
The unfortunate math behind consulting companies - thomas11
http://blog.asmartbear.com/consulting-company-accounting.html
======
pdx
While I agree with the general "consulting is not the path to riches" tone of
the article, I have a small nit.

What the author is doing is adding up all the worst case scenarios into one
big ugly pile of bad.

It reminded me of an mp3 player I designed once. I had to allocate z-height
for the LCD. An LCD can have a lot of subcomponents (EL Backlight, FPC cable,
rear reflective film, glass, front polarizing film, plastic protective lens,
etc. All of these have min/max dimensions on the spec sheet. An inexperienced
engineer, such as I was, would just add all the max dimensions to get max
z-height of the LCD and design for that. But I also needed it not to rattle
around, so I needed my design to also work if all the dimensions came in at
their minimum. Woops! It's thickness could apparently vary wildly. I didn't
want to burden my product with the complexity it would take to handle so much
variance in one component.

I then learned that tolerances are never added up "worst case" or you'd never
get anything built. Instead, you do a root mean square of them. The chances of
every component in your subassembly coming in at it's absolute maximum are
minuscule. The root mean square method accounts for this.

Anyway, I felt that the author of this piece was doing a little max tolerance
stacking.

~~~
vannevar
I don't think he's presenting worst-case scenarios, he's presenting averages
for the often-ignored hidden costs associated with an employee. His estimates
for things like taxes, administrative overhead, and bench time are in line
with my own experiences in consulting. If someone is thinking about expanding
their consulting business by hiring, this is a not a worst-case scenario but
rather the everyday conditions you are likely going to face.

~~~
mikeryan
So I'll run through a few cases where he's looking at worse case scenarios.

1\. He's losing 32 hours a month (almost a week a month) because people work
"less" then 8 hour days or take personal time. This is true perhaps on some
months. But most consulting teams will work long hours come crunch time.
Salaried employees make that time back when they do overtime to get a project
done. I know a lot of interactive shops who burn through talent because they
_are_ working 60 hour weeks. This extends to the lost days

2\. Then there's lost time to due to down time between projects _AND_ time put
into 10% time. Don't do this, this is a worse case scenario he just killed 4
days a month with this (or 48 days a year, really?). If you want 10% time and
have down time between projects then use the down time between projects for
10% time. Most folks I know hire when they can keep someone busy full time and
then back fill with contract help.

~~~
tptacek
As a general rule it seems fair to assume that consulting shops aren't going
to get 60 hour weeks out of their employees. The ones I know of that do that
pay OT for that time, or aggressively balance the time out with bona fide
vacation days.

Similarly: 80% utilization is a totally sane rule of thumb for a consulting
shop.

The thing that makes these points somewhat misleading in an HN context is that
most HN people wouldn't start consulting companies where bill rates are so low
that these things matter all that much. It's the same problem, writ large, as
Cohen's analysis that "just giving clients a 10% discount can crater your
profits". If 10% discounts are cratering your profits, find a better market to
work in.

~~~
mikeryan
_As a general rule it seems fair to assume that consulting shops aren't going
to get 60 hour weeks out of their employees_

Yes and if I wasn't clear I wasn't saying that. The point was some weeks will
be 30 hour weeks, but some will also be 50, while you will lose some time you
will also make it back. Your industry seems different from mine. Ours don't
tend to pay overtime or "aggressivly" balance vacation days (this happens but
only maybe 2-3 days a year), but we have larger and faster burn out rates. We
do tend to have significant bonus structures however.

~~~
tptacek
You and I aren't saying the same thing. The occasional 30 hour week is the
consulting fact of life called "utilization rate". Consulting firms don't get
to balance out utilization with overtime. You don't make up the 30 hour weeks
with 50 hour weeks.

The firms I know that have a culture of semi-frequent 50-60 hour weeks pay OT
rates for the off-hours work, regardless of prior utilization rates for those
consultants. This is a manifestation of the classic consulting problem of
"sales vs. delivery". It is not the consultant's problem if sales stuffs the
calendar full of too much work to staff in a 40 hour week.

~~~
tptacek
(We are, for the record, not one of those kinds of firms.)

------
gaius
I think the author of this article has _no_ experience with consulting
companies. $100/hr is well below what Accenture, IBM Global Services or any of
the other big names charge. And clients, by and large, are fine with it; it's
just a cost of doing business. And it's hard to argue that any of them haven't
"scaled"; Accenture is 200,000 people!

Remember, in business there is no such thing as "cheap" or "expensive".
There's "worth the money" or "not". A decision maker has decided that paying a
consulting firm $250/hr/consultant is cheaper than it would be to do their own
SAP implementation (and in turn, that SAP is worth more than it costs...)

FWIW a consultant as a rule of thumb would probably see 1/5 of his billing
rate, tho' I have seen some get 1/3 and some as low as 1/8.

~~~
raganwald
When you pay $250 an hour for a major consulting firm, you get $50 worth of
consultant, and $200 worth of "Nobody ever got fired for hiring
IBM/Accenture/CGI/Thoughtworks."

This is not a joke. When it isn't your money, your incentive is to make a
decision that cannot be second-guessed. Imagine you do five projects.
Accenture come in and have a big heavyweight process and they follow the
process each time, and four of the projects are ok but cost 2x what they could
have cost, and the fifth project is late and over budget. Well, the fault
clearly lies somewhere other than your decision to hire Accenture, they have a
process and a brand name! So you blamestorm a bit and it turns out that there
were unknown unknowns that couldn't have been foreseen and so on, and you keep
your job.

But if you decide to hire BoutiqueCo and things go wrong, your head is on the
block. If you do this five times and four times you save money but the fifth
time things blow up, you're fired. BoutiqueCo don't have any credibility when
blaming unknown unknowns with their "agile process" and what-not, and nobody
remembers the fact that you saved so much money on the first four projects you
could fund the fifth and sixth projects with the savings.

Small boutiques cannot get gigs with the companies that can afford to pay the
rates of the big firms unless they manage to create a very unique brand or
find other markets.

~~~
gaius
Where are the boutique agile companies doing cut-price SAP implementations?
They don't exist...

~~~
dagw
The few boutique SAP shops that exist generally charge twice what Accenture
charges, since they are staffed by top people with a proven track record of
getting the job done after Accenture have failed.

~~~
mbesto
Yup, that's what my company does!

------
raganwald
I long time ago I was playing bridge with a genius named Arno Hobart. I asked
him what he was up to, and he told me he was in the vending machine business.
"Oh?" I asked, surprised that such an intelligent man would work with such
mundane products.

"One of the things I like about this business," he explained, "Is that I make
money while I sleep." Yes, he really is smarter than the average bear.

~~~
tastybites
The examples I use to illustrate situations like these are urinal cake
companies, or toilet paper manufacturers. These people are rich. Rich beyond
your wildest dot com dreams.

Are these people (who own the above mentioned firms) any less "smart" than the
"genius" engineer who sits in a cubicle and makes 100k and is at the mercy of
his mortgage banker?

~~~
raganwald
Paul put it well when quoting the aphorism: "Where there's muck, there's
brass."

------
rubyrescue
i've grown from 1 (me) to 10 since october. we're trying to scale and it's
tough. i'm exhausted. i'm working A LOT. i've got too many clients... but i
can see the light toward having a stable set of clients with solid revenues -
and i'm creating jobs for 10 people in a developing country, which i'm getting
more satisfaction out of than i thought i would.

~~~
presidentender
I would like very much to go overseas with another competent, unwed developer
or two, start a consulting company, and slowly build a good corporate culture
by hiring the locals. Have you done a writeup on your experience?

~~~
bluekite2000
not a bad idea..what is stopping you?

~~~
presidentender
The combination of making quite a bit more money than I need where I am now
and a self-imposed duty to finish this contract.

~~~
bluekite2000
I m also interested in the same kind of career (spent the past 3 years in S.E
Asia doing startup) so let me know when you make enough money&have nothing
stopping you:)

------
JoeAltmaier
There's no leverage in consulting. Granted. Doing it anyway - as long as I'm
working for the man, I want to be the man.

~~~
matthewcford
Instead of one man, you have many they're called clients.

~~~
JoeAltmaier
To clarify: there are only 24 hours in the day. One man can do one man-year of
work in one year. That would be you, the consultant. Regardless of how many
clients you sign up.

Thus the lack of leverage - there is an absolute cap on what you can bill per
year.

~~~
rick888
This is exactly why I got out of consulting. I also don't like working for
consulting companies (even if I am a full-time employee there). To many times,
the company takes on too much work for the number of employees, and the
employee ends up suffering (tons of overtime..usually unpaid, pissed off
customers, etc).

One of the worst place charged companies a flat-fee per month for tech support
(some had 300 or 400 employees). There were about 10 of us that had to take on
everything.

It resulted in customers calling us up for things that weren't even really
problems..mostly just preference (IE: location of icons on the desktop).

------
tptacek
I really like most of Jason Cohen's posts, so this article is especially
disappointing.

The most fundamental problem with Cohen's analysis is how he arrives at bill
rates. "Everybody knows", he says, "that your consultant isn't worth $100/hr
--- you only pay him $30/hr!". Well, no, Jason. Nobody knows that, because
it's not true. Companies that engage consultants pay a significant premium to:
(a) retain talent for the exact duration that they need them, (b) on often
little-to-no notice, (c) with the flexibility of picking and choosing the
right consultants for the right jobs (d) with no obligations on benefits and
severance. And the consulting market is more liquid than the employment market
(full-time jobs are "sticky"), so prices more closely track value.

So it is the case that an hour of Rails/jQ consulting might bill out at $140,
while the talent delivering that work might effectively make $40/hr. The
talent is, in addition to base comp, also getting a stable job, experience
working alongside iPhone developers sharp enough to start a successful
consultancy, health, benefits, and all the other things that are the reason
that big companies have to pay so much to staff projects.

This model works so well that there are branches of the industry that are
difficult to staff outside of consulting. For instance, the very _very_ high
end of software security bills north of $400/hr. Even discounting for FTE
benefits, nobody can afford that person full-time. This sets up a virtuous
cycle whereby consultants amass expertise, drive scarcity in their field, and
increase their comp.

It should also go without saying that when your bill rate is very high, you
don't need to add consultants to make time for product development. You can
work half-time and still beat a bigco salary.

The rest of Cohen's arguments are somewhat blunted by the fact that the
underlying economics of consulting are _way_ better than he thinks they are.
To wit:

* The cost of fully loading headcount isn't scary when you're priced properly.

* Similarly, if you price with the market, the cost of "scaling" isn't scary. Offices are cheap compared to salaries.

* Most consulting firms deliberately aim to keep utilization below a threshold, and recruit to "cool off" when things get crazy. 40 hours a week, 50 weeks a year isn't desireable even as an owner.

* Lots of consultants have written blog posts about firing dysfunctional bigco clients. Yeah, in the real world, you have to deal with the 25 page MSA contracts; that's what you pay lawyers for. Yes, being in business is annoying. If it wasn't, everyone would do it.

* Yes, it's hard to build and ship products in "off hours". But you don't have to do that. Instead, you can scale to the point where it's cost effective to hire full time developers. Most YC companies get to market with 2-3 team members. It isn't a stretch to scale a consultancy to the point where it can fund 2 developers.

Against all these concerns about consulting is the unbelievably huge upside of
bootstrapping a company this way: you get near-unlimited lives. It is the
JUSTIN BAILEY of startup plans. In virtually every other model of bringing a
product to market, product failure ends the company. That's bad, because most
products fail. They really, really do. There is no reason that a product miss
should zero out all the hard work you put into building a team and a business.

~~~
euroclydon
Jason is getting dinged for describing the challenges a freelancer has in
scaling beyond one person, and using the broad term "consultancy" in the
title, so everyone's judging his essay against the counter-evidence of huge or
highly specialized firms.

Thomas, you didn't even come close to quoting him accurately or in context.
Here is the real quote:

 _If you bill out a so-called “$30/hour” employee at $60/hour, you’ll only
break even. You really need to bill out at $100/hour to make any kind of
profit.

Which is hard, because the client you’re billing knows this person doesn’t
really cost $100/hour. And when that client thinks about what’s “fair,” they
won’t go through the computation I just did; they’ll base it on the person’s
nominal rate plus a little profit for you. This caps the amount you can
actually re-bill before client feels ripped off._

~~~
tptacek
I think we all know that Jason is using nice round numbers to make the article
read better. I'm not attacking him for saying that bill rates are $100 when
they're really $150. I'm dinging him for suggesting that bill rates have
_anything at all to do with full-time rates_ ; the two are only partially
related.

You are also right (I considered editing my comment to reflect it) that there
is a huge market of sweatshop commodity consultants for whom this analysis is
completely true. Yes. Avoid this work. The nice thing about being the kind of
person who participates in online forums where every other week there's a
thread like "Ask HN: What New Technology Should I Learn This Month" is that
you tend to be flexible enough not to fall into that trap.

~~~
mbesto
> I'm dinging him for suggesting that bill rates have anything at all to do
> with full-time rates; the two are only partially related.

Huh? You just said you are dinging him for making a relationship but then
admitting that there is a relationship (albeit partially).

Let's pretend a consultancy is the equivalent of rent-a-center and an
individual consultant is a rented out TV. I'm a consumer and I want to rent
the TV. I know the TV cost (I searched it on Amazon) and I know I'm just
renting it for x amount of days. I know exactly what I'm getting for the price
I pay; I get to watch TV for a certain period of time. When building a
consulting practice this concept is a bit harder to achieve because the
customer has no idea what they will get for $150/hr or $400/hr. They may get a
TV that only works for half of the day or for a quarter of the day or half the
screen only works sometimes. If it was that easy to assess a person's talent
then the customer would just hire single contractors out.

I don't think Jason articulated what he meant by "worth" correctly. You're
right in saying there are other values (hence worth) attributed to paying for
consultants. However, I think what he is addressing is the fact that potential
customers have a very hard time deciding what value your second, or third or
fourth consultant is in your newly established consultancy practice. Who are
you (as the consulting director) to tell the potential customer that your
employee is worth $X/hr? Doesn't the customer ultimately assess the value of
what they are buying?

~~~
tptacek
Yes, that was an inartfully constructed sentence. No, consultancies are not
like "rent-a-centers". The fallacy here is that the fundamental unit of
commerce here is "talent/hour". Here's a sampling of all the things that have
value in these transactions:

* An hour of talent

* A committed hour of talent a week from now

* A committed hour of talent a year from now

* Any number of commited hours of talent from the same person

* An hour of talent on 1 month's notice

* An hour of talent on 1 day's notice

* An hour of talent from a problem domain specialist

* An hour of talent from someone intimately familiar with your company's business processes

* Hours of talent rotated through a small group of people to keep them fresh, at less than 3x the cost of a single person

* Total scheduling flexibility over talent/hours

* A candidate for internal career development (management, architecture, etc)

* An A-player who poses no political threat to the company's org chart

Some of these are benefits of full-time employees and some of them are
benefits of contractors. Some are benefits of staff-aug contracts and some are
benefits of project-based consulting and some are benefits of transactional
one-shot consulting/advisory gigs. It's naive to suggest that only a raw hour
of exercised talent is worth money.

~~~
mbesto
I deal with consultant price negotiations all the time and quite frankly it's
one of the hardest challenges that consulting companies face. I think I might
have lost you with my rent-a-center analogy; my point actually was to say that
they aren't like rent-a-centers. In the case of a consultancy assessing the
value of these transactions is extremely difficult do as a customer and more
importantly as the owner of a newly established consultancy owner. Not to
mentioned some of those transactions hold more value (and thus price/hr) to
different sets of customers. This is really where the unfortunate math behind
a starting a consultancy lies. At maturity (i.e. when you have consistent
client pipeline) these are much easier to decipher.

EDIT: I just realized I did actually say "let's pretend a consultancy is a
rent-a-center". I should have probably worded that differently - hence the
confusion.

~~~
tptacek
You and I are both firing on all rhetorical cylinders today, aren't we? :)

~~~
smartbear
FYI, I find the conversation fruitful! The criticism is much appreciated, and
readers will do well to hear your counter arguments.

I very much agree with your points, especially that "billable hours" is not
the point, that expediency or rarity of talent can easily be more important.

A fuller, more accurate treatment of the concept has to include that. Perhaps
it's still useful for folks to (sometimes!) think about optimizing the
person/hour, since that is of course an important part of the equation, and
optimizing it does help.

------
m0nastic
My initial reaction to this article was that I disagreed vehemently with most
of his points. Upon further reflection, nothing he's talking about is
applicable to anywhere I've worked, or anywhere in the industry I work in; so
my disagreement doesn't really matter as I guess "consulting companies"
apparently means different things to different people.

The only issue that presents itself in my industry regarding consulting is
that it's basically a linear scaling revenue model, and the pitfalls around
scheduling engagements.

My company's hourly rates for consulting are now about half of what they were
7 years ago, but it's still both immensely profitable and significantly
cheaper than what the client would pay to hire someone to perform the
requisite services.

------
lsc
eh, I have done this... contracting paid for prgmr.com. And really, I've had a
/whole lot/ more luck renting myself out and paying people to work on my
product than renting out my underlings. So yeah, I think he has many good
points.

On the other hand, some of the problems of being a contracting company and
being a product company cancel themselves out. You have time you can't sell to
other people? work on developing new features for the product. Hiring someone
new who you aren't sure about or who needs training? Pay them trainee wages
while training them up as they work on the product, then as you know their
capabilities, rent them out.

But overall, I agree with the "renting yourself out at exorbitant rates is
easier than renting out your underlings" advice, though this is at least
partially due to a lack of sales skills on my part; but yeah, there are a lot
of less obvious costs to renting out an employee.

------
PaulHoule
Ugh, I've seen small-town web development shops charge $130+ an hour for work
done by the grunts who get more like $30 an hour.

Some of these shops are very profitable and successful, and some of them
aren't.

Either way, the person who's got the most to complain about this situation is
the grunt, not the customer who imagines they could get the work for cheaper.
The grunt is very aware that he could produce a lot more value for someone,
and capture it, if he can get rid of the middleman. Although the work in a
consulting shop is varied, and can keep you on your toes, the need to bill 40
hours of project time every week leads to a lack of self-investment and
eventual burnout.

~~~
tptacek
$30 vs. $130 might be an extreme case, but remember that you can't easily back
out what a consultant should get paid from their bill rate. The bill rate
doesn't just pay the consultant; it also pays the firm for shouldering
project, schedule, and employee retention risk, and it also compensates the
firm for the effort of recruiting and training new consultants.

There clearly is abuse (everything that can be abused in industry will be
abused by someone). But you can't necessarily spot it from a simple comparison
of bill rates and wages.

~~~
clistctrl
not at all, the shop I worked at charged $250 an hour. When we charged $130 it
was a discount hoping for more work. I was paid very nicely in terms of salary
+ bonuses, but I ended up working so much overtime, i would doubt my hourly
wage was anywhere near $30/hr.

I saw the firm rapidly expand, we went from 15 people to 50. At first it was
fun, and games. Some pizza + beer here, and some ping pong there. Bam we're
working until 9 or 10 at night. But after a few years, I was burned. You can't
work a person that hard for a long period of time.

I'm almost better now, but in terms of energy, I'm NO WHERE near where I was
when I first started. The abuse is not in how much we make per hour, its in
how we're worked.

~~~
wallflower
Most of my friends that I knew from volunteering have left. Non-profit
administration is another high turn over industry. They are always working on
the next fund-raising campaign, donor push.

------
sudhirc
This article generalizes too much. Top Indian IT giants are consulting
companies and they are making a ton of money.

~~~
vannevar
The article doesn't say you can't make money. Nor does it say you can't scale.
It simply points out that there's no such thing as a free lunch, and that once
you start hiring employees you're going to have to charge more, which in turn
is going to make sales harder, which in turn means you will need to work more,
not less, than you did before you had the employees.

------
bretpiatt
You have to share the upside with your consultants, put a target to bill
1200-1500 hours per year depending on your average engagement length and how
much they will have to be on pre-sales work. Then split every hour after that
with them 50/50% up to 2000 billed hours and after 2000 hours billed give them
75%, keep 25%.

I know tech folks love to reinvent and learn things on their own and sometimes
it yields new and better results but in other cases we'd be better off to look
at how BigLaw has been billing out hourly associates for hundreds of years
very profitably.

~~~
tptacek
You should look hard at how the Big Law model is doing in 2011. Hint: not
awesome.

Instead of setting up business models that encourage people to break their
backs finding billable hours, why not the model where consultants have no idea
how many "hours" they billed because they don't care? Give people roles where
their projects are meaningful and interesting, their comp is stable, and their
career paths make sense. Recruit the best people from the vast pool of
candidates who want sane jobs with interesting work. Staff them at companies
that will pay a premium both for flexible staffing and for top-caliber work.
Call it a day.

~~~
gaius
But you kinda have to know (and care); the Agile words for this are
"calibration" and "velocity".

------
zavulon
This just made me very depressed. Very, very depressed, because it hit so
close to home.

------
thinkingeric
Thanks for sharing your thoughts. This kind of analysis is required for any
service business. Having done so for our company, I have the following
observations on 'What to do?":

Scale -- Bingo! The goal is to make the fixed overhead (incl employees) an
increasingly smaller percentage of revenue. But to handle the increased
revenue (ie, workload) you have to concentrate on increasing
efficiency/productivity. This has a lot of influence on decisions about
process. Obviously, the more routine those processes are, the cheaper (and
more easily replaced) the labor can be. Also, if the work is done under a
fixed price contract, you can achieve a greater effective hourly rate if you
are efficient and manage risk well.

Charge more -- "charging more pushes away your existing client base". This is
not such a bad thing if you have your eye on 'scaling' (ie bigger projects).
Bigger clients have deeper pockets (although they also have more unique needs,
which introduces more risk).

Build a product -- See Nassim Taleb's discussion about 'scalable work' in "The
Black Swan". The odds aren't good that this will pay off.

------
sciboy
I still find it weird that people charge an hourly rate. My company has been
doing fixed price projects, with changing scope, guaranteed bug fixes &
payment on delivery for the last eight years. We regularly beat out the "big
boys" and have never lost money on a project, even though some have gone on
longer than we planned.

I don't see the value for a customer in an hourly rate. If I am charging you
by the hour, I have an incentive to be slow. If I am charging fixed price, I
want to be fast, and if we are "liable" for bugs, we have an incentive for bug
free code.

I see it as putting our money where our mouth is. I'm confident that _even if
your scope changes_ we will still deliver for this fixed price. Why is this
not the norm?

~~~
gthank
Since we're swapping anecdotes: I'd guesstimate 75% of the fixed-bid projects
I worked on back when I worked for a consulting shop barely broke even or
actively lost money. Estimating the project well enough to make a profitable
bid is hard if, like many shops, you work in whatever domain happens to be
sending customers your way.

------
palehose
While some of these issues will happen from time to time, all of those
exceptions will not occur all the time, so it really isn't an accurate
assessment. This is more like the worst possible bounds of a successful
consulting company.

------
jister
While most people disagrees but my experience was different. I used to work
with a US firm years ago and my hourly rate was $12 however our company
charged $80 to $120/hr to our clients. This is how offshore companies
operates...

~~~
tsotha
Not just offshore. I once worked as an employee at a company that was paying
me $60k/year (which works out to roughly $30/hr), and billing me out at
$250/hr. There was a lot of pressure to work billable overtime, too, and as
salaried employees we didn't get paid for it.

------
vineet
This is hard to pull off - but I think part of the solution is in somehow not
competing with the average employee that you can get on the street.

For example, you can provide a skill that is not otherwise generally available
on the market. Or perhaps by doing consulting but on a closed source product
(by doing a per project sale instead). It will be great to brainstorm other
such ideas and approaches.

------
trustfundbaby
Somebody clarify the tax portion for me on this ... Don't companies only pay
half of social Security and Medicare on each employee? ... plus the employee
is also a tax writeoff for them right?

So is that 15% number accurate?

