Monday, June 24

The unfortunate math behind consulting companies (2011)

Hiring even one person creates a lot less profit than you’d think, and launching a product rarely works out. Here are some tips for consulting companies.

Consulting can be a great way to fund a startup or make a bunch of cash. It’s easy to start; Just pick an hourly rate and jump in. There are tons of online tools for time-tracking, project-management, and billing.

But someday soon you’ll notice there’s only so many billable hours in the day, and you’ll be tempted to expand. Maybe hire an employee for $30 per hour and re-bill them at $60. Easy money, right?

Unfortunately the math doesn’t work that way.

Here’s what really happens, and a few ways to combat it.

Double is nothing

Suppose you hire an employee at $60,000/year. There are 2,000 working hours in a year—40 hours per week times 50 weeks—leaving two weeks vacation. So your cost per billable hour is:

Nominal Cost: $30/hour

In terms of working days (WD), there’s 250 in a 50-week year. In America we have ten federal holidays bringing the annual WD count to 240. Recomputing the cost of the remaining billable hours, we have:

20 WD/month, $31/hour

We also have employment tax in America. Rules are complicated and vary by state, but as a rule of thumb you pay 15% in taxes including Medicare and Social Security. That changes the annual cost of your employee from $60,000 to $69,000 with an associated change in hourly cost:

20 WD/month, $36/hour

We’ve assumed an 8-hour work day, but any owner of a consulting company will tell you this rarely happens. Oh sure, founders work 60-80-hour weeks, but not employees. Besides, even if you’re in the office 8 hours a day it’s hard to be heads-down-on-task the entire time, and consulting is about billable hours. It’s hard to be billable for 8 hours a day, every day. From what I’ve seen the weekly billables are more like 36 hours instead of 40. That means you’re short 16 hours per month, which is equivalent to missing two full (8-hour) days. With this loss, now we’re at:

18 WD/month, $40/hour

Then personal life intrudes. You come in at noon because you had a morning dentist appointment. You take off early to wait for the A/C repair guy. You’re sick one day. All very reasonable and it doesn’t sound like much, but two half-days and a sick day means another two days lost:

16 WD/month, $45/hour

We’ve assumed you’re able to keep your employee completely busy throughout the year without down-time between projects, but that’s unrealistic. If you get two-week gigs, maybe there’s a day between them where the timing didn’t quite work out or you did some post-contract clean-up. If you land a six-month gig, that’s better, except it’s hard to time large deals like that to start and end exactly when you want,

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