Two readers, Sachin Garg and Prashant Bairy, respectively, asked questions about:
- the difference between Entrepreneurs and freelance consultants (this blog refered to the "subtle difference" between the two), and
- the difference between startups and small businesses
While these may seem like rather inconsequential semantic differences, i thought it would be interesting to dig a little deeper, figure out if there indeed are differences between the terms, and to share my views:
1. Entrepreneurs and freelance consultants
A few good links to understand the etymological meaning difference between the two terms are:
Now, the next question could be, if the difference is so great (freelance consultant provides his individual skill for a fee and is therefore like an employee "soldier of fortune", while an entrepreneur is trying to build an enterprise, with considerable risk, initiative and responsibility), then why did I say the difference is "subtle"? To this, my answer would be, that many entrepreneurial ventures, especially bootstrapped ones, begin as freelance consultancy operations... i.e. the entrepreneur begins as a freelancer, but slowly expands, adds people, processes and capabilities beyond his direct individual output, to create an enterprise. Since in real life, a freelancer may gradually morph into an entrepreneur (depending on his vision, preferences, capabilities, opportunities etc), I suggest that the difference could often be subtle. You may find freelancers who call themselves entrepreneurs, and that is not wrong, if indeed they are on that path... but you would probably never find an entrepreneur, who calls himself a freelancer.
2. Startups and small businesses Have attempted to explain through a diagram:
Thanks for your questions, hope this is useful to other readers as well!
As in the earlier parts of this series, our focus is on the bootstrap entrepreneur who may not have a fixed and firm business plan, who funds his business through modest and limited savings of his own, and has no major advantages, such as patented killer products, or a captive customer who will pay a profitable price. If you do happen to have some or all of those advantages, however, this could still be useful!
In the first several months of a startup’s life (often, the first few years), the main objective should not be to maximize revenues or profits, or to accelerate growth; it should instead be, to guarantee survival. For this, you need a fail-proof business model (FPBM), which will ensure that your startup would survive indefinitely if there are no major changes in conditions. The FPBM may not make you rich quickly, but it will give you freedom from worrying about survival. It will therefore allow you to build more sophisticated and profitable product or service offerings, or create advanced strategies for fast growth later on. However, not having an FPBM could render your startup vulnerable, and even prone to collapse, even if you have very compelling products and capabilities. I am sure that the vast majority of startups which fail, (especially many “surprising failures” founded by very capable and intelligent entrepreneurs), do so because of the absence of an FPBM.
So what is an FPBM? As we all know, nothing in the universe is 100% fail-proof – no matter how well you plan, a greater-than-expected disaster might strike. The point is, while you can never achieve 100% safety, you can keep traveling as far as you want towards the target of 100% safety… and the further you travel, the more risk-free you make your startup, which will guarantee its survival, and strengthen its base for future growth.
To explain FPBM, let us start with the simplistic explanation of profitability which everyone understands: you invest a certain amount of resource to deliver a product or service (let us call it “offering”) to a customer – this is your cost. The customer consumes your offering and pays you a higher amount – this is your revenue. The revenue you realize, should recover for you your total cost, plus it should leave you with some surplus, which is your profit. Now the entire concept of FPBM, which is the complete mantra to guarantee survival of the startup, is just the simple equation above, with three additional variables thrown in: hidden cost, risk and cash rotation!
So let us move on to the math which will help us create our FPBM – consider one single business transaction to begin with:
Equation 1: Profit = Revenue – Cost
Equation 2: Profit = Revenue – (Cost + Hidden Cost)
Equation 1 is the simplistic definition that everyone knows, while Equation 2 is a more precise calculation of profit. Notice that “revenue” is the same in equation 1 & 2… it is easy and unambiguous to measure, as it is the actual amount that the customer pays, so all you need to do is count what you get or read the amount on the cheque!
However, “hidden cost” could contain lots of fuzzy details, including examples such as:
- As a startup entrepreneur, are you paying yourself a fair salary?
- Are you at least collecting from your startup business enough money to cover your personal and family expenses, without postponing important purchases?
- If your revenue collection happens very late, what is the interest you pay on working capital?
- Did you have to borrow money to fork up the initial investment for your first business transaction, which you will have to pay back later, with interest?
- Did you make a commitment on this sale, for which you may have to spend time on this transaction later, for which the cost is not known, but the revenue is already limited to its initial value?
- Currently, you may be working from home, so your pricing does not cover the cost of an office. If your scale goes up and you move to an office, but overlook changing your pricing, or you are unable to due to market pressure, this is another hidden cost which can creep in.
Now quite often, real profit may turn out to be negative, if you measure hidden cost over-strictly… but an entrepreneur could disregard this, as he should also, by nature, maintain a healthy degree of optimistic and selective approximation, which we will suitably temper by applying our additional variables as shown below:
Equation 3: Profit = (Revenue – Revenue Reduction due to Risk) – (Cost + Hidden Cost + Cost Increase due to Risk)
Equation 3 is an even more realistic calculation of profit. So now, we have a potential reduction in revenue, as well as a potential increase in cost, due to risk. Risk is difficult to measure and may or may not happen, while hidden cost is difficult to measure, but will definitely get incurred. An example of risk is that the customer refuses to pay part of, or the whole of, what you bill him … so revenue may get reduced, or wiped out altogether.
If by now, you feel that the startup’s prospects are getting gloomier by the minute, let me assure you there is hope in the final variable, which is both an opportunity and a challenge – cash rotation.
Let us rewrite Equation 3 with the following symbols:
P = Profit
R = Revenue paid by Customer
rR = revenue reduction due to risk
C = Cost of delivering the offering to the Customer
HC = Hidden Cost
rC = cost increase due to risk
Equation 3: P = (R – rR) – (C + HC + rC)
Over a large number of transactions, the total would be the sums of all the transactions, or the sigma (∑):
Equation 4: ∑P = (∑R –∑ rR) – (∑C + ∑HC + ∑rC)
This would describe the total profit on transactions, for say July, Aug & Sep, to be the difference between total real revenue (revenue – loss due to risk) and total cost (cost + hidden cost + increase due to risk).
However, in reality, transactions happen continuously across time periods – July may have carried over transactions from June and even earlier, the closure of transactions in Sep may happen in Oct or later, and so on. Also, how you recognize revenue and profit for a period (whether on accrual, or project operation, or on cash basis) is a subject by itself, and one which we will not get into here.
What matters is this: the cash that comes into your startup company as revenues, after reductions due to risk, should be enough to cover the cash that is going out of the company not only to fund the production of offerings being delivered to customers, but also to cover fixed periodic expenses such as office rent, salaries for staff, electricity, internet & phone bills, installments on loans etc. If we denote these fixed expenses, or fixed costs, as FC, then we have an even more precise measurement of profit
Equation 5: ∑P = (∑R –∑ rR) – (∑C + ∑HC + ∑rC + FC)
The technical treatment of measurement of actual profit of a firm is obviously a huge ocean of a subject in itself, bringing in other factors such as depreciation, amortization, tax and so on, but we are restricting ourselves here to creating an FPBM for a simple, unfunded small business, so we can ignore these complexities for the moment.
Now, the actual FPBM that you create for your business, should satisfy the following conditions, for every rolling quarter (three months taken together, eg July-Aug-Sep, then Aug-Sep-Oct, then Sep-Oct-Nov, then Oct-Nov-Dec etc)
- ∑P should be positive in Equation 5: ∑P = (∑R –∑ rR) – (∑C + ∑HC + ∑rC + FC)
- Cash collected from revenues should cover cash being spent on delivery of offerings as well as fixed costs… this includes a few more points:
- The cash collected could be for offerings delivered in July, but the costs being paid for, could be for offerings to be delivered in Sep... that does not matter!
- One way to ensure that cash available from collections covers all payouts to be made is to collect a lot of cash, really fast from Customers… but this is not always possible
- The other way, is to negotiate for extended credit periods from suppliers, so that your cash payout also slows down
- Either way, inflow should be as fast as possible, while outflow should be as slow as possible (without hurting basic business ethical considerations, of course, such as paying salaries to employees on time!) This is in fact, the essence of cash-flow management for a small business
Creating and stabilizing an FPBM which does all the above, may take weeks, months, or even a couple of years, but it is well worth the effort:
- If you are a serious startup entrepreneur, looking at creating the next business behemoth, but currently bootstrapping, then stop everything else and first build a strong FPBM
- To design and build that FPBM, focus on just two target variables: profitability and cash-flow management
- To get profitability and cash-flow management right, analyze your customer revenues (and therefore pricing), your risk, your cost of delivery, hidden cost and your cash rotation
Once you get your FPBM right, the world is your playground :) - it is worthwhile to sacrifice other tempting preoccupations in the short term, like diversifying into new products, expanding into other geographies etc, until you have a good grip on your FPBM. After that, even as you expand and diversify, never lose sight of your FPBM!
In the next part, we will talk about how a bootstrap startup can acquire customers, retain them and manage relationships to grow predictably.
This is a true story, which illustrates a rule rather than an exception, but of a rather less apparent and seemingly paradoxical aspect, of professional growth. It may help you to strengthen yourself or your team members, while they are going through tough work situations and assignments, and see the light at the end of the tunnel... a long tunnel perhaps, but one, at the end of which, you will emerge amply rewarded!
In the mid-1990s, the job market for ERP consultants in India was exploding. Production engineers with significant experience on the shop-floor, who were earning about INR 15,000 a month would get retrained as SAP consultants and suddenly get jobs in the US for USD 100K+ a year… similarly, Chartered Accountants and Sales Managers would get jobs as ERP consultants for finance and distribution, and so on. Of course, the fact that this was big news, ensured that tons of professionals of all shapes, sizes, experience levels and qualifications were doing their best to become ERP consultants in a hurry, so the competition was also getting fierce.
Around the same time, I was trying to get my bootstrap business running and would do anything (well, nearly!) for a buck… one of the areas I dabbled in was placement (also called executive search, recruitment consultancy and so on). It was then that a friend walked into my tiny office saying, “koi acchi naukri dila re” (“get me a good job”). This friend (let’s call him Subbu) had an undergrad in mechanical engineering from a good university, and after three years of work, had gone to a top B-school for an MBA, after which he’d already moved two companies in a matter of months. Seeing his CV, I remarked that while his qualifications were good, his work experience post-MBA was insignificant, and quite bizarrely, he had not even mentioned his work experience for three years between his undergrad and MBA. When I asked Subbu why he had not written about his pre-MBA job, a shadow passed across his face.
With a pained expression, he told me how he’d worked in a “really depressing” (according to him!) public sector unit (PSU) which manufactured electronic products – a bureaucratic behemoth, where everyone wore a khaki uniform, went to lunch at the sound of the factory bell, took the bus home at the next bell, and were programmed to do almost the same thing everyday, until their retirement about 30 years later. “I was lucky to get out of there”, said Subbu, “they actually put me in materials management, which was the most boring place in the company, and I had to track inventory of thousands of parts with a foxpro program. Even in business school, a guest lecturer once said the dullest employees in a factory are put into inventory management, and everyone looked at me. All my colleagues in that department were double my age, and had no intentions of moving anywhere in life”, he said, wincing.
Something told me that it was important to include Subbu’s “depressing” PSU experience in his CV, as after all, it was 3 years of honest work, not to be trifled with. We argued, I won, and we had a new CV version.
A couple of weeks later, at an alumni dinner, I ran into a very senior alumnus, Chakravarthy (nicknamed Chax), who was a legend in the IT industry. Senior partner in a big-5 consulting firm, Chax was a rock star CEO, heading a team of several hundred top notch ERP professionals bagging all the big consulting and implementation contracts in the market. Chax asked me if I could find some good ERP consultants who were about my age and experience level – “JK, just so we don’t waste each other’s time”, he said, “don’t throw any fresher CVs at me, you know, like bright youngsters with degrees from great colleges and no work experience. I’m sure we’ll need them too, one day, but right now, I need people with solid experience in difficult areas of work, who have dirtied their hands… know what I mean?”
“What difficult areas, Chax”, I asked.
“Stuff like materials management”, he said, “for instance, people who have actually done it for a few years, in big manufacturing units… not learnt it from textbooks”…. EUREKA!! ...VOILA!! ...WHATEVER!!
The rest is history… Subbu joined Chax’s elite team (only because his work experience gave him a decisive edge over competitors), went on to become a national, regional and then a global tech resource, certified several times over in all kinds of stuff, and now, although he has moved out of ERP, he heads a 1,000+ man delivery center for a large global tech consulting organization.
For me, the moral of the story is simple: when you are doing the toughest, dirtiest work, it is highly probable that you are actually adding the most value to yourself, and in the process, differentiating your profile most sharply from competition.
Indeed, the software program manager who has never spent days and nights coding, the brand manager who has never sweated it out in field sales, the production manager who has not been on the shop-floor, the finance manager who has never pored over books of accounts, the investment banker who has not done hours of back-breaking research, the HR manager who has not resolved serious conflicts, the academic who has not spent hours in the classroom, the social worker who has not worked at the grassroots… all run one common risk – they may just NOT have the credibility to stand their ground, when their fundamentals are challenged. Every senior manager worth his salt, always has tales to tell about the real tough projects he or she has worked on, and the more you dirty your hands, the more you learn, the more confident you become… a fringe benefit is, the more war-stories you can recount to youngsters when you become the boss:)
Unfortunately, the image buildup about work in industry, is often inversely related to the actual value of work done – it is not fashionable to work hard, it is better to have the bells and whistles of a swank job. But the job that feels great in the short run, could be your greatest enemy in the long run – beware the cushy high-paying job, in the early stages of your career, where you are hardly breaking a sweat – it could just be the virus which destroys your career! On the other hand, if you are slogging it out in the trenches, sweating, bleeding and of course, cursing liberally, then, every minute you spend, will add oodles of value to your CV, your confidence and your personality. Not only that, as Subbu and I learned, you can, and MUST, talk with pride about the hard work you’ve done instead of being embarrassed by it! All you need is, the tonic to keep going when you are going through the grind – for this, you could use auto-suggestion to motivate yourself, like Johann Cryuff, the great Dutch footballer… “While I run uphill, I tell myself, I am running downhill!”
