraudulent, some are trying to lure you in with some unrealistic budget only to switch out later with “scope increases” and most are not true teams, nor do they have much capacity to be part of a team.
This fit problem is the primary reason most startups fail at, or don’t, outsource. Many have tried, and concluded that outsourcing does not work. This is unfortunate, as there are PSFs that do specialize in startups’ needs—but they are a lot harder to find. If you always chose your outsourcing partner based on low cost, or an overly impressive list of clients, then you owe it to yourself to seek out a startup-only PSF.
Cost of Outsourcing vs. Insourcing
In theory, outsourcing should always be cheaper. Someone whose core is designing products for startups is going to do it a lot more efficiently than a startup that has never done it before; and a lot of times this can be the case, but there are some things to watch out for:
- Complexity and Repeatability
- Frictional Cost
- Excess Capacity
- Strings Attached Resources
- Core
Complexity and Repeatability
The simpler the task and the more often it is repeated, the more likely a startup can come close to becoming word class. This can become even more the case if the task also needs a high level of customization to fit the specific startup’s needs. Conducting market validation surveys does not generally require very many specialized technical skills and is likely highly customized for each startup’s mission. Creating an MVP with almost no budget and no time requires a team of specialists that has skills, talent and experience in doing so.
Frictional Cost
Outsourcing has internal costs. To be effective, a relationship has to be developed. This relationship-building is not free, even if it is simply the opportunity cost of doing something else with your time. How do I pay them, communicate with them, manage them, and control them. All things being equal, a PSF that is a mile down the street will have a lot less frictional cost then one that is in a different country with a different language and culture. A PSF that works as a team is going to be a lot easier to manage than a lone wolf consultant. A PSF that specializes in startups is going to be much easier for controlling startup-type budgets.
Excess Capacity
No PSF can compete with free. A full time employee who has nothing to do, and is not going to be let go for whatever reason, is always going to cheaper even if they are not very efficient. Of course, for this to really be true, there needs to be a compelling reason for hiring this person in the first place.
Strings Attached Resources
Sometimes, a startup can access resources that are not available to other non-startup companies. Some incubators have internal resources that are provided for free, or at a greatly reduced cost. Some universities provide students. A strategic may provide internal resources to help a startup. Some vendors provide resources in anticipation of a startup being successful and bring them additional work down the road. These can work, but it’s our own experience that they often do not. Most of these sources have little understanding of how a startup works, and often push the startup to do the wrong thing, even if they do it very well. If you use strings attached resources, make sure they are under the direction of an experienced technology leader. In a team with collaborative decision making, they can reduce cost—but they rarely bring the collaboration tools to the table.
Core
Every company, startup or not, needs to have a core. Your core is what defines what your company is better at, or will be better at, than any other organization. If your product detects explosives using ion tube technology, you need to understand the physics of ion tubes better than anyone else, at least in terms of the application of explosive detection. This capability will define and differentiate your product in the marketplace. It is how you compete and obtain pricing power. These core activities need to be unique and protected (patents and trade secrets). However, the user interface, the power supply, the way it communicates to other systems are not necessarily core to the product, and it is likely there are PSFs who can provide this expertise for a lot less cost than developing these internally.
Pivoting
The majority of startups pivot many times before discovering a repeatable system and product for generating a profit. Indeed, many have argued (The Lean Startup, The Innovator’s Dilemma) that this ability to pivot quickly is THE reason startups can outperform established companies who have many times the resources of a startup. Once you hire a full time expert, your ability to pivot away from this expertise is diminished. Vendors are easy to fire, employees less so. Employees have an installed capital in their knowledge of the expertise. They will always resist a pivot away from this expertise because of their installed base of knowledge in this expertise. Walmart resisted the move to online retailing due to their installed base of physical stores. Meanwhile, Amazon had no stores, and has been free to innovate with a purely online experience. Amazon did not need to maximize the capital deployed in the physical stores because it had no stores. Before deciding to hire full time employees vs. outsourcing, a startup should consider the likelihood that the company will pivot away from this employee’s expertise and how having this expertise will diminish its ability to pivot.
Outsourcing product development can be a powerful tool for startups. However, it is not a magic wand that always leads to lower cost or even success. Choosing what to outsource, how to outsource, and who to outsource to requires careful analysis and thought. Just outsourcing to the lowest bidder or the PSF with the most impressive list of clients is not a substitute for this analysis.
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