The Small Business Owner’s Guide to Outsourcing: Two Essential Formulas
Here are two decisions many entrepreneurs get wrong:
- Which tasks you should, as a small business owner, outsource
- Which tasks your company should insource, meaning bring in-house
Oddly enough, they get them wrong for totally different reasons.
The problem with outsourcing
Thirteen years ago, I spoke with Tim Ferriss in the weeks before his first book, The 4-Hour Workweek, was published.
An early advocate of outsourcing—part proof of concept, part marketing hook, he even went so far as to “outsource” certain aspects of dating life—Tim proposed a simple formula:
- Determine what an hour of your time is worth (a calculation not as straightforward as it might seem).
- Subtract what it will cost to have someone else perform a certain task.
- If the result is negative, keep performing the task yourself. If the result is positive, outsource it: You’ll “save” money. And time.
The premise seemed to make sense. If an hour of my time is worth $40, and I hire a virtual assistant to sift through my inbox every day for $20 per hour, I can save $20 per hour.
That seems like a smart use of the principle of opportunity cost, the loss of potential gain from other alternatives when one alternative is chosen. If I choose to handle my own inbox, in exchange for saving $20 per hour I give up making $40 an hour.
The underlying assumption, of course, is that I will have higher-paying work to perform. But anyone who runs a growing service business understands the reality of—at best cyclical and at worst completely unpredictable—project and revenue flow. Some weeks you’re overwhelmed with work; other weeks you sit wondering if anyone will ever hire you again.
When you don’t have enough work to fill your time, you no longer replace “cheaper” work with “expensive” work. Instead of trading $40 per hour work for $20 per hour work, during slow times I trade $20 per hour of work for $0 per of hour work.
So yeah: I create an opportunity… but for someone else.
In general terms, the only time outsourcing your work makes sense is if you can fill the hours you save with better-paying tasks. Otherwise you’re just trading money for free time.
Not that there’s anything wrong with trading money for free time. Just make sure it’s a conscious decision.
A real-world outsourcing formula
Before you do any outsourcing math, take a step back and answer two questions first:
- Are all my hours filled? If not, outsourcing even the most mundane tasks doesn’t make sense. (And you aren’t working hard enough to grow your business.)
- Are all my hours filled with tasks that actually generate revenue? Everything you do should be designed to generate revenue, especially in the start-up phase. (For example, creating fancy internal reports is a luxury, not a necessity.) Remember, to make the outsourcing math work you need to generate revenue that more than offsets the cost of outsourcing.
If the answers to both questions are yes, then do the outsourcing math.
But with one caveat.
I could manage my own payroll. For the first two years, I did. Addition, subtraction, a little division… Ultimately, payroll is just math. As long as you understand the rules, regulations, and compliance requirements that underlie payroll processing, that is. And can keep up with the constant changes.
That’s why I outsource my payroll. It’s not only hard to get right, it’s too important to not get right.
If you have a number of employees, you may wish to outsource certain HR functions, even if you have the time to handle them yourself. Or bookkeeping and accounting. Or regulatory compliance. If something is really hard to get right, and too important to not get right… consider outsourcing it.
And then work hard to offset the cost by spending the time you save on activities that will make your business grow.
The problem with insourcing
Here’s a common scenario: You own a retail business and write a check every month for $6,000 to the marketing firm that handles your content strategy, social media, and advertising.
One day you’re signing that check and think, “$6,000? Every month? That’s $72,000 a year. I can save some money—and have a little more control over the process—if I hire a marketing manager and bring our marketing in house.”
Makes sense: Bringing expertise in house not only saves money, it could also save time. Popping into Marcy’s office to review next month’s marketing plan is a lot more efficient than setting up a meeting with a marketing firm. (And it could give you at least the impression that you’re more in control of your marketing and the person in charge of your marketing. So you’ll also have that going for you, which is nice.)
But what if a task needs to be performed on a semi-regular basis, or even one-off? Like designing and maintaining a new website, or setting up and maintaining a teleconferencing and remote work infrastructure or employee benefit plans.
Hiring superstars may be outside your budget. And even if it’s not, it probably should be: Outsourcing gives you access to talented people with specific expertise, and at a fraction of the cost required to bring them in house.
What you give up in “control” you can more than gain in skill, flexibility, and cost control—freeing up cash you can invest in revenue-generating activities.
A real-world insourcing formula
Before you do any insourcing math, answer the following questions:
- Is the function a full-time job? It’s tempting to play the full-time equivalent game and assume that one person can handle three different functions. (“I’ll hire someone who spends .3 of her time on marketing, .3 of her time on IT support, and .4 of her time fighting customer service fires.” Tempting, but misguided. Generalists typically produce average results. Most businesses can only afford one jack-of-all-trades: You.
- Does the function require ongoing professional development? Take programming or IT. Since technology changes at a dizzying pace, full-time employees will either fall behind or require you to constantly invest time and money to keep them up to speed.
Then do the insourcing math: Compare the cost of outsourcing to the cost of hiring a full-time employee. (Make sure you add benefits, taxes, infrastructure costs, etc. The average employee costs at least 1.5 times their base salary.)
And then think about the future. Even if insourcing makes financial sense, if you’re not certain you’ll need—or will be able to afford—a full-time employee six months or a year later, consider keeping your outsourcing arrangement in place.
While factors at least partly outside your control may cause you to have to lay off an employee, still: The last thing most business owners want to do is tell an employee they no longer have a job.
Only add an employee to the payroll when you’re confident that person will be able to stay on the payroll. Not only is it the right thing to do, it’s the best way to build a business with loyal, engaged, and motivated employees.