I know this because back in 2019, I tumbled down the OKR rabbit hole, enthusiastically adopting them as our company’s goal-setting framework. Right now you’re probably having one of three reactions:

“What is OKR? It sounds serious. Is it treatable?” (It’s a goal-setting approach called Objectives and Key Results used in business. Luckily, yes, there’s a cure. I made a full recovery!)

“What an idiot! OKRs are trash.” (I hear you, but stick with me for a few minutes.)

“I love OKRs!” (Just kidding. No one sane thinks this.)

In September 2019, I was the CEO of a technology consulting business where I had made dramatic changes over the previous twelve months. I was proud of what my team had achieved, but I knew more changes were needed for us to reach higher and more predictable levels of success. OKRs1 seemed like a good tool to continue that transformation.

The wide range of opinions on OKRs can be found in hot-take-filled posts like OKRs Are Bullshit and Stop Letting OKRs Masquerade as Strategy, to success stories like How Pinterest Uses OKRs To Achieve Stretch Goals. These mixed reactions aren’t unique to OKRs — you’ll find a wide range of reactions to every goal-setting framework: SMART, Balanced Scorecard, EOS, and Scaling Up all have ardent supporters and vocal detractors. I was skeptical that a framework alone would provide a quick fix to our challenges, but OKRs seemed like the best possible starting point.

After navigating many challenges with OKRs and talking to other leaders who have used similar frameworks, I’ve come to realize that they are often misused in counterproductive ways. Sometimes, this misuse is unintentional, as a poorly performed exercise can sometimes look and feel like it’s being done correctly based on how a goal was defined or implemented.

Other times, leaders’ egos are to blame. Setting the best business goals forces our egos to admit something unpleasant, like embarrassment from failure or uncertainty when others expect us to have answers. I’ve felt all of these feelings:

“My previous strategy failed.”

“The team I hand-picked and trusted to deliver isn’t performing, and it’s my fault.”

“This situation is dire and requires dramatic action.”

Delivering incredible results requires discomfort, and leaders’ egos can’t be excluded from this unpleasant-but-necessary byproduct of change. Every company and individual has their own idiosyncrasies, but my experiences have taught me that the challenges leaders face have many similarities. The discomforts arising from these challenges typically fall into one of three patterns:

1. The Productivity Illusion: Building systems rather than facing hard choices

“Should we get a product to help us track OKRs?”

This question was proposed soon after we finished the first draft of our new OKRs. On the surface, it seemed perfectly reasonable. I was tempted! “A software product probably would make this less painful,” I thought.

I even went deep into the weeds of looking at SaaS products for this purpose. And, I’ll admit — this brief diversion from the real task felt good. Ultimately, what I lacked in insight at that time was made up for by frugality and luck. Instead of an app, we made do with a Google Spreadsheet — a barebones approach that taught me a valuable lesson.

Implementing a new fancy-schmancy goal-tracking system or creating a flashy metric system can fool you into thinking you are making progress. The unfortunate reality is that these activities do not result in progress — they are the knowledge work equivalent of spending hours analyzing what new running shoes to buy instead of just going for a run.

The mentality adjustment needed to realize this is usually the real root of the problem and is more difficult to fix. If you or someone on your leadership team is reflexively finding excuses to delay work towards goals until/unless some other problem is fixed, it’s a form of professional procrastination. There is no way around this challenge, only through it. Open a Google sheet or Word document and start chipping away.

2. The Miscommunication Pattern: Team communication isn’t focused on goals

The calendar said it was time to plan our next quarterly all-hands meeting, but by my internal clock, the previous one felt like it was just yesterday. “People must be sick of hearing about this goal by now. Do we have enough interesting news about it to share an update?” I’d wonder.

The temptation to simply copy the agenda from the last meeting would often arise — it’s much easier to fill time with fluff than to craft a thoughtful message providing employees with what they need to know to achieve our collective goals. Instead of doing that hard work, it’s possible to fill some time and tick the box that an update was given, even if it was of no value.

Such a temptation might seem to stem from laziness, but there are often deeper root causes. Sometimes, the truth can be hard to verbalize. Explaining not just what the goals are but why they were chosen can be hard, especially if the goal-setting process itself didn’t start with leaders asking, “Why are we doing these specific things and not something else?”. And, if the organization isn’t yet attaining its goals, leaders may reflexively protect their egos by avoiding admitting failure or explaining a change in direction. As a result, the amount of time spent discussing goals is limited, or the substance is kept too superficial to be meaningful.

The antidote to this behavior is to use the temptation to “mail it in” when communicating about goals as a signal. The signal suggests that the message – or maybe the goals themselves – deserve deeper inspection. Sometimes, it’s hard for the individual responsible for delivering the message to spot the problem. Giving trusted leaders permission and encouragement to pressure test and critique communications about goals is a useful tactic to bring these problems to the surface.

3. The Conflict Avoidance Pattern: Delaying hard conversations about money

One of our leaders and I were having a difficult conversation. “Our commission plans still aren’t right,” he said, clearly frustrated. I wish I could say that this came as a surprise, but it didn’t. “We need to adjust them to stop rewarding the wrong kinds of sales,” he concluded.

I didn’t want to hear this. Changing employees' variable compensation plans can be disruptive. If expectations haven’t been set appropriately, or if employees believe these changes are because the company is taking advantage of them, these changes can be demoralizing.

In my head, I was already thinking of ways to delay the pain. “Maybe we can wait until Q4 to make the adjustments as part of a bigger revamp of compensation, and we’ll have more time to message it,” I pondered.

This thought process isn’t unique to me or to commission plans: many leaders flinch at when they know they need to have a difficult conversation about a widespread, impactful change. But in the long-run, avoiding short-term pain only works against their – and their employees – long-term interest. If business conditions require rapid adjustments to commission plans or anything else, having upfront conversations as soon as possible is always the better option.

—

The uncomfortable truth is that no goal-setting framework will save you from self-defeating psychological traps like those above. My awareness of these traps grew only through a combination of trial-and-error and leadership coaching — the fact that I call my coach my “work therapist” is only partially a joke!

Awareness of the patterns of failures and a willingness to confront them is the antidote to these self-defeating behaviors. As leaders working with a goal-setting system, we need to ask ourselves:

• What hard conversation am I avoiding by focusing on processes instead of outcomes?

• Do we have the appropriate style, frequency, and substance of communication about our goals and progress?

• What conversation am I avoiding, and what am I delaying or giving up as a result?

Goals are like exercise: if the process doesn’t challenge you, you’re probably doing it wrong. You don’t have to get it all right on the first try. Creating and managing ambitious goals at least a little bit wrong allows you to gather information and figure out how to course-correct. The only way to achieve the desired results is to be aware of the possible pitfalls along the way and adjust when you inevitably begin to fall into one of them.

The first year of my OKR experiment was rocky, but the goal-setting process continues to improve with experience. There is no way to get to the improvements made in year two without embracing the discomfort of year one. Just start.

—

Thanks to Tahsin Khan, Amit Bhatia, Lily, Rick Lewis, Larry Urish, and Emily Ann Hill for their feedback on earlier drafts of this post and to Sandhya Doma and Lily for sharing their experiences with goal-setting frameworks that helped shape my approach to this topic. Also, many thanks to my old leadership team and the “work therapist” I mentioned above, without whom I wouldn’t have learned all these lessons. :-)

The first time we told my dad he wasn’t going to get a new heart, we were sitting on our patio. It was a sunny, warm spring day in North Carolina, and the flower beds surrounding us were flush with the first signs of fresh flora. The yard and trees were vibrantly green, suddenly alive after their winter-long dormancy. Despite all the ingredients needed for a peaceful scene, I was filled with dread. My fiancée and I had rehearsed how to relay this news, but there was no easy segue that would soften the blow. 

“The doctors decided you aren’t a good candidate for a transplant,” our choreographed explanation abruptly ended. Speaking these words out loud only intensified our sadness.

He swore, then sobbed. 

—

I first learned about heart disease in third grade. My mom picked me up from school and revealed that my dad was in the hospital. “He had a problem with his heart,” she explained, “but he’ll be fine.”

He returned to work during the week, spent his weekends fixing up junk cars to make them slightly less junky, and plowed the snow out of parking lots in the winter for extra money. We’d go on road trips to Vermont and he was the president of the local school board. My dad was fine.

But there were also nights when he “wouldn’t feel good.” He had cardiology appointments but was often cagey about his condition. He took a number of prescription medications. Okay, so my dad was only sort of fine.

I was in high school when doctors gave him an implantable cardiac defibrillator. His health problems might’ve been given more attention had it not been for my mom’s cancer diagnosis. My mom spent the next eight years slowly dying, and whatever was wrong with his heart went untreated.

Given this pattern of my dad prioritizing others over himself, I was alarmed to receive an email – an email! – from my dad on a Friday afternoon, cryptically titled “Sunday.” He explained that he was being admitted to St. Peter’s, a nearby hospital, “for some adjustments to his heart.” The email had a chaotic, confused energy. “I’ll cease for the moment and check with St Peter’s to see if they have room for me,” it concluded.

I read it to my fiancée. “What the fuck is going on up there?” 

I booked a flight to upstate New York to find out.

—

On the phone with my fiancée two days later, I explained the situation. “They’re moving him to Columbia in the city. They can’t stabilize him here.” Much later, she would tell me that my voice trembled in a way she had never heard before. She knew something was very, very wrong.

“I’ll be there tomorrow,” she replied.

After several intensive days of treatment at Columbia, the cardiologist gave us the first of what would become many lessons on organ transplantation. 

“Your father’s congestive heart failure is too advanced. We have his medication adjusted, so he is stable right now, but the only life-extending treatment is a heart transplant. The waiting list here is about two and a half years,” she explained. “But, in his current condition, he probably won’t survive more than six months.”

My fiancée took the lead on a frantic, self-guided crash course on organ transplantation. She quickly learned that the wait time for a heart in North Carolina was only eight months and that the closest hospital that performs the surgery was a serendipitous fifteen minutes from our house. 

My dad was released from the hospital a few days later. We picked him up, drove to LaGuardia, and boarded a plane to Charlotte. He was moving in with us. 

—

The cardiology team in Charlotte made fast but temporary improvements to his health. While he still desperately needed a new heart, doctors called his condition punctuated equilibrium. Practically, it meant he was sick, but not dying immediately. This temporary reprieve gave us some breathing room to navigate the organ transplantation process – a process that takes months just to get on the waiting list for an organ.

Meanwhile, we tried to create a new “normal” life for all of us. In the chaos of my father’s medical emergency, my fiancée postponed and reworked our wedding plans. Instead of a destination wedding in Saint Lucia, we would have our ceremony in the public park near our house. Conveniently, it was even closer to the hospital. We had to plan for the possibility that an organ could arrive at any moment, including during the wedding.

Still, we tried to give my father as much freedom as possible. He loved driving, so once his cardiologist in Charlotte gave the green light, we encouraged him to go out for a joy ride. “We set the GPS destination for our house, so whenever you’re tired of driving around, just follow the instructions to come home,” we told him as we finished typing in his new home address. 

“If you have trouble, just call us on your cell phone.”

An hour later, my phone rang. As I answered his call, I could hear the GPS chirping away in the background. I assumed he had a question about the neighborhood he was in or wanted a recommendation for a place to stop. 

“Hey dad, what’s up?”

“I… I don’t know where I am. I don’t know how to get home.”

“Well…,” I said as I tried to process why the GPS wasn’t helping him. “I hear the GPS telling you to turn. You can just follow what it’s telling you to get home.”

He sounded scared as he said, “I’m not sure what to do.”

“Uhhh, okay,” I stammered. Something was wrong. “Umm, where are you right now? What do you see?”

“I see a gas station,” his nervous voice continued.

“Okay, stay on the phone with me and walk into the gas station. When you’re inside, hand your phone to the guy behind the counter, okay?”

—

Even while my mom was still alive, my dad had flashes of forgetfulness. He’d lose track of why he went to the store. He’d ask a question about some personal detail that seemed evident because it was so recently discussed. That sort of thing. 

“He’s under so much stress,” I'd think in those moments, giving leeway to the fact that he had a dying wife at home.

Retrieving my dad from the gas station was just one way that we learned about his cognitive struggles in addition to his cardiac ones.  Meanwhile, his thorough neurological work-up as part of the transplant evaluation process gave it a more formal name: Dementia. 

“When is my next doctor’s appointment?” (It’s tomorrow, for the fifth time!)

“What are we having for dinner?” (Does it matter? I will have to tell you again four more times, and you won’t remember anyway.)

“I haven’t heard from Woodie in a long time.” (He died last year, why can’t you remember this?!)

“This is like living with a goldfish,” I thought to myself frequently as we adjusted to a new, and slowly declining, normal.

The discovery of my dad’s dementia disqualified him from being a heart transplant candidate under the logic that if you can’t remember how you feel day-to-day, you can’t be relied on to remember to take your medicine, and you have an irreversible condition that will eventually kill you, why waste a perfectly good heart?

From the mundane to the tragic, the demented brain experiences the everyday routines of daily life as if they’re new. My dad lived on a perpetual merry-go-round, every rotation revealing some previously experienced joy – or tragedy – as if it were novel. Only two memories had staying power, deeply seared into his neurons in a way that even dementia couldn’t erase. He remembered that my mom died. And, he remembered the promise of a heart transplant extending his life.

“I must be getting my new heart soon, right?”

“I need to stay alive long enough for that new heart.”

“When is my heart transplant?”

There were endless variations on these questions and interjections. The casual observer may think, as we did in the beginning, that we could simply “remind” him that there would never be a new heart. But his reaction was the same the second, third, and hundredth times we had this conversation. There was no reminding him of the previous conversations. I eventually found the entire notion unsatisfying – he would relive the same trauma over and I would be more sad and frustrated.

Routine neurology appointments gave clarity to the otherwise shadowy nature of this kind of memory loss. 

“I’m going to say three words, and I’d like you to repeat them back and then try to remember them for a little bit,” my dad’s neurologist would begin.

“Sure,” my dad would say, enthusiastic about this exercise. He didn’t remember how he did on this test three months before. Forgetfulness, in some ways, made him undaunted. 

“Table. Apple. Penny.” The three words differed on every test, though it didn’t matter.

“Table, apple, penny,” my dad would dutifully echo back.

“Okay, great. Now, when is your birthday?” The neurologist had a knack for sincerely asking these simple questions, his intonation and facial expressions never betraying the calculating, diagnostic purpose behind the exchange.

Dementia hadn’t yet devoured memories from the 1940s. My dad knew his birthday.

“Good. Now, do you remember what those three words were?”

“Well, you see,” my dad would begin a long, rambling, and eventually incoherent diversion to the question. “I know you gave me some words,” this lecture would begin. He was a master at this kind of improv, filling the gaps in his memory with facts, figures, and stories. He routinely fooled strangers in casual conversations, relaying convincing stories, the products of fabricated memories generated on demand from a jumbled confusion in his mind. 

These experiences revealed that reality is not just the experience of your senses in a single moment. The mind creates order from your current circumstances by having coherent, consistent memories about what led to that moment. Some of our memories are from moments ago, like remembering three words or that you walked into the kitchen because you’re thirsty. But other memories are more complex, like defining who you’ve been, what you’ve done, and how you felt about it. It’s the combination of many moments and the perceptions that go with them that give reality its textures and contours.

—

As dementia marches on, randomly erasing old memories and preventing new ones from forming reliably, the patient starts to inhabit a different reality than everyone around them. How do you convince someone that their memories are false? What purpose would it even serve? How do you square the moral obligation to be truthful with the ethical duty of compassion? These were the dilemmas we faced in every casual, forgetful interaction.

I came to believe there were limits to how much I would – or could – bring my dad back to reality. 

As far as I can tell, this deception was harmless. Unnatural at first, it eventually became second nature in our home. As we casually drifted in and out of my dad’s transient reality, we found ways to compassionately avoid rocking the boat. 

Some false realities, like his belief that he took his medicine that morning when he actually hadn’t, mattered a lot and required reshaping his reality to match ours. “No, I’m sure you haven't taken your meds yet. It’s okay. Here they are. Why don’t you take them right now?” 

But many times, more trivial matters didn’t warrant dragging him back to our reality. “It looks like it’s really warm out today!” he’d say with excitement. Did it matter that we had already told him it was cold five times that morning? 

Sometimes, it was best to avoid wading into the waves of reality at all. 

We eventually learned that the most compassionate answer to “When am I getting my new heart?” was, “I don’t know, hopefully we’ll hear something tomorrow.” 

—

Thanks to , Jennifer Scott, Tahsin Khan and for their feedback on this essay.

It's often unclear how new technology will eventually shape the workplace or create entirely new categories of jobs. When PCs first became available in the ‘90s, few could have predicted how pivotal they would become to businesses. Not many people knew how to use them – so much so that Microsoft shipped early versions of Windows preloaded with the Solitaire game as a clever way to teach customers how to use a mouse1. Later, when the Internet became mainstream, many of its earliest use cases seemed purely for entertainment purposes. Enthusiasts and geeks built websites and used early versions of social media, but such novelties seemed to have no place in the professional world.

Many of those same geeks would become IT support workers, webmasters (how quaint of a term now!), or mobile app developers just a few years later. The combination of curiosity, experimentation, and willingness to try things out (even if they didn’t always work) made that possible. What if they had sat on the sidelines? Sure, they may have picked up on the new technology eventually – but some other early adopter probably would've swooped in and stolen the opportunity first.

The nearly-2025 flavor of this is AI. Like anything new, people fall into two categories: The early adopters are the folks who are actively building, using, or trying as many new AI tools as possible. Everyone else is in the bystander category, which ranges from the cautiously curious (“How can I use this stuff?”) to the stubborn skeptic (“I work 50 hours a week and need to clean my house, so unless the AI is going to take my kids to soccer, I don’t care.”) And, like those folks in the 90s and early 00s, many believe AI is a toy, unreliable and unsuitable for serious work. 

Such objections are understandable. Sometimes, the AI does hallucinate! And while this problem is improving, it does mean that good human judgment is still needed. Even so, the helpfulness and productivity gains are too dramatic to ignore. And for anyone who drew their conclusions on AI more than six months ago, the capabilities have improved significantly.

I’ll put it this way: If you haven’t used AI because you think its capabilities are overblown or won’t work for what you do, it’s worth a deeper look. 

Much of what is happening now with the application of AI rhymes with other historical, disruptive technology trends we’ve seen in the past. While the tools still have room to improve, there are useful things to learn now — I’m convinced using them now will provide a head start on what will become high-demand skills. The benefit of using AI today is similar to being among the first to fiddle with a Macintosh in the '80s or create a Facebook profile when you still needed a university email address. Figuring out how to interact with AI tools effectively (aka “prompt engineering”), developing an intuition about what works and where there are limitations, and knowing where the capabilities are improving isn’t just for fun. These are skills that will be career differentiators in the not-too-distant future. 

When companies realized they needed someone to manage their websites or run their social media accounts, the early adopters were not only the best equipped, but they were also in short supply! Learning these skills is like earning compound interest. The sooner you start, the more you’ll learn (and earn). 

Even if you’re not planning on changing jobs, technology is constantly transforming the nature of existing jobs. The day-to-day work of bookkeepers changed dramatically due to spreadsheets and accounting software. The job of machinists transitioned from using manual lathes to operating CNC machines. Architects no longer spend time drafting plans by hand, instead using CAD programs that allow them to spend time on more complex modeling. Becoming familiar with emerging technology is vital for career-switchers and career-lifers alike.

If you haven’t started using any AI tools, or if you’ve only been using tools like Microsoft Copilot in a work environment, it can be daunting to figure out where to start. The simplest advice is to use OpenAI’s ChatGPT 4o model or Anthropic’s Claude Sonnet 3.5 model. They’re both great, and as mentioned, tinkering when you're not sure how it works is part of the learning curve. If you have a more nuanced use case like software development or want to explore some of the newer tools, there are lots of other options2. 

Sometimes people want to use these tools but feel stuck finding something to use them for. If that sounds familiar, think about all of the annoying, monotonous tasks in your personal life that you’d love to make magically disappear:

Do you struggle with meal planning and coming up with ideas for lunch or dinner based on what you have in your fridge and pantry? Ask AI. 

Do you have a long to-do list that needs to be broken down into smaller tasks and analyzed for the best place to start? Ask AI. 

When helping your kid with homework, do you find yourself thinking, “I haven’t studied this subject in forever. How do I explain this to a 13-year-old?” Ask AI!

These everyday, mundane personal life tasks are a great way to start getting your feet wet — the intuition and skills that come with using AI can be honed outside of a strictly work context. In fact, once you start identifying minor, annoying problems suitable for AI, you’ll probably find yourself keeping a tab in your browser or an app on your phone close by to ask questions. After these helpful but low-stakes uses become second nature, it’ll be much easier to imagine how these same tools can be used for more advanced or specialized problems.

When I talk to people about AI use cases, they often ask, “What are you using it for?” The honest answer is always schizophrenic sounding, like this sample from the last week:

• As a writing partner for this essay — so meta! (AI generated an outline, analyzed the structure, and helped me find sections to cut and clarify.)

• To classify a long list of companies based on the company description and specific category definitions. (Don’t ask; somehow, it’s more boring than you can even imagine.) 

• On several software development tasks, including writing Python code, database queries, and creating a configuration file from a 600+ page PDF document with API specifications. (Even with some AI-generated errors, this saved me hours!) 

• To help me explain a math homework problem to an eighth grader. (“How does exponent division work again?”)

Sure, getting AI help for each of these real-life problems was helpful. But more importantly, every one of these interactions was an opportunity to learn more about what AI tools do well and where there are gaps in their capabilities: Which AI tool is best for this problem? What style of prompts get the most accurate answers? How should I format my data to receive the best results?

This experience will accumulate over time, and as these tools aren’t going away any time soon, the most effective users of AI tomorrow will be the people starting to use the tools today. 

That’s why I plan to take the compound interest of learning every chance I get. You might want to consider cashing in, too.

They fail because they prioritize unambitious projects in a misguided effort to achieve scale. Inside those companies, hiding amongst Excel spreadsheets and bureaucratic processes, are the ingredients for innovation.

The ingredients don’t appear on a balance sheet or org chart. They are abstract: ideas, passion, change. Willingness to challenge the status quo. All critical precursors to a great finished product, but too often they remain abstract – it takes a specific type of hard work to make them concrete. 

I confess to being an accomplice to some failed innovation attempts. I’ve helped administer the rigid processes that select poor ideas and dutifully led their implementation. I’ve watched teams with tremendous ideas and technical potential squelched by unimaginative executives. I’ve witnessed the slow burn of talented, committed people who have toiled on unambitious projects for years, ultimately failing to transform an industry. And, most embarrassingly, I ate some “empty calorie” innovation meals – while the projects that created them spiraled to their eventual failure. 

But we also have a front row seat to the frontiers of ambition: SpaceX catching a 440,000 pound rocket from 131 miles above Earth, Google creating self-driving cars with Waymo, Microsoft reinventing itself as a public cloud company and AI leader with Azure and its OpenAI partnership.

Innovation can happen anywhere, but it never happens overnight. SpaceX is now a 22 year old startup. Waymo was conceived around 2008, when Barack Obama first took office. Microsoft’s transformation under chief Satya Nadella has been ten years in the making. Setbacks happened routinely. It’s easy to overestimate the speed of success. It's only in hindsight that people claim to have known that an ambitious idea was destined to succeed.

Innovation doesn’t need to be flashy to make an impact. Breakthroughs are often only visible beneath the surface, invisible to all except industry insiders. As an example, data scientists created new algorithms that optimized the storage and distribution of food from warehouses, enabling adaptations to rapidly changing purchasing patterns. At the height of the COVID pandemic, these innovations prevented much more severe food shortages. If you’re thinking, “this doesn’t sound that cool,” you just proved my point!

Not all attempts at innovation are created equal. Their relative inequality can be viewed through two lenses, ambition and scale. Distilling innovation into a simplistic framework allows direct, honest comparison of otherwise unrelated ideas.

Ambition is hard to quantify, but developing an efficient, reusable spacecraft with a 20-fold reduction in cost, is clearly on one end of the spectrum. At the opposite end is a team adding a product feature their competitor already has to their mobile app. 

Scale can be measured by two instructive metrics: how many people will use the thing and how much revenue or profit it will create. Crucially, scale can change over time – an important feature of innovation that we will revisit.

The universe of innovation efforts can be distilled into a two-dimensional view, plotting their ambitiousness (how crazy the idea seems) on one axis and their scale (# of customers, $ impact) on the other:

Like every two-by-two grid created by a consultant (guilty as charged!), the upper right quadrant is the sweet spot. The challenge is the path to get there.

The companies that earnestly attempt to innovate but fail often come up short because they worry too much – and too soon – about scale and undershoot the ambition of the improvement. An easy trap to get caught in.

The companies lionized for innovation have trajectories like this:

They start with little-to-no scale. Many began with zero customers. Even if the company had scale with other products, they iterated on a new product and figured out how to scale it later. Experienced innovators know this can take years! 

However, big companies fail when they are too accustomed to scale. Product teams improve their wares through iteration that is too incremental. When applied to innovation, the iteration muscle memory kicks in. Aspirationally, it looks like this:

But when the expected innovation never happens, or if the idea wasn’t innovative in the first place, reality looks like this:

This might be fine if the goal was to generate a little revenue or add a feature. Let’s be honest and call it what it is: an iteration, not a grandiose idea. 

Best case scenario, this is still accretive to a company’s profit. Most often, the product is filler material in an innovation team’s portfolio so they can declare success and move on. The worst case scenario though, is disastrous. Losing hundreds to billions of dollars while delivering little to no benefit to customers. 

In starting with scale, most “innovation” is really a new feature bolted on to an existing product. Framing the work as innovative, rather than just good product management, sets the bar artificially high. 

This is why I call it “empty calorie” innovation — it seems desirable when you order (design) it, tastes good when you eat (launch) it, but it provides none of the nutrients to the organization as succeeding with something truly ambitious. 

So if this is why big companies fail at innovation, how can they do better? 

For early stage startups, Paul Graham’s excellent essay “Do Things that Don’t Scale” is a well-known treatise, widely regarded as the gospel for creating valuable products from scratch. His ideas are no longer controversial for young companies because they’ve been proven to work. To larger companies, his ideas like performing manual tasks first, automating later, or working one-on-one with early prospective customers, are still anathema.

I am proposing an application of “do things that don’t scale” for big companies: Innovation efforts should start from a truly ambitious idea. There is no shortcut to achieving scale, and it is very rare that a simple idea evolves into something transformational. Instead of trying to “cheat scale” by building scaffolding, start with ambition and figure out how to scale later. 

One objection to this approach is that public companies have a structural constraint: the quarterly earnings cycle. That’s a cop out – for many companies, pleading with Wall Street is a prison of their own making. It’s no coincidence that the most innovative public companies have conditioned their investors to expect longer return cycles on strategic investment. Amazon, Apple, Google/Alphabet, and Meta all buck the myopic trend of earnings being delivered from short-term investments. Public companies need more air cover from CEOs and investor relations teams to set expectations of long-term investment for ambitious projects. 

While private companies aren’t accountable to the public markets, they often have boards or investors with similar attitudes. Finance teams too easily convince themselves that the time to achieve ROI is too long or the IRR is too low in a spreadsheet model. Excel is a wonderful tool when used responsibly, but the spreadsheet is where ambition goes to die. Remember, models are just models. The risks posed by failing to innovate are real, and history is littered with “successful” companies that were made extinct by more imaginative competitors. (All those dead companies had Excel models, too!)

Ambition doesn’t have to be expensive. Starting without scale actually means lower initial costs in operations and support. If cost is the only reason a project can’t get started, look for the hidden assumptions about scale that are wrong.

Empty calorie innovation is a bad corporate diet, and the leadership of those companies can do better. Many of the obstacles to better innovation can be addressed by starting from ambition rather than scale. Conveniently, eliminating scale as a requirement for approving an innovation effort often makes the financial investment more palatable. Every successful innovation I’ve worked on had these characteristics at the beginning. In the kitchen of innovation, the best meals begin with good ingredients and the idea for an ambitious dish – not worrying about how big your dining room is. 

Real innovation tastes better, and a better corporate diet is good for everyone!

My very first work experience started with this software – I was paid to do some programming using dBase, an early database system.

This is obviously a bygone era, but understanding why is as relevant today as it was twenty years ago.

Software is rarely free, and the disruption caused by generative AI could upend one of the most popular ways software is currently sold. As someone who made a living writing code for 15 years during the last period of tumultuous change, I expect the coming years to be similarly chaotic!

Software business models may sound mundane, but the stakes couldn’t be higher — and the opportunity for bold entrepreneurs couldn't be greater. 

(If you’re familiar with the origins of SaaS and its distribution and financial models, feel free to jump ahead to the emerging threat from generative AI.)

Whether it’s an app on your phone, the program used by your bank to produce your account statements, or the accounting software used by a small business you buy from, someone is paying for it. It costs money to run servers, maintain the software, and handle customer support. Often the way that payment is made is through a subscription, paying monthly or annually for ongoing access to the software – but it wasn’t always that way.

A customer bought some software, received the software physically, and could use it as long as they wanted and following the legal agreement of the license. Back in those days, it was common to have a pile of cardboard boxes like the one above – they even had manuals! – and stacks of floppy disks for installing the software on your computer.

Everything changed around the year 2000. A new idea, software-as-a-service or “SaaS” for short, was popularized by Salesforce. This was only possible because the internet connected previously isolated computers, and because web browsers became powerful enough to deliver a software experience over the internet. 

As a developer at this time, this blew my mind. Web pages were no longer static – they became canvases not just for written content and images, but for an unlimited range of applications. 

Instead of an IT person needing to install software from CDs on individual PCs or expensive servers in a frigid data center, users could simply point a browser at a web page. Buying servers, upgrading software, and being cold in a data center was now someone else’s problem! 

That innovation was also enormously valuable: McKinsey valued the global SaaS market at $3T (yes, trillions) in 2022.

When people talk about SaaS, they are often talking about two different, but related, ideas. To understand the opportunity created by generative AI, we need to tease these two concepts apart.

On one hand, SaaS describes how software is delivered to the customer. Rather than shipping software with physical media, the software is delivered over the internet. This model is everywhere: many people use a word processor in the browser, like Google Docs. App stores can also deliver software in a SaaS model using a similar technique, allowing software to be downloaded and then providing the services that power that app over the internet. This is the SaaS distribution model.

On the other hand, SaaS refers to how that software is paid for. Rather than paying once for a license, customers in a SaaS model typically pay on a subscription basis. This model is also everywhere: consumer smartphone apps like Tinder and digital add-ons like Snapchat+ charge for a subscription. In the business world, everything from small business apps like QuickBooks Online to enterprise apps like Salesforce and Microsoft 365 also use this recurring subscription model. This is the SaaS financial model.

If you’ve ever gone through your app subscriptions and wondered, “Why did I buy this?” or worse yet, “What is this subscription?”, congratulations! You are not alone, and this is precisely what finance or procurement teams at every big company go through with their software, too. No innovation comes without some negative consequences.

For people who have only bought or sold software in the SaaS-dominated era, it’s impossible to overstate how significant a change the SaaS financial model was. It transformed the software industry. The success of entire categories of venture capital funds that invest in SaaS software businesses is based on the premise of recurring revenue with high margins. 

The emerging threat from generative AI

Software wasn’t always sold as a subscription, though, and the opportunity again exists to disrupt what is now the status quo, as generative AI offers dramatic improvements to efficiency and enables new ways to monetize services. The flip side of this opportunity is a threat to the traditional SaaS model, particularly for software sold to businesses.

The opportunity and threat emerge from two complementary trends: generative AI is simultaneously reducing the cost to build and maintain software, and so-called “agentic” AI use cases are changing how the value of software is priced. (Agentic AI isn’t as fancy as it sounds - bear with me here!)

Historically, one of the largest costs of creating and maintaining software was human labor. While the technology and tools used to create software have gotten much better over the last two decades, the complexity of modern software has also grown. As a result, the economics just haven’t changed much – until now.

In the last year, AI models capable of writing software and fixing bugs have become significantly more efficient. According to one widely accepted industry benchmark, the success rate of the most capable AI models for resolving software bugs went from 3% last October to an astonishing 43% one year later. 

My experience squares with this: just two months ago, an AI chatbot rewrote several hundred lines of code for me. Did it need a little help along the way? Yes. But was the lazy developer in me thrilled? Also, yes!

Of course, 43% isn’t high enough quality to remove the need for human software developers, and this is just one benchmark that measures one particular type of coding problem. But the trend is significant and here to stay: the models will only continue to improve and are already good enough that entrepreneurs need to take advantage of what is likely to be rapidly improving cost efficiency for building software. 

This could very well be another “Salesforce moment” – a defining period of transition that remakes how billion-dollar businesses are built. 

While these new AI models make building software cheaper for entrepreneurs, this technology is available to everyone. Prospective customers of software startups are realizing that they, too, can take advantage of these efficiencies and build software themselves. 

Due to the expense and complexity, just ten years ago it would’ve been unthinkable for most large companies to build any “commodity” software themselves unless it created a significant competitive advantage. That cost and complexity are being reduced by AI. And, however expensive or complicated they remain today, they will be less so with the more capable models available in a year.

This will inevitably compress margins in SaaS businesses. The bold, scrappy founder of today will benefit from adopting the AI tools that make software businesses more efficient. There is money to be made by what is effectively an arbitrage of efficiency: delivering equivalent products at cheaper cost enabled by lower expenses. The natural conclusion of this is an efficiency arms race, which is ultimately deleterious to software businesses as it reduces the cost, and ultimately the value to be extracted, from building software. 

Luckily, the agentic AI use cases provide an antidote to these lower-margin headwinds for founders. 

Ask five AI entrepreneurs for the definition of “agentic AI” and you’ll get seven answers. The specifics vary, but the core idea is this: AI “agents” carry out a task to achieve a specific goal, and each time that goal is successfully achieved, a fee is charged. 

It’s helpful to use a specific example: Companies often use software to manage business processes, like handling a customer request for a refund. The traditional, non-agentic approach to this would be a software tool that allows a call center agent to document the request, route it to the correct department, and have an employee follow a series of steps to complete the request. This traditional approach often uses a recurring, subscription SaaS financial model. The business pays annually for a subscription to the software that handles the process and is used by the business’s employees. 

Alternatively, using the agentic AI approach, the customer would submit a request, and the AI, working autonomously, would perform all the steps the human employees would follow to resolve the request, either approving the refund and processing the payment, or denying the refund and communicating the outcome to the customer. Agentic AI has the opportunity to present a new model: the business pays only for the requests the AI handles successfully. 

This “outcome-based” pricing model aligns the success of business providing the AI agent with the business buying the service. 

The business knows that they will pay a fixed fee, say $5, per successful agentic AI interaction. And the business selling the service is highly motivated to make as many interactions as possible successful. 

Approaching pricing this way requires some creativity: the old habits associated with recurring subscription revenue business models, and the margins they generate, are deeply ingrained. I get it – I love high-margin businesses too!

That attachment also creates vulnerability to disruption. While legacy businesses dependent on those subscription revenue profit margins cling to the old way of pricing their products, scrappy startups see an opportunity to try new approaches to pricing. As Jeff Bezos once said, “Your margin is my opportunity.”

Entrepreneurs who embrace periods of dramatic change become the leaders of the next wave of innovation. While generative AI is one area of innovation, the innovation in more efficient and different business models may be equally disruptive. The technology industry is now at an inflection point, and the entrepreneurs starting companies today have a choice to make. 

Fortune favors the bold.

This week I pick up where last week’s conversation with Ellen Daley left off. As I mentioned last week, Ellen was the CEO of Acorio, a ServiceNow consultancy that became ServiceNow’s largest boutique partner.

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This week’s episode discusses the ins and outs of building a partner-centric professional services business. These partner-centric models revolve around a product company that uses services providers to provide consultative help to their mutual clients and perform implementation or integration work to make clients successful.

Picking a Partner

• Look for large addressable markets with a low barrier to entry. Acorio thought ServiceNow was attractive because it had a large addressable market with no significant barrier to entry in the partner ecosystem.

• Consider how much follow-on opportunity may come from a typical services engagement using the partner’s product. Acorio viewed ServiceNow as a “good bet” because it presented an entry point to a client organization through IT but with cross-selling opportunities to other departments (e.g., HR).

• The maturity of the partner ecosystem is an essential factor. When Acorio started, most of ServiceNow’s partner’s ecosystem wasn’t yet at scale. It presented a significant opportunity to grow a large business quickly. If a partner ecosystem already has many “at scale” players, waiting for them to exit and creating an opportunity for more boutique, high-growth partners can be better.

How Partner-Centric Services Businesses Are Different

• Partner-centric services businesses have an additional audience. They have to think about interacting with, marketing and selling to, and managing relationships with their clients and the product company partner.

• The need to market to the partner. The partner (who makes the product/technology) needs to understand what services companies in their ecosystem can provide, how they are differentiated, and when they fit their mutual customers well.

• The need to “sell” to the partner’s sales reps. These are the sales reps in the field who are selling product licenses/subscriptions. It’s not enough for a “partnership” team at the partner to know about services businesses in the ecosystem; the sellers are the ones face-to-face with prospects and influence how services engagements are satisfied.

• Simultaneously maintaining direct access to prospects and customers. Despite being partner-centric, having a direct marketing and sales relationship with prospects and customers is essential. Without this relationship, a services business is vulnerable to a partner “turning off the spigot” to opportunities.

Starting & Nurturing Partner Relationships

• The starting point is usually a public-facing partner portal. Even if you have deep relationships with the product company, virtually all roads to partnership begin with filling out some online application.

• Established, mature ecosystems may be very automated. The larger and more mature the partner ecosystem, the more automated the process can be.

• Make sure there are interactions through the partner’s organization. Ideally, a services company is interacting with people in the partner company across their:

  • sales organization, which is often geographically or industry-aligned, so it can include numerous people

  • marketing organization

  • product organization, which rarely helps with commercial opportunities but builds brand value for the services company

  • professional services or customer outcomes business, even though it may be competitive with the services company at times

  • executive team

• Map out who you need to interact with within each of those organizations. If a services company is relatively small or young, it can be beneficial to only focus on specific individuals in the same geography as the service provider.

• Understand what motivates individuals within the partner organization. Generally, most partner teams care about selling more licenses/subscriptions. A services company’s ability to articulate how its capabilities support that outcome can be a point of differentiation compared to other providers in the ecosystem.

Why Product Companies Need A Services Ecosystem

• Services companies have a more “intimate” relationship with the client. The services provider can offer a more trusted, third-party perspective that is more helpful to the client.

• Represent the partner’s products and benefits organically. Because the services provider can better understand the client’s needs, they can put the product in the best possible light.

• Easier co-marketing opportunities in the field. Partner programs often include market development funding (MDF). The product company helps fund these marketing opportunities through local in-person events or online webinars. The events typically combine someone from the product company, someone from the services company, and sometimes a customer to talk about the product.

• Product companies expect services firms in their ecosystem to help these activities. While the services company has a lot of latitude in shaping the event, it is usually an expectation that the services providers take they occur.

Size & Stage For Services Businesses Getting Into Partner Ecosystems

• Get started early if your vision is to be partner-centric.

• Case studies matter. Have 2-3 good case studies before approaching the partner to demonstrate value and capabilities. This makes partnership much more compelling.

• Hire people who can work collaboratively with product companies as a partner. Sometimes the product company’s staff, particularly partner reps and salespeople can have strong personalities. They often believe they are “calling the shots” - and they usually are. Having sales and marketing folks who can work effectively in that environment is vital.

• Embrace sharing talent between the services business and the product company. Staff that comes from or goes to a partner can be an excellent way to strengthen the partnership and build organic alliances internally within both companies.

Challenges & Downsides of Partnerships

• Partner teams can ask their services companies to do a lot of work. Sometimes this work may not find its way to the sales organization. The services company needs to have some finesse in managing expectations and knowing what work is necessary and adds value.

• Individual sales reps can sometimes break the rules. Partner organizations often lack the power to control or stop “bad behavior” by sales reps responsible for license/subscription revenue. Services companies should be cautious about complaining too much and instead focus on reps with whom they have a better relationship.

• Product companies may use their own professional services teams competitively. This is particularly common when they expect a bad quarter and need increased revenue. When this kind of thing happens as a temporary ebb & flow, services providers shouldn’t get too worked up about it. Expect that it will happen occasionally, and ensure you have a direct channel for selling work.

• There will sometimes be tension between the client and the partner sales rep. Sales reps may pressure a services provider to generate license/subscription revenue when the client says, “I’m not buying any more products.” Again, finesse is required to maintain a good relationship with both parties.

• Exclusivity with one partner has a lot of risks. Suppose a services business is aligned with only one product partner. In that case, it is very vulnerable to the volatility that can come from the product company having a bad quarter or two, having leadership changes, etc. Two strategic partners are a good number; more is hard to manage.

Three Things Ellen Wish She’d Known When She Started

• Know what motivates your partner. Aligning the services company’s offerings and differentiation to the product partner’s incentives is powerful for growth.

• Don’t freak out if partners act destructively in the short term. Take a long-term view. There are more deals out there!

• Partnerships are relationships. They will have peaks and valleys. Don’t make it feel transactional!

✌🏼 That’s it for this week! I’ve planned more conversations with experienced leaders in the product partnership space. Send me the questions or topics you want to see covered:

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Ellen was the CEO of Acorio, a ServiceNow consultancy that became ServiceNow’s largest boutique partner. Along the way, Acorio was recognized on Inc’s Best Workplaces list and had one of the highest customer satisfaction scores in the ServiceNow ecosystem. Acorio was sold to NTT Data in October 2020.

Today’s podcast episode is the first part of our conversation that focuses on the characteristics of fast-growing professional services companies. Part two of our conversation will be posted next week, discussing partner-led sales approaches. Subscribe below so you’d miss it.

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Ellen and I covered a lot of ground in this episode. Here’s a summary of some of the high points in our conversation:

Professional background and traits for services company leadership

• A willingness to be analytical & data-oriented. Managing the business using objective, quantitative measures is essential, especially in fast-growing businesses. Identifying the key metrics that matter, particularly regarding financial performance, is essential.

• Recognition that running a P&L is different than running a company. Running a P&L is challenging and requires skill, but running a company’s finances introduces entirely different problems to solve. For example, most early-stage, fast-growing companies often encounter cash flow challenges, which large company P&L leaders seldom have to worry about.

• A background with roles that teach the value of creating, selling, and delivering premium services. The perception and reality of “premium” often come from more than just the technology being delivered - it is the combination of people, delivery processes, and operational excellence.

• Possessing the ability to dial down the desire for process so it’s size appropriate for the business. Working for large companies often involves lots of processes. Early-stage, fast-growing businesses need less process than big companies, but that doesn’t mean no process.

What makes fast-growing businesses different

• Fast-growing businesses require a different mindset and a different decision-making approach. One example of common day-to-day decision-making that enables fast growth is how aggressively new staff members are hired. A more conservative approach, i.e., only hiring when new work is signed, can lead to slower growth.

• Revenue growth typically determines whether a business is “fast-growing.” Growth rates that qualify as fast-growing on a percentage basis usually get smaller as the absolute numbers get bigger. For example:

  • Growth rates in <$70M annual revenue businesses change rapidly. Very early-stage companies can grow at 50-100% or more, but growth rates typically decelerate into the 30-50% range.

  • In a $70-100M annual revenue business, 30+% yearly revenue growth is fast

  • At >$100M in annual revenue, >20% yearly growth is fast

• Focus on sales with a rigorous go-to-market approach and investment aimed at sales & marketing. Slower-growing businesses can get away with less sales and marketing investment and higher profits, but a scalable sales and marketing function is necessary to sustain fast growth.

The evolution of sales in fast-growing businesses

• Don’t hire sales teams too quickly at first. These investments eat cash, and you may not be ready for it.

• Start with a strong sales leader who can also be an active salesperson. The ideal hire is someone capable of running sales efforts independently but can also begin hiring and running a successful sales team.

• It’s hard to predict success with salespeople in high-growth environments. Many early-stage companies have a high rate of failures, i.e., 50% or more of initial sales hires not working out.

• A salesperson with a track record of success in a combination of big companies and startups is a good indicator. However, past success doesn’t guarantee future success.

• Salespeople can be successful in some companies and fail in others. Someone who fails spectacularly in a role at an early-stage company can still go on to be wildly successful at another company. Sales success is very context-dependent.

• Investment in marketing is essential for both sales and talent/recruiting. Fast-growing companies need to be able to hire quickly, and creating brand awareness helps attract new talent.

Managing the balance between revenue growth and profitability

• Running at break-even is very risky. It is a strategy some businesses pursue, but Ellen (and I!) don’t recommend it. It leaves minimal margin for error, and running out of cash in the current macroeconomic environment can easily be fatal to the business.

• Growing a $10-30M business growing mid-20s to 30% annually with low double-digit EBITDA is healthy.

• Building a fast-growing business should also mean being a great place to work and making a significant impact for clients. Maintaining a minimum level of profitability is an excellent forcing function.

Healthy gross margin and project margins

• Healthy project margins when selling consultative, project-based work are 55-60%.

• High growth, as described above, requires investment for delivery management. Aggregate gross margins in the 37-45% range are a good target.

• Managed services are an excellent way to lift overall margin. These services are like “annuities” for revenue, meaning they are frequently renewed.

• Target larger deals even if they are fewer in number. Sometimes services companies will believe selling dozens of small engagements is easier and think they can fool themselves into believing they are high margin. In reality, some overhead comes from any engagement, and selling fewer, large engagements is often a better recipe for a high aggregate gross margin.

Funding fast growth

• Lines of credit can be hard to come by. It took Ellen 9 banks! However, lines of credit can be beneficial to fund growth and are worth spending the time to get.

• Selling equity in early-stage companies to raise capital is an option. However, few investors are interested in that stage (too early for PE) of services companies, so finding that sort of investment can be challenging. Founders risk losing control of their company, so it’s essential to know and trust any investors being considered.

• Professional investors often can’t help operationally. However, professional investors often provide sound corporate governance, which can be helpful. Independent board members playing an advisory role fill the gap of operational expertise that professional investors often lack.

Keys to success when setting out to build a fast-growing business

• Pick a strategy and stick with it long enough to test if it works. It can take 12-18 months to see traction. Leadership shouldn’t be so married to a strategy that it drives the business into the ground. However, it can take time to see strategies pay off, so leadership should be prepared to stay the course and know what progress should look like.

• Identify a differentiated service offering. Build a narrative around that differentiation that demonstrates the value the company provides.

• Strategy has to identify a specific market, i.e., industry + client size + geography.

• Don’t pick too many partners. Also, know that partners never give leads for free - be prepared to do work for leads and sales.

• Have a cadence to releasing and promoting thought leadership targeted at multiple buyers in target companies. This is needed support for the sales team.

✌🏼 That’s it for this week, but there’s still another half of the conversation! Next week’s episode will pick up where this one leaves off to cover partner-centric sales approaches in more detail. Subscribe below so you don’t miss it.

Your feedback helps me focus on the type of material you care about, so please vote!

I published about narrow focus being a superpower a couple of weeks ago. I also recorded a podcast episode with Aater Suleman about building company culture focusing on remote-first services businesses.

Geographic focus is an essential theme in both of these. This week I’m drilling into a little more detail on some of the dilemmas related to growing geographically and how to avoid them.

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Motivations for geographic growth

1. Increasing sales

2. Access to talent for delivery

3. There is no 3. 😉

Joking aside, most companies start looking at new geographies because they think they can grow sales faster, access more or less expensive talent for delivery, or both.

Achieving these goals can take time and effort. The first time a business tries to do it, they often screw it up.

I’ll get to why in a second, but first, it’s worth unpacking a little nuance.

Increasing sales

Accessing new markets is tempting to any business. Services businesses, particularly in the US, sometimes start thinking down this path when they’ve had some success with sales but start feeling revenue growth slow down.

The “problem” is that the US market is huge. It’s large in absolute and relative terms of spending. It’s large in terms of the variety of sizes and types of prospective customers. And it’s also really deep in the sense that in many developed industry verticals, a business can sell to many prospective customers.

If a US-based business feels sales are stalling out and wants to grow internationally, it’s usually a symptom of an underdeveloped sales process. For very mature companies that have been selling in the US market for many years and have genuinely penetrated the entire market, the company may have reached the bottom of the well.

But, for most early-stage, high-growth businesses, this isn’t the case. The reality is that optimizing the business’ sales approach is much more likely to address the growth problem.

If a US-based business feels sales are stalling out in a specific area of the country and wants to grow domestically, a new US-based location may help. This is particularly true for businesses that have a well-established sales approach, typically with $5M of annual revenue, and the sales approach uses face-to-face sales.

Some key questions to clarify the “increase sales” motivation:

1. Is the market in the new geography being considered large enough relative to current markets to drive the needed sales improvement?

2. Are the current markets really fully penetrated? (A good test is to ask how your best competitor would answer that question about the same market!)

3. Is the sales approach being used in the current geography predictable, repeatable, and scalable?

Access to delivery talent

Services businesses are people businesses. The availability of talent is a crucial ingredient to growth. It’s natural to look at geographic expansion to find more staff. Again, though, it’s essential to consider the nuances of delivery.

Adding a new location for delivery talent may require a new delivery model. If a business has always had the staff doing delivery work co-located in one place, suddenly introducing a new location begs some crucial questions: Are the staff in the new location also going to only work with each other (basically replicating what the current location does)? Or will teams in the new location work on the same projects as the current location?

The latter introduces a new way of working for everyone involved. That can work, but it needs to be handled deliberately by working through the processes and interactions that make delivery successful.

A new delivery location implies needing the operational capacity to manage delivery, recruiting, and people management. It’s essential to think through not just how staff will deliver the work in a new location but how the business will recruit that talent and help manage their performance and careers. The complexity a new location introduces varies significantly depending on how similar or different a new location is to existing locations.

Growing domestically vs. internationally

For businesses in the US, domestic geographic growth in this context can mean:

• opening an office in another city to sell to clients in that area, and/or

• opening an office in another city to have delivery talent in that location, and/or

• introducing a new style of working, i.e., staff has been remote-first but is now going to work in person in an office, or staff has been in an office but now will be in a new office or also be remote

Leadership may be lulled into thinking that these sorts of domestic growth will “just work” and will automatically fit into the business's existing sales, delivery, cultural, and operational aspects. This usually isn’t true - it takes more deliberate planning.

International growth often has the same motivations thematically but with subtle differences:

• a new international geography to sell into is often sought because the business feels like its current market is tapped out; they believe they can grow faster by accessing a new, untapped market

• a new location for delivery may be motivated by the cost of the labor in that geography rather than just access to or availability of talent

• supporting a near-shore or off-shore delivery model may be viewed as strategically valuable to the business

It’s important for US businesses considering geographic expansion to recognize that:

1. While domestic expansion is more straightforward than international expansion, it’s not easy.

2. Businesses often have practices built into their sales processes, delivery methodologies, working culture, and operations that depend on the geographic approach used when the company started. Often they aren’t written down and only get identified when they break because of change - like adding a new geography.

3. Successfully executing geographic growth domestically does not guarantee success with international expansion, even though some of the considerations seem similar.

Why geographic growth can be hard

The complexity of geographic growth is a function of (at least) six different factors:

1. Purpose (the motivation discussed above)

2. Language

3. Time zone

4. Employment culture (how employees in that geography expect to work)

5. Commercial culture (how prospective customers expect to be sold to)

6. How that growth is executed

All of these factors live on a spectrum of more straightforward (but not necessarily easy!) to more complex:

It is helpful to think through each of these dimensions when considering geographic expansion and the potential challenges or unknowns for a possible expansion.

Some lessons learned

As a way of highlighting the “hidden” complexities of geographic expansion, I’ll end by sharing three examples of lessons that I’ve seen businesses learn the hard way:

Building a sales + delivery team in a new location at the same time is hard

It’s hard enough to do one of these well - doing both simultaneously is very challenging to pull off. It usually requires local leadership for sales and delivery as separate roles.

It’s also a distraction for the leadership of the business in the existing locations. More energy than expected usually goes into supporting the new leadership in the new location to ensure this kind of expansion is successful.

Lesson learned: even if a new geography is needed for sales and delivery expansion, it can be simpler to start by focusing on only one area.

The “same language” isn’t always the same

For US-based businesses, believing that any English-speaking international geography is just as “easy” to communicate with as a US location can be tempting. This is rarely true, and it pops up in unexpected ways.

One of the more basic assumptions businesses sometimes make is that sales and marketing collateral can be reused anywhere English is the primary language.

Unfortunately, the material rarely feels localized. PDFs of printed collateral in the US are formatted for 8.5” x 11” paper, whereas many English-speaking counties use A4 paper. Written, professional American English is easily detected by prospects in other English-speaking “Commonwealth” countries and is usually not received as warmly as truly localized English.

Other little things give away the lack of localization. Domain names may not use the local top-level domains. Phone numbers and email addresses will feel foreign despite sharing a common language. Even industry-specific terms may have slightly different spellings or usage that introduce friction in communicating with prospects.

Lesson learned: language localization is essential in international expansion even when the language is the “same.”

Limited overlapping work hours make it hard to transmit culture and work on problems together

Businesses sometimes underestimate how much time leadership and peer groups need to work together synchronously. Unless the company has built a remote-first, asynchronous culture, live communication is critical to building and growing a new geography. (Even if a company has a robust remote-first culture, adding staff in a new, far-flung time zone will stretch it!)

With limited overlapping work hours, committed teams will often alternate which party gets the “bad” hours to interact with their peers. They mean well, but this saps energy and focus. There is just no shortcut to team-building that helps transmit the culture to far-flung teams: it takes time, and there are only so many hours in a day that people can work.

Lesson learned: a minimum of 4 hours of overlapping working time is needed to enable leadership to work together and transmit culture to geographically distant teams.

Okay, so how do businesses grow geographically?

There is no one-size-fits-all answer, but I believe the core principles are:

• Rigorously challenge the assumptions about geographic assumption being needed for sales growth. Ask others in the same industry, try to find out how much revenue competitors can generate in the same geography, and benchmark sales effectiveness. There are often more effective ways to address stagnating revenue growth.

• Leadership should assume geographic expansion will be significantly more complex than expected until proven wrong. This doesn’t mean it can’t or shouldn’t be done, but that they should be prepared to spend more time and energy than they expect to make expansion successful.

• Find ways to experiment with growth and identify problematic areas with lower stakes. For example, test out a distributed team delivery model using a team distributed in one country, with the same language, spread across one or two time zones before making it work with an off-shore team ten timezones away.

• Design geographic expansion plans so that at most two dimensions above are on the “difficult” end of the spectrum. If the planned geographic expansion has many tricky bits, the risk/reward tradeoff is probably too lopsided.

✌🏼That’s it for this week. Subscribe below if this topic interests you! Subscribing ensures you won’t miss future posts, and it helps me know what people like reading about and makes my writing more easily discovered.

This week I’m joined by Steve Bernet, a CFO and finance leader, to talk about navigating an investment banking sales process for selling a professional services business. Listen to our full conversation for all the details. Also, consider subscribing to get future posts and podcasts in your email…

Show Notes

0:59 - Steve’s introduction & bio
2:24 - High level overview of the stages of the sales process
4:16 - Getting ready for the process, working with advisors and crafting the narrative
7:02 - Preparing to be “in market” and getting ready to meet with prospective buyers
8:40 - The importance of running the business well while you’re in market
10:56 - Producing data to support the sales process and some common challenges
12:51 - Meeting with prospective buyers for the first time and doing management meetings
19:17 - The similarities and differences between strategic buyers and private equity / financial sponsors
25:14 - Getting to a “letter of intent” and some common challenges during due diligence
30:31 - What happens after the closing
34:07 - Keys to a successful sales transaction
36:58 - Some common problems that cause sales processes to go poorly
41:09 - What to do if a sales process fails

✌🏼 That’s it for today. Stay tuned as I’ll be following up on the process of sales processes with some key takeaways. Let me know what questions you have or additional topics you’d like to hear about!

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Today I’m sharing the first of those collaborations with Aater Suleman, an experienced professional services founder of the firm Flux7 that NTT Data acquired in 2019. Aater is now helping other professional services founders through his accelerator, Vixul. Think of it as the Y Combinator of IT services.

In the podcast, Aater and I discuss remote work, culture building, and his experiences in founding and growing Flux7, which was fully remote from the start. We delve into the benefits and challenges of work cultures in professional services companies, the differences between remote, in-person, and hybrid work environments, and the key factors contributing to successful remote work cultures.

Listen through the player at the top of this post, or look for the podcast wherever you listen. It will also be showing up in podcast directories over the next day or so. I’ve summarized the key parts of the discussion below and have a full transcript at the bottom of today’s post.

Key Points From Our Discussion

1. Be deliberate about building a culture and the way of working: The culture of professional services businesses is even more important than in product companies because these are people-centric businesses. There is no digital interface to professional services - it’s all about how people behave, work, and feel.
   
   Clearly define and document the culture and values of the company, ensuring that expectations are clear for all employees. This will help guide their behavior and interactions regardless of how employees work (in-person, remote, or hybrid).
   
   Defining core values that are aligned with the culture you want and being explicit about how people work are important first steps, but it can’t end there. Leadership needs to model these behaviors for others, and clients observing the core values in their engagements is an important confirmation that the culture is manifesting itself the way leadership expects.

2. Ensure your culture and ways of working are aligned with your prospective customers: For example, if you know that your way of working is remote-centric and a prospective customer can’t or won’t work that way, the engagement will not be successful. It’s better to “qualify out” prospects that are a bad fit.

3. Foster connections among team members: In a remote work setting, it is crucial to create opportunities for team members to interact and build relationships. This can include one-on-one meetings, group chats, and virtual team-building activities. Encourage open communication channels and provide platforms for informal conversations, emulating the "hallway conversations" found in physical offices.

4. Ensure inclusive culture for remote and in-office workers: If you have a hybrid work environment, ensure that both remote and in-office employees are equally included in the company culture. This can be achieved by adopting practices and tools that work for both groups and being aware of potential biases towards in-office employees.

5. Emphasize clear and consistent communication: Remote work, in particular, requires more deliberate and structured communication to keep everyone on the same page. Utilize tools and platforms that facilitate collaboration and information sharing. Encourage transparency and open communication across the company.

6. Monitor and measure success in the context of culture: Regularly assess the effectiveness of employee engagement and, if working remotely, remote work policies and practices. Track key performance indicators (KPIs) to ensure that the remote work culture is achieving its goals. Be open to adjusting based on feedback and observed outcomes, and share your findings with employees regularly. Glassdoor reviews are a trailing indicator of employee sentiment, so use other tools to get an early read on how employees feel so you can take action faster to correct culture or engagement problems.

7. Lead by example: It's essential for leadership to model the desired remote work culture and behaviors. This includes embracing the remote work environment, participating in virtual activities, and actively engaging with remote employees.

By following these takeaways, you can create a strong foundation for a successful remote work culture that enables your team members to be productive, engaged, and connected, despite the physical distance.

What questions do you have about professional services culture building or ways of working? Send them over and I’ll work on them for a future post or podcast.

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Do you know someone with a perspective you’d like to see or hear about professional services? Let me know, I’d love to talk to them!

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Full Transcript

CH:

Welcome to the podcast. Today we're going to be discussing services, businesses culture, and have a particular focus on remote working culture. And to do that I'm joined by Aater Suleman, who's a super experienced founder in the space, we're going to talk about his background and all of his experiences in building cultures in IT services, businesses, and how to do that in a very remote centric kind of way in a second, but first Aater, welcome to the podcast.

AS:

Thank you so much, Chris. Thank you for having me.

CH:

So I know a big part of what we're going to talk about today is culture. And I know this is a thing that's both you and I have a lot of passion around, because we've had conversations about it before. But before we get into that, I think it's helpful for folks who don't know you have a little bit of background about really kind of how you came about knowing about this in the services business that you built. So maybe you can just give us a little bit of background on the company that you started and how you ended up thinking about this so much.

AS:

Absolutely, I would take you back even a little further in my background, because that actually is how I became so passionate about culture. So this was about 18 years ago, I was in graduate school at that time, I got to experience working with a team at Intel that was a startup under the Intel Capital Program. And we were working on building a brand new product for Intel called Intel Larrabee folks who follow the silicon circles will know that probably still remember that name from 20 years ago, it was a pretty big splash of news, long and short of it that was that, frankly, I enjoyed working with that team and in that culture so much that it ended up changing the path of my career. My original plan had always been that I will go to my PhD and then actually become a professor. But working with that particular team on that product was so much fun that I ended up deciding to not become full time professor, just pursue that thing on the side and ended up going down the entrepreneurial path. So hence, culture, I think it's not just a passion of mine that developed post, but it's practically what defines my career and has defined who I became, was what I learned while working at that team. So fast forward a few years, I left Intel and then started my first startup flex seven in 2013. We were services company that built its name doing DevOps and AWS work, typically focused on enterprise clients in a few industries. And our main goal would be to help these companies transform how they ran operations and make them more cloud and DevOps centric, more automation focused. And when we started with Flex seven, we were a garage startup, like most of the startups are, I think we went a different path for most startups is that when we started doing well, we decided that instead of at that point, renting an office, which by the way, I did go and actually look at some offices, we took a different direction. And we said, Well, how about everyone just works from home and the garage is too small. And that was also motivated by the fact that we did have some offshore engineers working with us. So my point was, well, they're working with us pretty effectively. Why do we need an office here, even though we are in Austin, but that's not a good reason just to take on an expense. We built that organization completely office less over the course of next five years until we reached our exit, and remote culture. My passion for culture. And our decision to go remote is kind of how you can say and develop the expertise and some of the experience that we'll be talking about today.

CH:

Yeah, and I think it's kind of easy in current times to think, well, this is a pretty natural thing. But I remember, you know, we were starting level right around the same time that you were starting Flux7. And so in 2014, people did work remotely sometimes, but it wasn't just a foregone conclusion that you could run a company remotely in those days. And so, you know, it's interesting that you, you kind of so immediately went down that path.

AS:

That is absolutely right. It was going against conventional wisdom for sure, at that time. But I think some of that debt have to do with us being a services company as well, because and I actually do feel that services companies in some cases are a better candidate for remote work because we were already distributed, like it or not, geographically there was it was not like everyone was in Austin. So even if we started an office in Austin, a percentage of folks would still be remote. Now, yes, we could get then a second office in some other part of the world, and then maybe a third office in the third part of the world. But from the perspective of one office to the other, it really is remote. It's just that you have a group of people talking to a group of people rather than individuals. And so in some ways, while it was unconventional, it was pretty natural for us to go that route. Because some people are already kind of remote and working from home, and we're not seeing them, why can't we bring that model to the rest of the team as well? So for us, it was actually less of a stretch, if you will, from that standpoint, it was just a natural progression that we were headed, I guess the right way to say it is we didn't cave into conventional wisdom.

CH:

Yeah. Well, I know, we'll spend more time on the remote work aspect back to this in a second. But I think just backing up and even focusing on culture and services businesses is a good place to start. And like you said, this is something that I know you're passionate about. I think for people who haven't been in a services business or who haven't started a services business, it may not be obvious why creating a culture in a services business is important or why it's hard. So I know I've got my own thoughts on this. But I'd love to start with kind of your thoughts on number one, like what why is it a thing to even care about? And number two, is it really a hard thing to do? Or? Or is it just like starting or creating a culture in any other business

AS:

I actually believe that culture is more important in a services business than, for example, a SaaS startup if you're starting off, and the reason is that, fundamentally, it's been well understood that every business succeeds by being customer centric and customer obsessed. In SaaS startup, that typically implies making my user interface really good. And we all know that companies go through cycles and cycles of making sure that their user interface their website is extremely friendly, and is up at all times and loads fast, and all the right things because the more pleasureful that experiences, the more they're going to use our software product or an app and go from there. Now, turn that into the services business, the fundamental rules of business do not change because we are in services. So the goal still has to be providing a delightful customer experience that the customers will remember and want to come back and use more. But the difference is that our interface is not a digital user experience, but rather a human driven user experience. Which means that the way that human beings interact with those customers have to play that same role and say that the Amazon website plays for amazon.com, because just the amount of effort that goes at Amazon to make amazon.com extremely user friendly, I feel is the equivalent of how much effort should go into a services business to make sure that the culture is built in such a way that employees are genuinely happy and genuinely are aligned with the core values of the business. And the correct expectation set with the customer that these are values, then make it a delightful customer experience. If you tell them that you're going to be, for example, our three core values were humble, innovative, and transparent. And we permeated it through every engagement to every SOW our customers knew our core values as well, because that is how we said what the user experience is going to look like from the first pitch that we had. And we did stand by that. And that is how we expected our customers to evaluate us. And that's the lens we always wanted them to look into. So I feel it's very important and more important than it is in a company the way the most of the staff is kind of behind a web interface, if you will, or an API to answer your second question really quickly, is it different? I think it is fundamentally different when you build culture in a services company. And it is in fact a slightly harder problem. In fact, a good statistical way to gauge the difficulty there is if you actually go and say look at the Glassdoor ratings of some of the top services companies and compare them with some of the product companies, you will see a noticeable difference. The reason is because in a product company, fundamentally, everything is working towards that one website or that one API. But in a services company, by definition, each group or each individual, sometimes even maybe working for a different problem for a different customer. So how do you keep them connected to your culture? Makes it a more more difficult problem to actually solve. But still yet the more important?

CH:

Yeah, I totally agree on that. The last part, so maybe to kind of play back some of what you said and dig into it in a little bit more detail. I think services businesses, you know, fundamentally are people businesses, and like you were saying, the only interface the only experience that you have is a human one, the digital one. There really is no digital interface when you're running a services business.

And so having a kind of feeling or culture that comes through in the people is super important. But you have to be deliberate about how you create that. Or else it just kind of creates itself. And it may not be the thing that you want it to be right maybe to just to ask if you agree with this, I think if you're not consciously creating culture, some culture is being created within your company, but you're not necessarily controlling it or steering it in anyway. Right?

AS:

I completely agree with that. Yeah, in fact, I always say that the most important thing that you can do with culture is to be deliberate about it, you have to make that a thought until you deliberate about it and you're conscious about it, you will learn the culture will get created by accident, if it's not intentional, and may not be the culture that you want.

CH:

Yeah. And I think the comparison to product companies is good, because I agree with you, I think a lot of people, they start with a mental model that's very based on having a digital product of some sort. And the culture, you know, first, I think the culture is somewhat generated by what the feeling or the spirit of that product is. But I think the other thing that I've always thought is true in these kinds of services business cultures is, you don't have that common rallying cry around what it is that you're doing to your point, people are working on different clients, they're going from one client to another, some people may be engaged at a client for a long period of time, they may not interact with their coworkers as much. And so it becomes way more important to have some kind of glue around what people do and what they believe and why they're doing what they're doing. Because there is no kind of common element otherwise, there's nothing else that they're kind of all working on together. Is that do you think that that's right? Or? Or do you think that there's a another way around that challenge for services businesses?

AS:

I think you're spot on. Actually, I would agree with everything said that it is about the deliberation. And that's exactly what makes it challenging. Interestingly enough, that this is one area where the intersection of remote and services, it's actually helpful. Because like you said, if you're in a services business where, say your typical employees spending four or five days a week at a customer site physically, it becomes a lot harder to manage that then if you have a situation where you have a remote team that is mostly working from I guess, in this gives their homes are the equivalent of that in a non remote culture would be from your office, because taking an hour, 30 minutes out of there for team meeting is a lot more practical than it is for somebody who's physically at a different site. So I think in some ways remote and services from a culture standpoint might actually be a plus.

CH:

Yeah. You know what one of the things that you mentioned that I wanted to come back to was the Glassdoor topic. And I think for anybody who's run a business, you've probably had some positive and some negative experiences with Glassdoor, but but my sense of glass door is that it's kind of like a trailing indicator. So Glassdoor reviews end up on Glassdoor, and they say what they say. And to some extent, there's not a whole lot you can do about what happened in the past, you can influence what happens in the future. But I think the thing that I always thought we should do more of and I think we did do a lot of this at Levvel was to try to get a kind of read on how people felt about the company and the business before it ever showed up on Glassdoor. And I'm curious, I know you've got a lot of thoughts on this. But what's your advice to a founder or leadership team? That's trying to say, hey, you know what, I want to know what's going on? Before I read it on a Glassdoor review.

AS:

This goes back to our earlier discussion on it, you have to be deliberate. And I guess I'm gonna pull off the classic, you can't control something that you cannot measure. So you have to be measuring it and Glassdoor is when you find out that somebody is unhappy and glassed over it is too late. You're absolutely right. So as a matter of principle, you want to have a tighter feedback loop and you want to be hearing from people as frequently as possible. These days, it's actually become a lot easier. There are tools that will actually give you things like micro polls give you quick ideas, how folks are sensing things. There's mood indicators that you can actually collect even from your Slack conversations that may be happening within your company on how people are feeling, you could explicitly be reaching out and asking them from time to time as well. And we really did all of the above. So we did have a lot of automation and trying to understand the sentiment. But then we had some explicit surveys, microphones going out on a weekly basis, typically just one question every week to get some sense on how folks are feeling. And then we had more explicit one on one check ins not just with managers, but with the culture team, as well to make sure that people are in fact feeling the way we think they are. And all of that did contribute to the Glassdoor rating. And so we did have intermediate metrics before Last two, I think it's really important to say the other thing, by the way, talk about being deliberate. When we created Okay, as far a quarter, almost always, they would be a key result or an objective connected to our, either the internal metric or the cluster metric. So, in a way, you talked about how to get people to rally around certain things, I would safely say, this was one of the top three things that we rallied about, which was let's all build a company that we all enjoy working at. And let's this was one of the callings that actually brought us all together as a company. And that really helped because culture became everyone's job as well. And everyone was very protective of the culture. And it was always music to my ears when, frankly, when in a negative conversation about a particular person, and somebody would use the word something like, well, that person is not being humble, or not being innovative or not being transparent when they actually connected it back to the core values, even when they're negative feedback, it was brilliant to kind of see that that means we have managed to crowdsource culture.

CH:

Yeah, you've got a common anchor that everyone shares as being the Northstar for how you should behave or how you should act or what's actually valued at the company,

AS:

given that people are not building one single product that actually all gave us something to rally around as well, that we are a company that is very proud of our culture.

CH:

That's great. One more thing on on the measurement piece of it. So you know, one of the things about Glassdoor is it's very public, and people know what what's out there for these intermediate measurements that you're talking about where you are doing micro polls, or using some kind of statistical process like, you know, collecting employee NPS or something like that? How much did you share that data internally, with employees?

AS:

Very transparent. Every monthly meeting, I would have a slide on what we are seeing. And we will always talk about what are the hypotheses that we think if something is going down? Why? And then what initiatives are being put in place to turn that around? And if it's going up, then also why and what we believe has actually led to these results. So yeah, it was a very big again, everyone on the culture. So it was a single KPI that we all shared in the company.

CH:

And that's great. We did something very similar. And I think that it's a good way to model transparency. Because if you value transparency, as an organization, it's easy to be transparent. When things are good. It's a little bit or a lot uncomfortable, to share things when things are not so good. And I think that's where you earn true credibility in being transparent is can you talk about bad news,

AS:

that's when you really have to live the example. So to keep transparency was one of our three core values. And I'm assuming some of my ex team members will be watching this at some point. So for the first time, I'm actually going to share with them that there were days when I would be preparing for a team meeting. And I was wondering, I wish this was not one of those values, because I don't want to be sharing this right now. But I have to because that's one of the values. And that's what it means to actually have a core value that you live by.

Unknown Speaker

No, I think that's an important element of vulnerability as a leader. A lot of times I share your sentiment, right? You I think I always felt this need to kind of portray, like, it was comfortable to be transparent. But it's not. I mean, it's, you'd be lying. If you said that it was I mean, there's always moments where you're just like, oh, geez, like this would be so much easier if I didn't have to, you know, be honest about this. But

AS:

yeah, I've definitely had those moments.

CH:

Yeah, you and I probably think about culture, and a lot of the same ways as it relates to building services businesses. But I really want to get into the remote element of this because I think this is something where what you did was, in some ways, kind of like starting the path down remote work before it was a popular thing to do. So I'm curious maybe as a starting point, what what do you think the biggest challenge was that you ran into as you're building this remote working environment?

AS:

I think the biggest challenge was to convince everyone that this was going to work because it was the conventional wisdom that we went up against. So ironically, I think the biggest challenge came in the early days of just making convincing everyone that this is the right thing to do. And this will actually work come together. As you start to have proof, it became a lot easier. So that particular challenge kind of started to fade away. And in fact, the positives started to emerge. And we were able to talk about it with proof that we were doing so well that that particular challenge started to go away. But I think at no point in time, can I say that it was a challenge to be remote, frankly. But I think the reason I can make that statement is only because we had kind of painted the price upfront, if you will, in convincing everyone that this is the right thing to do if it was basically another most succinct way of saying that would be that. It's required a mindset shift. So you kind of had to do that mindset shift in the beginning. So if you're hiring somebody, you're making sure you're going to make sure that they are ready to adapt that new mindset If it's not working out, you do have to make some hard decisions if they're not ready to adapt that mindset. But once you have a team of folks who actually believe that this will work, frankly, there aren't much challenges at all, I actually think it's a lot easier than most people think it is. In fact, whenever people talk about the challenges of remote work, candidly, first thing I do is look at their profile to see if they've actually ever worked remotely in a real remote company. And typically, the answer is no.

CH:

Yeah. Well, just to dig in a little bit more. So when you say convincing everyone, is that was that convincing your employees or prospective hires? Or was that convincing? Your clients or prospects or all the above?

AS:

I would say it came at all different levels. So probably should start with convincing myself, then the employees would be we would actually run into conversations where we will have to explain why we believe this would work and in many cases to be candid, like six months review or the with the employee? And the answer would be like, Well, when I started, I wasn't sure if this was going to work. But now that I've seen it, I don't think I can ever go back to an office. So some of it was just that, but then it did not stop at just employees, we would have customers get concerned at times as well, where kind of wanted to just get back to the old ways, if you will of like, can you just send somebody to our office? Or can you guys just have these people physically present when I'm coming. And we will have to actually explain to them the effectiveness of what we were actually doing and how it was actually better. So I think one of the most telling for me story was working with a large Fortune 100 client, our first large enterprise client, and we were approaching a deadline. So the customer, the senior level executive at the company sent me an email saying, Hey, can we fly over to Austin? Or can you guys fly over to our site? And I guess I took a very bold stance, and I actually responded back with here's the data that I have, that shows that the collaboration between our teams, as-is is fantastic, and way above the industry average of anybody working in the same office. So I would hate to say this, but I feel that we will add risk in the project by introducing a new variable that we don't know how it's going to play out. And he agreed, and that project became such a huge success, actually, that it was our claim to fame for years to come.

CH:

Yeah. Did you ever have to break the remote only rule? Or did you deliver all of your projects fully remote,

AS:

they early days, we had one project where we did actually have some on site presence. After that it was at least 99% remote. So we always used to call it the remote first culture. So the default would always be remote. And if a real need arises to be at a client site to deal with something we would show up there. So even for that same client, my co founder, Ali did actually fly over and spend some time a few days there on site. But we did not fly the entire team in we did not even consider that as an option.

CH:

Yeah. And when you were having sales, or pre sales conversations with prospective clients was at all completely remote too?

AS:

Yes, nearly all remote, again, remote first. So if a real need arose, we would actually fly out to a client. But that would be very rare occasion. In fact, I always hear stories about consulting company founders being on the plane 24/7, my average of the last three or four years, it was probably one travel a month, maybe one day a month. That was the max.

CH:

Yeah, my experience was very different. So I'm probably much closer to one of those founders that you hear the horror stories about being on the plane all the time. So I do get it. But, you know, I think that it was at least in large part due to the fact that we were really kind of like a hybrid of remote and in person. And we delivered that way too for some of our clients. You know, one of the things I'm always curious about when I hear about these ways of delivering are these ways of operating that are different. Did your competitors pick up on the fact that this was your way of delivering? And did they ever try to use that against you in a competitive setting?

AS:

So I would actually attach it back to an earlier comment, right? It is about being deliberate about culture. And I think you and I can both will violently agree again, that it's also been about deliberate during sales. So frankly, any company that touted themselves as somebody that will fly people in to get the work done, I would not even consider them my competitors. If we are dealing with a client that has an entire remote culture, where they would value as I used to jokingly call it they would drop off a truckload of consultants to your dock. That's not our client. So we would actually finish that conversation and the customer would not be qualified beyond that.

CH:

Yeah. So you you actually use that as a qualification parameter for prospects.

AS:

That's exactly right. And to be actually just an interesting fact, into positioning. One of the things we actually realized was that the customers that were most sensitive to Working with remote teams were the ones that were all co located in a single building, sometimes even on a single floor. So we would, in fact, when we created prospect lists were to pay attention to that. And if you were dealing with a company with multiple offices, really, they may not realize it, but they already are remote. So they would not have any issues with remote. But what says when we were dealing with the company, we did run into one, where literally, the entire IT department was on fourth floor of an office in Dallas, Texas, very clear that that's not going to be a good client should not be the one we should be pursuing in the first place. Thanks to all the information available these days, we could actually build an ideal client profile with that criteria and create prospect lists, knowing that these companies have multiple offices. In fact, clients, especially with offices in multiple countries became some of our best clients, because we will already be we'll meet them exactly where they are.

CH:

Yeah, they don't require convincing because they do it themselves.

AS:

Exactly.

CH:

Now, I do think that what you're saying, though, about clients, or prospects who are starting down that path, but not all the way, there are probably an interesting, you know, needle to thread, because on the one hand, like you can see it in them, right, that my kind of litmus test was, once you're at two buildings, it's too difficult, right? If you're on the fourth floor of one building, and you've got a coworker on the third floor of another building, you're going to send a Slack message, or pick up a phone or send a text message or something, right, you're not going down the elevator, we're walking across a campus going up another elevator. So they're whether that office is across the campus, or in another state or in another country, it's almost it doesn't matter. But they may not have internalized the fact that they have a remote culture yet. So they might still be looking for that kind of comfort that comes from being able to be in person even if they'd never use it.

AS:

That is correct. And in fact, an interesting example, and why we used to use city or different cities as a filter, because folks who would be in into buildings on the same campus would still have the ability to join, like their daily standup in person, very commonly done that. So basically, the way we will look at it is if they already have virtual participants in their daily standup, it will be a fit, if they have zero daily virtual participants in their daily standup and we'll be the first ones introducing a virtual participant, I can completely understand that will be a frustrating experience. And I don't want to be the first virtual participant in any meeting, frankly. So we would walk away from those deals pretty quickly.

CH:

So do you think that this decision about whether you're remote first or in person, is it binary? Like is does it have to be either you're remote or you're in person? Or do you think this hybrid of some people are remote? Some people work in an office? And I'm thinking specifically about services businesses? Is that workable?

AS:

I strongly feel it is workable. So the short answer is yes, I think the most important tenet rather than even getting into remote and non remote is what we were talking about earlier, which is talking about having a culture and owning the culture. And a culture can be built around a strong statement here. But a culture I believe can be built around any of those settings and environments. So it is more about being intentional. The key would be to if let's say you're willing a hybrid culture, owns that culture and figure out how you're going to hit the minimum viable, minimum lovable criteria in that culture. We became a mod only shop and we we created tools and processes around that. If you're a hybrid culture, you can do that if your physical culture, you can do that, too. And I think there is no shortage of companies where people literally sit next to each other hate each other as well. So there's absolutely no data to say remote is harder or hybrid is harder.

CH:

Yeah, I think my maybe strong opinion weakly held on this is I think hybrid, probably is harder. But I think it's harder, because I think, by virtue of the way that people get into it, I think a lot of hybrid culture has probably come about because people aren't deliberate about we're only going to do in person or we're only going to do remote. And so if you feel like you want to support both, and you don't go into it, like you said with a kind of deliberate mindset around how you create it, then you can very easily without even intending to stumble into this way of having these two different remote you know, two different cultures, one that remote people have and one that in person people have and then that leads to a different set of challenges. And so I think to your point, hybrid is doable. So I agree with you on that. I do think it's, it's harder and it's it's easy to get kind of sideways in it if you're not being deliberate about how you create it.

AS:

I agree and no scientific evidence on what I'm about to say. But I actually believe that one of the reasons we were able to succeed with remote This was 10 years ago, was when the initial team decided that even though the the guys who were right in Austin decided that we actually going to be remote So for instance, Ali was literally living three houses down from me. And I think talk about being deliberate, instead of walking over which he eeasily could he preferred to meet each other on Slack and digital media. And that actually really helped, because we could both experience the exact same challenges. So, frankly, I think the same emulation can be done in a hybrid environment where even if, let's just say you have an executive leadership team, if some of them are hybrid, and that some work from home and some will come to the office, I think that'll actually emulate the experience to the leadership team, the challenge would be if all the leadership, everyone comes to the office every day, but then you have office employees who are somewhere mode, I think that's where real challenges begin, because no management can no longer relate to what's actually happening with the teams. So that was very deliberate on our part, to say 100 feet from each other, but we are not walking over.

CH:

Yeah, well, I think like you said, the thing that you can very easily slip into if you're sharing an office is, even if you're super deliberate about, hey, everyone is going to join this meeting on zoom from their office, even though we could all be in a conference room together so that everyone who's remote has the same experience, you're still getting the benefit in the office, from the people that are co located have the random conversations that happen in the hallway conversations. And I think that's the thing that it takes a tremendous amount of discipline to not do that. Because it's so easy to have happen. That happens naturally.

AS:

I fully agree with that and talk about do we like being deliberate about culture? I think one of those things that we had to figure out was the equivalent of hallway conversations in a remote environment. And how do you actually do that? Because that was probably one of the biggest things that confused everybody else was that? Are we going to just completely lose out on the hallway and informal conversation?

CH:

Yeah. So how did you do that?

AS:

Slack was our hallway, it was physically office, we would actually invite our clients to Slack, just so they were all part of our slack as well. So they could see what our office looks like. And the slack activity was a KPI that I used to measure slack Stream Analytics were a very big part of our top level KPIs and measurements. So just to give you an idea, our team would literally have 1000s of kudos flying every month towards each other. A typical active customer channel on Slack would have about 10,000 messages exchanged every month, which would fall outweigh in some cases, if even if people are co located. Sometimes people don't talk that much. So we actually, again, it's comes down to being very deliberate having real world targets, talking about in just taking a very deliberate approach towards that. But yeah, that's how we emulated and then we would have just to break it down a little further. Beyond slack, we did have informal events, virtual events, we will actually get together and have lunch, just everyone company orders lunch for everyone has delivered where folks are. And we would actually have tried a game days, we would get together and play virtual games. So there was some deliberate effort and some creativity that went into making it work.

CH:

And that's great. On the slack topic just a little bit more. So did you look at or did you think about the amount of messages that were happening in either public or private channels as being better or different than direct messages? Like, I guess I'm wondering, did you put a different lens on DMs versus channel based communications just again, to have that kind of like hallway, group culture present?

AS:

So culture was such that we would refer wherever possible to go public rather than direct message? So yes, I would actually look at that as if the direct message percentages are going above something is going wrong, because we have somehow something in the culture has changed. So yes, I would actually I did use to monitor that as a KPI on percentage of direct messages versus public messages.

CH:

And when people came into the company, was there some kind of explicit communication and like the employee handbook or something, or the onboarding, about how to use Slack? Or was that something that people kind of picked up by living in the culture,

AS:

we did have a very long document that we call the flexible culture recipe or culture book. And that did outline some of these very soft elements of the culture and slack and how to use Slack. And when we use Slack, even versus say, jump on a call, we're all laid out in there. Makes sense. And it was an by the way, I should maybe one, one emphasis it was not the employee handbook. Employee Handbook always kind of comes across as a very boring document. This was actually a very fun document with fun pictures, and Smiley's and emojis all over the place. This was just telling people how we behave as a company.

CH:

Well, maybe just one more question on this before we start to wrap up. So if someone's considering building a remote work environment, you've already touched on the importance of being deliberate about it and thinking through it, but are there three things things that they could take away from this conversation or your experiences of what they should do to be successful without?

AS:

I think we've touched on all three at this point deliberate is definitely one. But let's get make it a little more tangible, maybe as a response to your question. So I would highly recommend writing down what you expect us the culture. So the flex seven culture book is actually my most prized possession from flex seven, as a company, I still still puts a smile on my face when I look at the document. And very, very helpful. So I think being deliberate to me then turns into let's it, writing it down, not just talking about it. In a building of remote culture, it's even more important to write it down, I believe, although I think it's important important in every setting, but even more important in a remote culture. The second also something we have touched upon, which is to truly be folks who are creating the culture need to be in a similar environment. So I think hybrid physical virtual, you want them to be living the same experience, so they understand the challenges. And that deliberation is actually coming from real experience, not just a lab experiment, if you will. And the third piece we have also touched upon, which is the cycle of communication, you have to be more deliberate because the Hallway Conversations are not there. So connecting people with each other one on one, connecting people across the organization with each other, connecting them back with HIV frequently, with leadership very frequently, I used to have one on ones with everyone in the team at a lower frequency that I could sustain some of those things, you have to replicate the hallway conversations, if you will, to be honest with you, I would just make a slightly controversial statement here. I actually believe that the deliberate way of connecting people was far more effective than Hallway Conversations. Because you have no measurement, no control and no organization around them. We were able to do it, I believe a lot better to be honest with having an actual program and plan on how we actually make that work and measuring success of that as we went.

CH:

Yeah, I think one of the things that happens automatically, or almost, you know, for free, so to speak, is that if you're deliberate about doing it digitally, these conversations can become much more legible in the sense that they're documented, and they can be written down or shared or digested in ways that Hallway Conversations honestly can't. And it becomes really hard to keep people in sync with those hallway conversations. Whereas if you've got this kind of prescriptive way that you go about doing it in a digital setting, then people can kind of read up on things that they missed in Slack, or read up on something that that happened digitally, that there's an actual kind of written record of

AS:

I completely agree with that. That's definitely how I think it transpired.

CH:

Yes. Cool. Well, one more thing before we wrap. So we haven't talked at all about Vixul. And what you're doing now, so maybe it'd be good for you to give a little bit of an overview of what you've been doing after Flux7 and some of the exciting things that you've got going on with Vixul?

AS:

Absolutely. So Flux7 was a great learning experience for us. We went and built a services organization uncovered a lot of these lessons, sometimes the hard way. And other times, we just got lucky around the importance of things like culture, but then how do you build the sales side, the delivery side, the cash management, everything was a learning for us because we came from a technical engineering background. So when I was designing what's going to be the next venture went back to rule number one of entrepreneurship, which is go back and scratch your own itch. So we knew that there is actually a challenge with early stage services founders, that there is practically no institutional help or even references available to guide them on how to make the decision, right. I think you hear the sentence services companies are hard to scale all all the time. But nobody ever then finishes that sentence by saying, and this is how to do it better. So we decided to finish that sentence and say, well, let's come up with a way to do it better there is there is knowledge out there, but it's all scattered. It needs to be institutionalized. There's people like yourself, Chris, who actually have built services companies have very strong opinions and know how to do it. But so let's actually build a platform where all of that knowledge and expertise could be gathered and then made available to folks who needed the most and have the least access which is the early stage services founders. So all that combined and putting it into a real model. We have built accelerator, which is the first startup accelerator to our knowledge in the world, which focuses are exclusively on IT services companies and early stage, which we define as under $6 million in revenue. were carefully crafted to before even the private equity gets interested in the company's idea there is as you bring those folks in take them through a 90 day boot. very much inspired by Y Combinator which is a model company and help them we have adopted the Y Combinator model over to the services company. So just help them, turn the tide within the 90 days, create some tangible outcomes and then continue to help them for about a couple of two year period after the boot camp so that they can see the actual results of the efforts.

CH:

I love it. I think one of the things that we talked about when you were first telling me about this is something that you and I both experienced, which is there's no end to the articles online about how to run or start a product business. But there's a real large gap of the same types of articles for services businesses, so you're you're helping to fill that gap. Right?

AS:

Can you give me actually even the few articles you find typically talking about the the challenges, and I've written by folks who have not necessarily built services companies, but are just talking about what's wrong with the services as a business model. So I guess I'm a completely bullish on the services business in the IT sector, I do believe it plays not just an important role, but frankly, is an enabler for all the product business that's happening to, and hence I just started double down and let's actually make this into an ecosystem.

CH:

Great. So for people who want to learn more, where do they learn more about Vixul.

AS:

So the first source would be our website, which is vixul.com. You can also look at our LinkedIn page, which has information and a lot of the most recent updates, and always feel free to reach out to us. You can get to that through LinkedIn or through email.

CH:

Awesome. Well, Aater, thanks for the conversation today. This has been great. I really appreciate you sharing your insights and some of the lessons learned along the way for culture and services businesses.

AS:

Likewise, well, thank you very much for having me.

“Can you do X type of project?”. X is something the company has never done before.

“Do you know about X industry?”. X is an industry the company has never worked in.

“Can you work from X city, where our team is based?”. X is a city the company has no staff.

“Would you be able to use this obscure combination of technologies X, Y, and Z that we insist is our standard?”. X, Y, and Z is the most esoteric combination of things ever seen.

Yes. Yes. Yes. Yes.

Sometimes this is due to a scrappy, entrepreneurial spirit. The people saying yes are confident they can figure it out - and probably can. That scrappy spirit is needed to win, especially in the early stages of business!

Sometimes it’s part of the journey of finding the services equivalent of “product-market fit.”

Sometimes, a company must figure out its narrative, where it’s going, and what will work in a given market.

But many times, it’s a huge distraction. It drains the energy away from the things that are going well in the search for revenue. For the case study. For the experience.

Knowing where to focus makes it easier to say no to things that feel necessary in the short term but slow down growth or profitability in the long term.

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Focus Creates Differentiation In Large Markets

The reality for many professional services businesses is that their addressable markets are larger than they think. There is more opportunity than it sometimes feels is “out there” to win. Paradoxically, being too broad in the services offered, how they are sold, and to whom make it harder to win work for two reasons.

1. Internal Distraction

Every sales opportunity requires attention to win, especially when a company is young and the muscle memory of sales motions and proposal creation is still being built. And similarly, each won opportunity that requires a different skillset, delivery methodology, or style of engagement with the client introduces new challenges.

Over time, these distractions and new challenges compound. People spend time chasing opportunities they’re unlikely to win. Projects that require new types of talent get sold, so a new “bench” gets created, but without the focus to maximize their utilization.

Worse yet, because of the lack of commonality between projects, the team doesn’t have the opportunity to develop delivery frameworks to aid with quality, consistent delivery.

2. External Confusion

This lack of focus comes through to prospective customers. Prospects are likely talking to multiple firms. The ones with focus show sales material that aligns with the buyer’s needs (in one or more dimensions), show a deep understanding of the problem or opportunity and highlight how the services company has invested in that area.

Conversely, the ones without focus can’t fake it. Many try, but prospective buyers almost always pick up on it. The reality is that buyers probably over-index on this - intelligent, scrappy people may be able to solve the buyer’s problem just fine. That reality doesn’t matter to the buyer. They think their particular problem or opportunity is unique, and the best approach for a services business proposing a solution is to demonstrate a focus aligned with their perceived needs.

Over time, this creates external confusion with prospective buyers. They look for some cohesive narrative around what a firm can do for them, and when they can’t identify it - or it feels superficial - they get confused.

“What does this company do? Why are they better than competitor X at this thing? Do they know what they’re doing?” This is a thought process that no services business wants their prospect going down in the middle of a competitive sales process.

Focus Leads To Identity, Identity Leads To Differentiation

Determining areas of focus re-enforces the business' identity and eliminates entire categories of opportunities that aren’t a good fit for the company. This is a killer combination because it simultaneously addresses both problems above.

Re-enforcing the business's identity and its services is helpful for marketing, sales, delivery success, and operations. These examples are being known as the experts in a particular (narrow) domain, serving a specific geography, or having deep knowledge about a particular technology or tool. That identity supports differentiation in the sales process, which leads to being able to authentically present expertise and differentiation relative to competitors. It also increases the likelihood of delivery success because the business is more likely to do similar projects.

But how does a business pick which areas to focus on? And what happens if the focus becomes too narrow and excludes all the prospective buyers?

A Framework For Focus

While a services business could identify all sorts of areas for focus, I propose five dimensions are helpful to consider:

1. Industry specialization: identifying a specific industry, or more likely, a sub-segment of an industry, allows the business to identify prospective buyers and build deep expertise.

2. Geographic focus: this often means serving clients in a particular geography, and that sometimes translates to focusing on recruiting talent in that same geography.

3. Sales model: how you go about selling is often an area of focus and something I covered in my earlier post Picking Sales Models and Services Offerings.

4. Skillset specialization: skillset specialization to some degree is necessary, but how focused a business can be is a matter of degrees. For example, a software development services business could specialize in all front-end and back-end development using all modern JavaScript or TypeScript frameworks, or they could be hyper-specialized in a specific framework like React. Similarly, a project and program management services business might use any delivery methodology. They might specialize in a particular approach, like using SAFe, or only do higher-level complex program and change management.

5. Project type/delivery specialization: a firm may specialize in a specific type of engagement accompanied by a specialized delivery framework. For example, a Salesforce consultancy may develop deep expertise in CRM migrations rather than implementing and maintaining all Salesforce products. Or, a product design firm may have a proprietary delivery framework used to design, build and launch a new digital product.

There are degrees of focus or specialization across each of these five dimensions. Having a deep focus or specialization in all five is too focused, leading to a target market that is too narrow to build a scalable business. Conversely, focusing on none of these dimensions is a disaster for early-stage firms needing a cohesive narrative about their offerings.

In practice, having a deep specialization in at least two, and likely three, of the five dimensions is the sweet spot for having focus, a differentiated service offering, but a wide enough market to achieve a scale of $5-10M in annual revenue that can be expanded from.

These specialization choices may manifest differently for different types of services business. A way of visualizing those relative differences is with a radar chart like this:

We can apply this visualization to two of the examples above. The grey line for a “Software Partner” could be the Salesforce partner focused on CRM migrations. Their sales model focuses on a partner-relationship sales motion and a deep skillset specialization in Salesforce’s CRM product and data migrations from other CRMs. There is a moderate focus on project type and delivery specialization because these projects lend themselves to some level of repeatability but vary in the details based on the current CRM in use and differences in data models. There is little focus on geographic focus - they can serve clients anywhere in the country - and minor specialization is needed in specific industries.

Conversely, the blue line for “Regional PMO Services” could be a firm that provides clients with a generalized project and program management support. They have a deep geographic focus in one or a few large metro areas and primarily do work in a specific industry, like financial services. However, they have only a moderate amount of skillset specialization because they have to adopt their clients' project and program methodologies, and the sales model is relationship-based and highly variable depending on the opportunity.

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How To Use The Framework

A framework like this is a means to an end, not an end in and of itself. The point is to have a working thesis about where a business is focused. That thesis helps inform decisions about the ideal customer profile, how a sales organization is built, the type of delivery staff needed, and the kinds of work that are a good fit.

Where a business sets itself in these dimensions can change over time. It may be that the initial area of focus isn’t scalable. For example, maybe the software development example above that focused only on React is too narrow, or another competing framework gains significant traction. Alternatively, success with a narrow focus may allow a business to reach a scale that can defensibly enter an adjacent area, lessening the focus in a particular dimension. For example, the PMO services business might succeed in the New York and Boston markets and decide to expand into Philadelphia.

Decisions should be made considering the focus areas, but there should be some allowances for deviation. Early-stage businesses require a combination of discipline, instinct, and luck. A framework like this supplies some discipline. It’s not a substitute for instinct. The critical thing about allowing for deviation from what this (or any other) framework would suggest is to hypothesize why deviating is the right thing to do. Once there is enough data to validate or invalidate your hypothesis, revisit whether the framework was correct (i.e., deviating from an area of focus resulted in a bad outcome) or if the placement of the dimensions in the framework needs to change (i.e., the level of focus needs to be adjusted up or down).

That’s it for this week. I’m planning some deeper dives on some of these topics in the coming weeks. Drop a comment below or shoot me an email with any follow-up questions you have! ✌🏼

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First, I’m excited to announce that I’ll collaborate with other experienced professional services entrepreneurs and leaders from related industries over the next several weeks.

The first collab will be with an experienced finance leader discussing investment bank M&A sales processes. The second will be with another professional services entrepreneur who built a great, fully remote working culture.

I will be trying out a new format for those posts, and I’d like to answer your questions! What do you want to know about M&A and selling services businesses? What questions would you ask the founder of an IT consulting firm with many lessons learned building a fully remote team?

Comment below or reply to this email and let me know your questions.

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Second, I wanted to revisit my earlier post about pricing projects and estimating labor costs…

Time & Materials

How To: Pricing Proposed Projects and Estimating Labor Costs

First, a quick programming note: I’ve renamed this newsletter to “Time & Materials”, an homage to the nature of the business I write about most often. It’s apropos given the topic of this week’s newsletter…

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3 years ago · 1 comment · Chris Hart

There are some common pitfalls with pricing and reporting on margin, so let’s dive into where people get stuck and how to get unstuck!

Not Reporting on Margin At All

The riskiest pitfall is not reporting on realized project margin at all. Unfortunately, this can be common for early-stage services businesses.

The sooner you develop the discipline for this reporting, the better off you will be. The administrative burden of this reporting only becomes greater as a business grows; it's much easier to figure out how to do this reporting at a smaller scale and evolve the capability as you grow than it is to kick the can down the road to when you have an even larger business. Businesses lacking this reporting may also be missing out on profit they could otherwise earn!

The fix:

1. Use your timecard data to calculate the total number of hours (whether billed or unbilled) by each staff member and by project.
   

2. Calculate each employee or contractor's “fully-loaded” cost for the hours they worked.
   
   For employees, this includes the costs of benefits, employer-paid taxes, etc. To simplify this calculation, calculate a “load factor” by determining the total cost of those benefits and the percentage it represents for employee wages. In most US businesses, it’s pretty common to see load factors of 18-25%, meaning that the total labor cost of an employee is 1.8x - 1.25x their salary.
   
   For contractors, this is typically much more straightforward, though contractors may be paid different rates depending on the project or work.
   

3. Calculate other unbillable expenses for the project.
   
   This could include software or services you need specifically for that project or client that aren’t included in the business’ typical expenses. For example, if a client requires a subscription for a software or service you use only for them, that should be included.
   

4. Calculate the profitability and realized margin for the project or client. Profit for the project or client is easy: total fees billed - (total labor costs + total unbillable expenses). You can also calculate the realized margin by dividing the profit by the revenue.

You can use this data to compare your actual project margin vs. the expected margin you calculated when you priced the project. Is it different? If so, why? Can you improve the margin on this project? Can you improve how you price similar projects in the future?

Not Fully Accounting for Project Costs

This is common when a services business is monitoring the profitability of a project based on the billable staff directly responsible for the project but not accounting for non-billable staff who are spending time on the project.

For example, services businesses often have salespeople, account managers, or potentially even project management or other project oversight, spending time on a project but not billing the client.

Nothing is inherently wrong with unbillable staff working on a project, but it should be captured in your project-level profitability reporting. Time spent on a project is a cost regardless of whether the client pays. If the client isn’t paying for the work, the services firm is!

The fix:

1. Anyone who interacts with clients or contributes to client work should fill out time cards. Yes, this is unpleasant if it’s not the current practice. Yes, people will complain. Leadership should explain why this change is being made (to gain better insights about the business and the actual cost of servicing clients) and share the learnings as much as possible. This can be a good way for leadership to learn how much time goes into successful delivery and recognize the contributions of people who may not have been as visible.
   

2. Business expenses specific to a client or project should be recorded and calculated as part of the delivery cost.
   
   That Adobe subscription a designer needed because the client insisted on Illustrator files instead of using Figma? Project cost.
   
   The AWS bill for a dedicated development test environment only used for this client but billed to an employee’s credit card? Project cost.
   
   Ideally, someone responsible for the project’s overall delivery tracks these expenses.

Not Fully Accounting for Client Management Costs

This is a variation of the previous pitfall. Here, project-level profitability fully reflects non-billable costs on a project basis, but client management costs are not being accounted for in reporting.

This is more common when multiple projects are active with a single client, and cross-project or more senior-level client relationship time is spent with client personnel. Again, there is nothing wrong with this activity occurring - it's often critical for success! - but it is a cost that should be reflected in the profitability of that client.

The fix:

1. Time and travel for client relationship building should be recorded similarly to project expenses. As relationships grow and a firm has multiple projects with a single client, it may take a lot of work to tie this directly to a specific project.
   

2. Over time, splitting this out as a separate line item may be helpful. One way to do this is to create a client management “project” in your time tracking system for this activity. This prevents hours that leadership may spend with a client on more top-level relationship discussions from distorting the client management that goes into a specific project.

Not Accounting for Pre-Sales Time and Expenses

It's common for services companies to invest in a client relationship or sales opportunity by spending time on pre-sales design, scoping, or engineering work. There is often non-billable expense tied to this activity, like travel to visit the client, entertainment expense for dinners, and so on.

Pre-sales time may be accounted for with the techniques mentioned above for existing clients, but how does this expense get captured for a prospect?

At the risk of being repetitious, there is nothing wrong with these expenses per se - it's the cost of doing business. However, they are often hidden sources of degraded performance that can only be uncovered with discipline.

Knowing how much it costs to land that big deal and whether that client relationship will ultimately be profitable is helpful.

The fix:

1. Establish some threshold for tracking pre-sales time and expense. There are diminishing returns for monitoring at a very granular level; for small firms, it can be too much. Having a threshold like “spending more than 8 hours building a POC or custom sales material” or “spending more than $2,000 on travel to visit a prospect” goes a long way to maintaining everyone’s sanity and capturing the costs that add up.
   

2. Record time and expenses for pre-sales with prospects above that threshold. This can be done by setting up a prospect as a client but marking all the time and expenses as non-billable.
   

3. Periodically review pre-sales costs. Once you’re tracking these expenses, you can check in monthly, quarterly, and yearly on the costs associated with selling and check to ensure they are good investments when a deal closes.

Not Taking Action

With the data outlined above, producing reports on the profitability of projects and clients becomes easy. Armed with this information, the leadership of projects or client relationships have the insight needed to know how profitable a project or client actually is. The pitfall some services firms fall into is having data about clients that are not profitable but not taking action.

Ideally, this information informs decisions about existing projects, like doing unbillable work to fix problems with delivery, adding more senior staff than you previously planned to help with a thorny issue, and so on. It also helps guide future decisions.

It also comes up when there is staffing contention (e.g., all other things being equal, it’s best to allocate billable staff to the most profitable projects or clients). Similarly, this data is used in pricing future work (e.g., a client with low profitability may need future work priced at higher rates, whereas you could more readily negotiate pricing with a client when their other projects have high profitability).

What happens when the data shows unprofitable projects, but something else is needed to correct the problem?

The fix:

1. Identify a single person who has responsibility for managing the profitability of a project/client. This can be a different person for each client, but the key is to have someone who knows it is her job to manage profitability. That person needs to be empowered to make the necessary changes to “fix” the problem, whether it’s working with the client to change rates, adjust staffing, etc.
   

2. Review client-level profitability monthly as a leadership team and set target profitability levels that every project should attain. If a project or client falls below that level, develop a plan to address it and measure progress against that plan.
   
   In some cases, nothing can be done immediately - the project is already sold and staffed, and success for the client requires it to be delivered in a way that isn’t very profitable. It happens.
   
   Leadership should ensure that the next project for that client gets priced more appropriately or that, over time, the focus is given to projects with better financial performance.

✌🏼 That’s it for this week. Don’t forget to submit your questions! I can’t wait to share these new collaborations with you. Make sure you don’t miss out when they get published by subscribing below.

Before starting the process, the first question to answer is: why sell?

Motivations to sell

There are three reasons most owners want to sell: liquidity, growth, or to transition to something different. Sometimes it's a combination of those reasons. Understanding the motivation to sell is vital because it helps determine the types of buyers to consider and how to approach the process.

Liquidity

At the risk of stating the obvious, if the owners want to make money by selling the business, the business has to be valuable enough for a buyer to pay for in cash or some other liquid asset (e.g., public stock).

In this scenario, strategic buyers - that is, other companies that want to acquire some combination of your talent, revenue, or other operational value - are the most likely to be a match. These buyers can use a combination of cash and stock (if they are publicly listed), creating a liquidity event for the seller(s).

Private equity firms can also be buyers, but they typically are looking for some or all of the management to continue working in the business. Often a significant portion of the proceeds from a sale to private equity is in stock that may not be liquid (there's a reason it's called private equity). The equity component incentivizes management to stay involved with the business and drive growth. This creates the possibility of two liquidity events: one when the sale occurs and a second, future sale after the company grows. The second liquidity event can often be larger than the first, leading to a better financial outcome for owners willing to remain active in the company.

Growth and Operational Excellence

Sometimes services businesses get stuck and need help continuing to grow in size. Other times, a services business may be growing but sees an opportunity to accelerate that growth by combining it with another company or to protect its competitive advantage in a market.

Strategic buyers can help with growth, but it may look different from it would with a private equity buyer. A strategic buyer often wants or needs to fully integrate the acquired business into their own. So, while the components that come from the sold business are still growing, it's happening in a broader, existing organizational context. Occasionally a strategic buyer may keep the acquired company separate. It's rare, and often they end up getting integrated eventually.

Private equity buyers are very good at helping with growth. Although every firm is slightly different, they are generally financially and operationally disciplined. Their goal is to acquire businesses that complement their capabilities and portfolio, increase their value, and sell them.

Another critical aspect of growth is operational excellence. As services businesses grow, the processes, tooling, and sophistication of operations also need to improve. Both strategic buyers and PE buyers can help with this.

Transition to something different

Sometimes owners actively involved in the business want to transition to doing something new/different. They don't want to continue being involved in the business to help grow it. What they've built may need to be more valuable to generate a significant liquidity event, but the company may be doing well enough that it doesn't make sense to shut it down.

This is a tough spot for owners. Finding a buyer for this kind of business is usually tricky. Unless the owners have taken steps to transition out of the company's day-to-day management for some time, buyers may not see enough value to pay for the business.

The takeaway: owners need to be honest with themselves about why they're selling, what they expect to gain, and the range of options available to them as a result.

How services businesses are valued

The simple explanation usually given is that services businesses are valued based on a multiple of revenue or EBITDA.

While this is true, the complete answer is more complicated. Many factors influence the multiples used, including:

• Growth rate: A company with an excellent track record of year-over-year growth is typically worth more. It is sometimes possible to get credit for future growth, effectively making it a “forward multiple” if the backlog is robust and shows an acceleration of the business.

• Nature of services: Modern capabilities using technologies in high demand and not viewed as a commodity will command a higher multiple. Older technology or commoditized services will fetch a lower multiple, all other things being equal.

• Size of the business: Strategic and PE acquirers have a target company size they are looking for, typically measured in revenue. Selling a business with below $10M in revenue can be difficult. It generally gets more straightforward as the revenue of the seller's business increases.

• Geographic considerations: The geographies from which services are delivered, and the geographies of clients, often influence multiples. If the staff of the company selling or the companies they sell to are in a jurisdiction with geo-political risks, that may reduce the multiple or eliminate buyers from consideration.

• Client concentration: If too much revenue comes from one or a small number of customers, the multiple may go down compared to a similar business with less concentration.

• Net revenue retention: How much revenue is "retained" year-over-year with existing clients can be a significant factor in valuation. This metric measures what percentage of your revenue in year N was generated by the same clients in year N-1. High net revenue retention - in the 80% range or higher - is typically much more valuable because it shows durable client relationships.

• Intellectual property: This often comes in the form of accelerators, proprietary processes, or tooling that would be hard to replicate, which can differentiate the services provided to clients. Note that this is not product revenue; having revenue from something other than services often complicates the valuation process and rarely works to the seller’s advantage.

• EBITDA: Lower profitability can be overlooked if other aspects of the business are attractive, but the company needs to demonstrate it can be profitable. High gross margins, a track record of scalable growth, and high net revenue retention are the best combination for overcoming low EBITDA.

Finally, the way the sale occurs influences value. A competitive sales process with multiple prospective buyers will generally increase the value. A sales process with only one buyer has no competitive tension, so the company selling may be valued lower.

The takeaway: Understand the factors that affect valuation so you can maximize the value of the business. For this strategy to be effective, there should be a track record of at least a year of the positive aspects of the business’ performance. Run the business accordingly!

Ways to find a buyer

There are three ways sellers typically find a buyer:

1. Cold inbound from a prospective buyer

2. Organically, through networking with the leadership of businesses that could potentially acquire them

3. Working with an investment bank to run a sales process where the bankers use their network of prospective buyers

Cold inbound is rare, but it does happen. These types of transactions are usually not the best outcome for the seller because there is no competitive tension to maximize the value of the business. Also, because the buyers and sellers meet initially in the context of a potential sale, it can be hard to judge if there is a good cultural fit. Owners can't assume this will happen, so if they want to have any control of their destiny, they must look at other options to find a buyer.

Organic connections that lead to sales are better than cold inbound because the buyers and sellers have gotten more familiar with one another outside the context of a sales transaction. Finding any buyer organically through one’s network can be challenging. Even if you find a prospective buyer, it can be hard to create competitive tension in these transactions. There are only so many prospective parties that most companies can bring to the table.

A sales process run by an investment bank typically maximizes the value of the company being sold and the likelihood of a successful transaction. Sell-side investment bankers generally have done dozens of transactions and have a broad network of prospective buyers.

While an investment bank may have the best outcome, it does come at a cost. The seller pays the bank for its services, and the sales process can be very demanding. Selling a business to cold inbound or organic connections can be simpler, but the process is usually out of the seller's control.

The takeaway: even if owners may never want to sell or know they're not ready to sell yet, developing a network of prospective buyers and investment bankers is helpful. You'll get to know who you like in a lower-pressure setting, and they'll already know about your business when it comes time to sell.

Consider what type of buyer is suitable for the business and the sellers

Given all the factors above, consider what type of buyer would be attracted to the company and what type of business meets the sellers' goals.

So much of a sales process revolves around the price that it can be easy to lose track of an important fact: at the end of the process, the leadership of the company being sold will stand in front of their employees to tell them what happened. Essentially, the owners or leadership are picking their employees' next employer.

For anyone involved in the business after the transaction closes, the culture of the buyer matters. Making a decision based solely on price is easy - it's a quantitative exercise. After money changes hands, though, it's all about the people. The cultural component is a much more qualitative consideration. You should like each other!

The takeaway: Sellers should have some opinion about the ideal buyer for their business. Strategic vs. PE, the type of company culture that will be a fit with management and employees, and what type of combination is the most likely to motivate people to succeed are essential.

Make sure you're ready for the type of sales process you intend to run

Selling a company is not easy. Most founders or CEOs who have been through the process will tell you it is one of the hardest things they have ever done. The company's leadership involved in the sales process should be prepared because it will be stressful, distracting, and time-consuming. Success is not guaranteed. Many transactions fall apart between when a letter of intent is signed to literally minutes before the closing.

All transactions require some level of due diligence. How intensive that process is will vary, but it always involves sharing details about legal agreements, finances, taxes, and every aspect of business operations.

A sales process where a buyer and seller work together directly without bankers may be shorter and more straightforward but still very demanding. Less due diligence may be required if the buyer is a private company. A public company has obligations that require a much deeper level of due diligence.

The due diligence process is critical to closing the transaction successfully. It requires supplying lots of documentation and answering many questions the sellers may not anticipate. The process is (slightly) less stressful if you have as much documentation as possible ready in advance. Investment bankers help tremendously with this part of the process because they know the information needed for diligence and can anticipate buyers' questions.

The takeaway: sellers should make sure they are prepared for the sales process mentally and in terms of having business matters buttoned up. Needing to find critical business documents, dealing with major legal matters, or being distracted by significant family or personal issues is a recipe for disaster.

Determine who will be involved in the process (and who won't)

It's crucial to figure out in advance who will be involved in the sales process. The most senior management in the company typically must be involved. There will be conversations requiring senior management participation, and they will normally need to support due diligence requests.

Beyond senior leadership, owners need to consider how widely known to make the sales process. Telling employees may create counterproductive stress. Not every attempt at a sale will result in a transaction happening, so it can create pressure for no reason.

Also, once you begin serious discussions with a prospective buyer, NDAs are required for everyone involved. The people who can know about the sales process at this stage are usually very limited, especially if the buyer is a public company, because the details of a potential transaction may be material, non-public information. Employees who know a sale is being considered will want information that management can rarely provide. This can create even more stress.

If you tell employees, it's also very likely that customers will find out. If customers find out one of their vendors may be sold, it can create unnecessary stress. The reality is that buyers and sellers are highly motivated to make sure business with customers is maintained due to an acquisition. Still, customers may worry and change their buying patterns during a sales process, leading to additional complications for the sellers.

Sellers will need support in a few areas that typically require third parties. Lawyers familiar with the company's legal matters and these business transactions are critical. Accountants and tax professionals familiar with the company's financial records and tax filings are also needed.

The takeaway: consider how widely known the sales process will be within the company. Generally, the fewer people involved, the better. Sellers will benefit from having employees and as much management as possible focused on "business-as-usual" operations. The fewer people that know reduce the chances of sensitive information leaking to customers. Also, the buyer will likely require the sellers to restrict information about the sale.

Get started

All this preparation is just the beginning. I’ll be covering the actual sales process in a later post!

1. What type of sales model is appropriate for the services being offered?

2. Are you using a “seller/doer” or dedicated salesperson(s) within that sales model?

3. How do you compensate the people selling?

I wrote about picking sales models and services offerings a few weeks ago. For today’s post, I’m focusing on cases where “direct sales” is the answer to question 1.

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Let’s consider questions 2 and 3 to set up some critical context for the rest of the post.

The evolution of sales in a services company

The sales function typically goes through stages as a company grows and matures:

It usually starts with a founder doing all of the selling using her network. At some point, the company reaches the point where having someone dedicated to selling is needed to continue growing at the same (or faster) rate.

Question 2 determines which fork in the road is taken: is it better to have a dedicated seller/doer or a dedicated salesperson?

A seller/doer remains involved in delivering work - usually in a billable capacity - while also selling.

This can work well with high-touch, strategic- or management-consulting style engagements. It also works well when the relationship with the client is expected to be long-term (i.e., multiple years). The seller/doer typically has a high degree of expertise in delivering the work and is usually involved with only one, or at most two or three, clients at once.

A dedicated salesperson is focused on account and relationship management. They do not participate in delivering the services at all. As a result, they usually need to involve someone from a delivery team in defining and scoping engagements. A dedicated salesperson is dedicated to selling, but not necessarily to a single client or prospect. A dedicated salesperson can interact with more clients and prospects than a seller/doer.

For today’s post, I will focus on this dedicated sales approach because it’s the one that most often requires sales commission plans. It can be helpful to see the implications of this path before you get to the “at scale” version, too.

Sales commission plans

One component of this is creating a sales commission plan that encourages the desired behavior of salespeople.

Of course, all good salespeople want to sell. Encouraging the desired behavior means focusing on the right kinds of opportunities for the business. It is also one of the hardest things to get right.

All sales commission plans run the risk of unintended consequences. The second-order effects of a seemingly simple decision can be hard to predict. For example, suppose there is no way to “make up” a quota miss in a previous quarter in a future quarter.

In that case, a salesperson may sub-optimize an opportunity that is close to closing to get it to close in the quarter, even if spending a couple more days might lead to a more significant deal that is better for the business. Sub-optimizing could mean reducing rates to speed up approval by the prospect, shortening the length of an engagement, or cutting corners on scoping.

As services companies grow into hundreds or thousands of employees, sales commission plans may, by necessity, become more complicated. Today I will focus on building good commission plans for smaller businesses.

Creating good commission plans

Good sales commission plans echo the top-level business objectives and strategy, particularly concerning revenue growth and profitability targets. If these objectives aren’t well-defined, sales commission plans are quickly muddied.

Bad commission plans often include lots of different levers or variables and are hard to administer because the underlying data to calculate commissions is hard to get, and the calculations are burdensome.

In a typical dedicated sales commission model, 30-50% of a salesperson’s compensation will be from commission. Think about the “on target earnings” (OTE) of a salesperson who meets their quota. Whatever that number can be decomposed into these three components:

Commission on revenue

Approximately 30-40% of the overall commission should be based on invoiced (i.e., recognizable) revenue.

Commission plans that reward bookings rather than revenue may incentivize selling large deals that may never generate the total value of the booking. This can create a significant cash flow burden on the business because commission payments must be made without the receivables to fund it.

Commission on project margin

Another 30-40% of the commission should be based on achieving a project gross margin target. This component can be scaled where more commission is earned as the margin increases. For example, a higher commission percentage might be paid above a percentage of realized project margin. Similarly, the commission earned would decrease if the realized project margin decreased.

This aligns the salesperson's interests to maximize the profitability of the business. Without this being a significant component of their commission, a salesperson may be tempted to sell projects at a lower (or zero!) gross margin because it's easier to win business, and there is no penalty for doing so.

The key to calculating this margin component is to have reliable, repeatable data on realized project margin that can be tied back to the opportunity the salesperson sold. This can be harder than it sounds! If you aren’t already producing monthly reporting on actual project margin, ensure you can create that report before introducing this commission component. (I've written about pricing projects and estimating labor costs before.)

Commission based on quota attainment

The remaining percentage of the commission should be based on achieving quarterly quota targets. The quota target should be a stretch goal that is difficult but attainable. If every salesperson is hitting their quota every quarter, your quotas need to be higher! Aim for 60-80% of salespeople to make their quotas.

Commission plans should allow for a trailing quarter quota recovery. A salesperson who misses their quota in one quarter can recover that quota attainment commission if they exceed it the next quarter. For example, if the quota wasn’t met in Q1, but in Q2, a salesperson crushes it and exceeds their Q2 quota (achieving their Q2 quota and completely making up for the shortfall in Q1), they would get their Q1 and Q2 quota attainment commission.

The leadership of the business can consider extending this quota recovery benefit to any quarter within the fiscal year. This gives more flexibility to the salesperson, and, as a small, private company, quarterly targets may be less critical than yearly targets.

In this scenario, a salesperson could, for example, narrowly miss their Q1 and Q2 quota, meet their Q3 quota, and in Q4 close a monster sale. The Q4 win achieves their Q4 quota and makes up for the shortfall in their Q1 and Q2 quotas. As a result, they would be paid quota attainment for all four quarters.

Doing this prevents destructive behaviors like selling a smaller deal in the current quarter because it’s easier to close than spending more time and having it slip to the next quarter. It also rewards good behaviors, allowing a salesperson who legitimately had a lousy quarter to dig themselves out through high performance.

Other commission plan considerations

There are a couple of other things that should be included in commission plans - subject to the laws in the jurisdiction they’re being used in - to protect the business and salespeople:

Reserve the right to change commission plans at any time

The provision to change a commission plan should be invoked rarely and only when it is essential to address a critical problem with the business (e.g., severe financial distress that could be business-ending) or an unintended consequence of the plan that is unfavorable to the salesperson.

Sales personnel should have confidence that the ground won’t move underneath their feet unless it’s really important for business success. If leadership needs to make an off-schedule change to commission plans, it should be coupled with good communication explaining why it’s necessary.

Commission plans terminate immediately upon the termination of employment

This creates clarity for both parties about what happens if a salesperson’s job is terminated. Commission agreements should be clear about when a commission is considered “earned” because all earned commissions must be paid to a terminated employee.

Some states in the US also have employment laws that require the payment of commissions to terminated employees on a particular schedule - sometimes much faster than a normal payroll cycle. It’s always a good practice to have an employment lawyer review commission agreements and ensure that the business is operationally prepared to comply with local law.

Grandfather legacy commission agreements for fairness

Changing commission plans always creates stress for salespeople. Business needs and evolving business conditions also generate pressure on leadership. It’s essential to be fair to both parties. If a change to a commission plan significantly disadvantages or demoralizes a salesperson, it’s terrible for both the salesperson and the business. One way to rectify this is to grandfather some legacy commission plans for specific accounts, opportunities, or a transitional period.

Putting commission plans into action

I’ve covered the key components of what goes into a commission plan. Now what?

Rolling out a commission plan will go more smoothly with the following planning:

1. Work with a lawyer to draft a commission plan agreement template addressing the above points. Key numbers that may change, like the commission rates on revenue, margin, and quota attainment, should be highlighted so you can adjust them as you model different variables in the plan.

2. Model different scenarios for each salesperson to see how much commission would be paid in a worst-case, average-case, and best-case year. It’s helpful to have a spreadsheet-driven model where you can plug in the variables of revenue and average project margin by quarter and see how that affects commissions.
   
   Consider it through both the company’s lens (“is this in line with our budget for SG&A expense?” and “will we have the cash to pay this when it’s earned?”) and the salesperson’s lens (“is this fair compensation for performance and in line with OTE expectations?”).

3. Test the business’ ability to report on the sales and invoicing data necessary to calculate commissions. One good way to do a “dry run” is to try to generate a spreadsheet with sales commission calculations for the previous quarter before rolling out the plans. Does all the data exist in CRM systems, invoices, etc.? Is the process repeatable every quarter?

4. Communicate with the affected salesperson(s). Like any change to compensation, this may have legal implications depending on the company’s existing employment agreements and where the company operates. Beyond being legal, it should be seen as a “win/win” by both parties: motivation for the salesperson to perform and motivating for the company to support the salesperson's success.

✌🏼 That’s it for this week. What have you seen work - or not work - in commission plans?

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Three categories of forecasting

It’s useful to think about revenue forecasts in three categories:

1. Backlog: The amount of revenue you would recognize by delivering only the work to which your current clients are contractually committed, as covered last week.

2. Pipeline: This is work that has not been sold yet, but you have some “line of sight” to finding and closing. Of course, different opportunities in your pipeline may have different levels of certainty, so each contribution to the pipeline should be weighted to reflect the probability of closing. Also, there is usually some future pipeline you expect to develop from sales activities but are not far enough along (yet) to connect to a specific customer.

3. Soft Commit: This type of forecast is from work that sits in between the first two categories. It is work that you don’t yet have a signed contract for, but it is virtually guaranteed. You may have a verbal commitment from a customer, a contract may be in the process of being signed, etc.

With these categories in mind, let’s revisit our forecast from last week.

Forecasting all categories of future revenue

Adding a column to the table from last week’s forecast table allows each row of the forecast to have a “forecast type”. As a result, the same customer may appear multiple times:

In this example, we have Acme Corporation with backlog through August and a soft commitment for work extending through the end of the year. This fictional scenario is pretty common, where an existing customer has work that is “in flight” and knows that an extension is needed and has already verbally agreed to it. Similarly, we have Initech with soft commitment overlapping with backlog. This could be a case where we know the team needs to grow to accommodate the work that has already been sold and needs to continue longer to do knowledge transfer or ramp down.

Conversely, we have Globex Corp, which has pipeline appearing beginning in June. This fictional scenario could be a case where a new opportunity has developed unrelated to the existing work appearing in the backlog. The example above could be a similar amount of work as the existing project but weighted at 50% because of uncertainty about whether the opportunity will be won.

Finally, we have some new companies appearing with only pipeline numbers. InGen and Stark Industries weren’t in the forecast example last week because they aren’t current clients. They are new prospects with varying degrees of certainty around whether the work will be won. And, as the forecast gets close to the end of the year, we have a placeholder labeled “Customer TBD” for one or more new customers who we expect to contribute to the pipeline.

Analyzing forecasts by category

This decomposition of the forecast by category shows how much revenue is coming from each category in total by month:

Reviewing forecast to actuals every month will reveal important sources of variance:

• Backlog that wasn’t recognized for some reason. As discussed last week, this could be from a variety of causes. Assuming the work is continuing with the client, it can usually be easily corrected in future months’ forecasts.

• Soft commit forecasts that didn’t convert to backlog as expected. This can be particularly worrisome for work you thought was all but guaranteed hasn’t been signed and usually warrants investigation.

• Pipeline that didn’t convert to backlog as expected. Of course, not every individual opportunity in a sales pipeline will convert, but in the aggregate, it is helpful to be able to accurately forecast the sales pipeline’s contribution to revenue. It can be helpful to examine variance from both individual opportunities and in the aggregate to make the forecasting process more predictive.

Visualizing the forecast by category as a stacked bar chart is easy from the pivot table view and can also be helpful:

This visualization highlights where and when the composition of a forecast gets more (or less) risky.

Assessing the generation and probability of pipeline

One of the biggest challenges to this type of forecasting is accurately forecasting how much new pipeline can be generated and the probability of an opportunity to close.

Without a lot of data from historical opportunities that have been closed (either won or lost), this process can be more art than science. Initially, monthly reviews of pipeline forecasts and variance are the best way to get more accurate. Focusing on minimizing “downside” variance - being surprised about a lack of pipeline or lost opportunities - is the most beneficial place to start.

Over time, a more data-driven approach can be adopted as a business gets more predictable. Metrics can help estimate pipeline value by looking at things like:

• win rate percentage

• lead-to-opportunity conversion rate

• average initial opportunity value

• average duration from opportunity identification to win/loss

Just start

This forecasting method may feel uncomfortable initially, especially in organizations that have been successful through “just figuring it out”.

As businesses scale, this kind of financial discipline helps solve (or prevent) the challenges that come with bigger teams, bigger revenue numbers, and more people involved in the sales and delivery processes.

The best way to overcome the discomfort of an unfamiliar process is to just start. Don’t let perfection be the enemy of good.

✌🏼 That’s it for this week. Are there topics you’d be interested in seeing covered in this newsletter? Drop a comment below and let me know.

The month just ended. Your instincts were telling you this would be a great month for revenue. Very exciting! Invoices get generated. You look at the total, and… it’s much less than you expected. The knot in the pit of your stomach comes back.

“What happened?” you ask.

Surprises are scary

🔮 Being able to forecast revenue significantly reduces the chances of being surprised by those “down months”.

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When you do get the occasional surprise, the tools used for revenue forecasting give you a framework to figure out:

1. What happened

2. How to get better to prevent the same type of surprise in the future

Early-stage services founders and management teams sometimes avoid trying to forecast their revenue. They may think it’s just not possible, it’s not worth the time, or their instincts are “good enough”.

Nothing could be further from the truth.

It is possible, and the insights and peace of mind that come from predicting the future enable better business decision-making with less stress.

And - no matter how good one’s instincts are - eventually, the business will outgrow the ability to be managed by gut. (This is a great problem to have!)

Today I’m going to focus only on forecasting revenue from work that’s already been sold. Forecasting revenue from your sales pipeline is easier once you can forecast existing work.

Total backlog is (the start of) the answer

💭 The central concept to forecasting revenue from work you’ve already sold is backlog.

In its simplest form, backlog is the amount of revenue you would recognize by delivering only the work to which your current clients are contractually committed.

The way you calculate that varies depending on the contractual structure:

• Time & materials without a not-to-exceed (“NTE”) clause: estimating the total billable hours remaining multiplied by the rate(s) for each category of hours you can bill

• Time & materials with an NTE clause: same as above, but capped at the NTE value

• Milestone: the total of all currently un-billed milestones

• Fixed fee: the full contract amount minus the amount you’ve already invoiced

You can go through this exercise and get a simple table that would look like this:

In this fictional example, if you didn’t sell another dollar of new work, you’d be able to recognize just under $4.1mm of revenue. This is helpful because it gives you a sense of how much revenue is in your future.

What’s missing? When that revenue will be billed.

Backlog by month is the next step

🗓️ Understanding the timing of when work is being invoiced is critical to running a services business.

Once you have the total backlog, you can decompose it for each client by month, distributing the revenue over time.

In this crude example, you can see some projects are starting and ending in different months, some projects have ramp-up/ramp-down times, and some projects have milestone-based revenue:

This is a crude example partly because it doesn’t account for the number of working days in a month. The fact that February is three days shorter than March distorts the backlog in both months.

An improvement of this analysis is to look at the billable days in each month (shown below as the number above each month) and estimate the daily revenue per client by the number of working days:

You can see that this approach leads to a backlog by month that can vary by as much as -7.8% to +3.7% compared to the previous approach. This is getting much closer to an accurate forecast of when revenue will be recognized!

You can imagine getting even more accurate still by taking into account vacation time and unplanned absences.

📈 Graphing the backlog enables you to easily see trends with individual clients and how revenue changes month to month.

This is an easy visual to create that is a crystal ball into the future of the business. It reveals when projects are ramping up and down, when milestones are occurring, and the big-picture trend line of revenue.

Analyzing variance is a superpower

🤓 Comparing actual revenue invoiced to the revenue forecast reveals where estimates were off so you can become more accurate.

Refreshing the forecast and comparing it to your actuals will highlight sources of variance. Some common problems that lead to variance are missing timecards, time off that wasn’t forecasted, or conditions at a client changing, causing more or fewer hours to be worked. This allows you to correct the underlying problem or update your forecast accordingly.

Doing this month after month will result in better forecasts and fewer surprises.

✌🏼That’s it for today. If this was helpful, it’d mean a lot to me if you like this post below.

If this sort of how-to guide is helpful to people, I’ll do a follow-up to it that shows how sales forecasting fits into this type of model.

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☹️ Headline numbers aren't great. While Q4 and FY22 revenue was above their guide from Q3, earnings per share narrowly missed consensus expectations of $1.02. There are always revenue headwinds in Q4 because it has fewer billable days, but this most recent quarter was also worse by most measures compared to 4Q21 suggesting there is more at play than seasonality.

📉 Top-line trends have been very concerning. While revenue was growing in 2021, that growth decelerated quickly in 2022. Their 2023 Q1 guidance of -1.0% to flat revenue YoY on a constant currency basis shows that the top-line headwinds have momentum.

💰 Cognizant's book-to-bill ratio has been relatively flat for most of 2022 but did show 12% YoY growth in Q4. Cognizant also announced in January inking a 10-year renewal with CoreLogic for $1B. Assuming this deal was booked in Q1 of 2023 and not in Q4 of 2022, the Q4 growth number could bode well for Q1 being another strong quarter for bookings. However, if the deal was booked in Q4 and only announced in Q1, the pipeline picture is much fuzzier.

🥾 Leadership changes were needed. Former CEO Brian Humphries was abruptly replaced in January with Infosys veteran Ravi Kumar. Kumar was originally hired to fill a vacant position in the Americas. Other board and leadership changes have also happened, and all signs point to a feeling that the shake-up was needed to focus on growth.

🤔 Demand seems hard for leadership to gauge. From Kumar on the earnings call:

"It will take time to rebuild the pipeline and go after larger opportunities. Please know we put a lot of thought into our decision to hold off on providing full year guidance. But before making commitments I can stand behind, I really need to spend more time digging into the business and talking to associates and clients."

It's hard to tease apart how much of this is softening demand due to macro conditions vs. demand that could be there with improved sales execution.

🐢 Utilization headwinds coupled with significantly slowing attrition must have hit operating margins. In Cognizant's 3Q22 earnings call, then-CEO Humphries highlighted the work leadership was doing to counteract a wave of voluntary attrition. Those efforts appear to have worked or benefited from the broader tightening of the labor market. Quarterly annualized voluntary attrition slowed from 29% in Q3 to 19% in Q4. Utilization also decreased sequentially, with offshore utilization (exclusive of trainees) going from 83% to 81%, and onshore utilization going from 90% to 88% (the lowest its been in three years). It's possible that leadership underestimated the softening of demand and overestimated the actions they needed to take to manage attrition to achieve target staffing levels.

🏦 Financial services has been a particularly weak segment. Revenue shrunk 1.4% on a constant currency basis. Although some of the revenue reduction came from the sale of a subsidiary, it only explains about 40% of the decline. This segment stands out as the other three segments posted between 5.4% and 9.3% growth for the year in constant currency.

In the commentary, Cognizant also revealed that bookings declined the most in this segment as well. As a result, I suspect this weakness will persist for at least another quarter. Financial services is a very heterogenous sector in the current macroeconomic conditions: while some areas like mortgage and capital markets have been hard hit by cost-cutting, others like deposits and lending are areas of investment in the current rate environment.

The key question: is Cognizant losing deals to competitors in areas where investment is happening, or is pipeline shrinking because of concentration in areas that do poorly in high rate, potentially recessionary periods?

What should early-stage services businesses do with this information?

I think it’s helpful for early-stage businesses to see how established public companies talk about their performance and what they see happening in the market.

No early-stage company should try to emulate a public company’s predictability or governance, but there are useful cues in their analysis and the commercial trends they see.

Three things stand out to me from Cognizant’s latest earnings for early-stage services businesses:

• The combination of decelerating revenue, slowing pipeline, decreasing voluntary attrition, and decreasing utilization is a powerful cautionary tale. A company the size of Cognizant has the capital to withstand suppressed operating margins for a while. And yet… even they needed to make significant changes.
  
  Lesson: React to declining business conditions faster than you think necessary.

• The macro-environment may not be as bad as some people think, and digital services remain durable during economic downturns. While there was some talk of fuzzy macro factors, my read of the earnings commentary is pretty positive in that regard. Given the headwinds faced by Cognizant from factors within their control, there was reasonable constant currency revenue growth in three of their four sectors.
  
  Lesson: If you’re doing high-value digital work, there are still many growth opportunities.

• If you’re competing against Cognizant in accounts where they are well-established, expect it to be brutal. There is immense focus on growth right now, and Kumar talked about wanting to do bigger deals. I would bet there will be intense competition to win every possible deal in large accounts where Cognizant already has a strong foothold. They are working on longer timelines than smaller, niche players and have an under-utilized bench that they will be eager to deploy.
  
  Lesson: Understand the motivations of your competitors and where you may face threats inside of accounts you think are safe.

That’s it for today. This is the first time I’m sharing this kind of analysis here so I’d love your feedback. Did I miss something? Leave a comment.

Do you want to see more writing like this? Take the poll below to let me know.

Time & materials (T&M) projects are the easiest professional services proposals to price, yet they are often where services businesses get into trouble. Labor costs of billable staff are usually the largest single expense category for a professional services company. Estimating the gross margin of a project accurately is critical to running a profitable services business.

So, how do you avoid the pitfalls of pricing mistakes eroding your profit? It starts with accurately estimating a project’s gross margin…

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Labor Cost Estimation Techniques

Estimating a project's gross margin requires estimating the actual costs of the staff being used to deliver the work. The difference between the revenue generated by the billable staff (their rates) and their costs is your gross margin. But first...

Why Not Use Actual Labor Costs?

It's tempting to try to use actual labor costs. If you have a small team, actual labor costs may be easy. The challenges with actual labor costs creep in quickly, though:

1. Changing staff on a project can cause gross margin surprises. If you have to make a staffing change on a project, the chances that the new staff member costs exactly the same as the staff they are replacing is low. Other pricing strategies will help ensure that your gross margin doesn't fluctuate by surprise when staffing changes occur.

2. As more people are involved in pricing projects, using actual labor costs becomes more complicated. As services companies grow, more people typically get involved in pricing a proposed project. When only one person (typically someone senior in the company) is doing pricing, it's easy for them to know how much every billable staff member costs (i.e., how much they make and their fully loaded cost). This becomes more complicated and more sensitive as you have more people. You may not want everyone responsible for pricing projects to know everyone's salary. Even if you did, you'd have to keep the people pricing projects abreast of salary changes.

3. Every time you add billable staff members to the company, you have a new expense to track. This makes it hard to keep pricing calculators up-to-date and easy to use.

Single Blended Hourly Cost

A single, blended hourly cost is the easiest solution for small teams that are typically doing the same type of work without wide pay ranges. If all billable staff are roughly "fungible" in terms of the type of work they can do, this makes pricing deals really simple. In this model, you calculate the average fully loaded cost (i.e., inclusive of the costs of all benefits, etc.) of all billable staff.

Once you know the average cost (hourly, daily, weekly, etc.) of billable staff, then it's simple to estimate the gross margin: (billable rate - average fully loaded cost) / billable rate = gross margin. (This assumes that there were no non-billable expenses for simplicity - more on this in a different post!)

Hourly Cost Based on Skill / Discipline

The single blended hourly cost often breaks down when you have different skill sets or disciplines billable on projects where the staff members have different salary ranges. For example, you may have two or more different skill sets billing time on the same project. Each skill set may command a different hourly rate, and the staff performing that work may be compensated very differently.

A typical example of this is a project that has software engineers, visual designers, and a specialized skill set, like machine learning, all participating on the project. In such cases, the fully loaded costs of each type of resource are usually very different. Using a single blended hourly cost won't be accurate.

The simplest solution is calculating the average fully loaded cost by skill set or discipline. In this model, you apply the single blended hourly cost approach to each group of billable staff with a particular skill set or discipline to determine each group member’s fully loaded costs. From there, you calculate an hourly rate for each skill set and then can easily calculate the gross margin.

Hourly Cost Based on Seniority

This is a variation of the skill/discipline cost model. Instead of grouping billable staff based on skill or discipline, you group them based on seniority. If you have groups of billable staff with the same skill set but varying levels of seniority, it can be helpful to have some title or grade system corresponding to seniority. That title or grade is used when you present billable staff in each group to the client (e.g., junior-, mid-, or senior-level engineer) with different rates. Presumably, there are also different expectations about the work product by seniority.

Similar to the hourly cost model based on skill or discipline, you can calculate the average fully loaded cost for each seniority group. Based on billing staff at different levels of seniority to a client at different rates, you can easily calculate the gross margin for the project.

With a large or diverse enough bench, it may be necessary to adopt a hybrid of both skill set and seniority-based rates. In that model, you may have a rate card for the various permutations of skill levels in each discipline you have employees.

Other Gross Margin Estimation Considerations

Correctly estimating gross margin is necessary to be able to accurately predict the profitability of the business. Selecting the correct approach above is an important first step, but there are three places where errors often creep into gross margin estimation that can undermine the value of the exercise.

Billable Hours / Days In a Month

Each month of the year can vary slightly in terms of the number of billable hours or days in the month. Things like the total number of days in the month, where days fall on the calendar (i.e., # of weekdays vs. # of weekend days), and holidays all affect the number of billable days. When forecasting revenue, it's critical to know how many billable days are in the month and use that as the basis for the number of hours you're starting with to estimate revenue from each project. This has a material effect on gross margin because the amount of revenue generated by a billable staff member can change month-to-month, even if the project they are working on and their rate stays the same.

Accounting For Paid Time Off

Paid time off, like for illness or vacation, will occur in every business. Making allowances for it in your gross margin forecasts is critical. One of the most simple ways to do this is to review historical time card data to see the average number of days of absences in a month. You can then apply a percentage of missing days that decreases the number of billable hours on the project. Using this technique when forecasting future months’ revenue helps account for decreases in revenue that will degrade your gross margin.

A slightly more sophisticated forecasting model takes seasonality into account. In the United States, people tend to take more time off in November and December due to the Thanksgiving and Christmas holidays and in the early summer months. Over time, you may find that you can more accurately forecast the % of days off on a month-by-month basis and apply a variable adjustment to billable hours based on the month.

Consistency & Making It Easy

Gross margin estimation must be easy for people to do and be done consistently to avoid errors. The simplest way to do this is to create a "margin calculator" as a Google Sheet or Excel workbook that must be used by anyone involved in pricing a project. The calculator should hard code the input parameters for labor costs (based on the model you choose from the list above) and assumptions around the number of billable days and the PTO adjustments you believe is appropriate.

The only inputs the person pricing the project needs to provide on their own is the number of staff (potentially by skill set/discipline or by seniority, depending on your pricing approach), the duration of each staff member’s engagement on the project, and their billable rate.