The Scrappy Startup Advantage - Part 1: Production Costs

The Scrappy Startup Advantage - Part 1: Production Costs

Introduction

Note: This is part 1 of a multipart series. As more parts are released links will be placed here.

One of the biggest misconceptions and reasons for not starting a startup you might hear is that as an indie maker, you will never be able to compete with the existing monoliths in the market. 20 years ago, no one imagined you'd be able to compete with Walmart, with it's hundreds of billions in revenue and thousands of stores, reaching almost the entire US population, or that you could create an entertainment and media distribution network that would take on the likes of AT&T, Comcast or Sky, or that you would be able to create a communication network that could ever hope to compete with the existing mobile network providers who pay billions just for the right to use a particular  range of radio frequencies.

Yet, as though coming almost out of nowhere, the likes of Amazon, Netflix and WhatsApp in periods of time that previously were unheard of, have completely turned their respective industries upside down. Amazon now competes directly with Walmart in both reach and scale, Netflix has destroyed the entire video rentals industry and now looks to be on a path to do the same to traditional cable and satellite broadcasters, and WhatsApp, Viber, WeChat and other communications apps have all but turned the worlds mobile network operators into little more than wireless internet providers for millennial and Gen-Zs (With older generations slowly but surely following suit).

And these aren't one offs. Every large company in existence today had disrupted something before it. Google disrupted AltaVista, Yahoo, and traditional news outlets, Lenovo bought IBMs personal computer division when the later found itself unable to compete with the new competitor from the East (or several of those from the west), AWS and Microsoft Azure have resulted in the closing down of private and shared data-centers all over the world and seen commercial server sales stagnate[1] or at years even decline[2] during a period while software is taking over the world and worldwide computing power grows exponentially.

And all of this is no coincidence, just like people, large corporations also often follow a lifecycle. In 2017, there were only 60 companies in the Fortune 500 which were also part of the same group in 1955 and it is expected that by 2026 the average time a company spends in the S&P500 before it is replace will be 14 years[3]. As Corporations get larger, they also get slower, less efficient and more and more susceptible to a swift and sudden death.  Black swan events and regular worldwide recessions act as a plagues, wiping out the weakest and leaving space for new generations as well as the stronger survivors to fill their voids.

Most importantly however, is that even the healthiest of these companies aren't bullet proof, and even what seems to be the most insignificant outside threat, if moving swiftly enough and targeted strategically can bring the largest and healthiest company to it's knees. Research in Motion (BlackBerry) and Nokia were both very healthy and profitable companies before the iPhone came along and swiftly disrupted the mobile phone market, with Nokia famously mocking Apple, who while celebrating their one millionth iPhone sale, release a statement noting that they sell a million phones a week, just three years before Nokia found itself forced into a strategic partnership with Microsoft, which eventually ended in Nokia exiting the mobile market completely.

While there are many reasons why large companies, despite their billions in cash and access to resources out of reach to a indie makers and startup founders, are just as prone to disruption as anyone else, in this article I name a few of the inefficencies that large corporations suffer from which serves to weaken and slow them down, and the advantages scrappy startups have as a result.

Part 1 - Production Costs

Probably the biggest disadvantage corporations have is just the vastly greater direct cost of the production of software. Large corporation often spend multiple times what it would cost a single founder or small startup to produce software of similiar quality, with a team of software developers, QAs, delivery managers, business analysts, product managers, and entire structure of management and support staff in other places within the corporations, often doing no more work than one or two startup founders completely focused on a single vision.

There can be many reasons for this, and as unique as each large corporation might be, the reasons can be just as unique, however a few of the most common reasons are;

Total Cost of Employment (Per Employee)

The total cost of employment for a corporation is often far greater than just an employees base salary. Things like office space, HR resources, software, tools and benefits can see your wage grow to multiple times what your actual wage is, and far greater than your take-home pay, which is what you are giving up to start your startup.

Using London as an example location, and with a salary of £63,000 GBP, the mean salary for a software engineer, a company can often spend as much as £87,000 GBP on just the direct costs of employments, which includes on average £10,000 in office space costs for an office in Central London, £4,500 in average recruitment fees per year (13,500 spread over 3 years, the average length of employment for a software engineer [ref]), £7,500 in employer national insurance contributions, and £1,950 in employer pension contributions.

Additionally, many employers must offer benefits and incentives which could further increase this cost, such as health insurance, free snacks, etc. However i have not included these costs as founders would also need to provision such things for themselves.

The equivalent cost to the founder however, who often work from home or cafes, measured as opportunity cost, is £43,000 in tax-home pay, under half of the total cost for a corporation, before considering any other expense.

Dedication and Motivation

Note: As this section has limited solid research or accepted conclusions, and would be too difficult to generalize in any case, i have kept it purposely vague.

Dedication and motivation can be one of the most important factors in the output from a thought worker. And while this topic should be a blog post (and will be in a future post), or entire book of it's own, the corporate environment, with it's many rules, procedures and politics, can often find itself being a de-motivator for many employees. While this is difficult to measure, and definitely changes from person to person, with some people possibly being motivated even in corporate environments, however, a dedicated and motivated startup founder who's work has a direct impact on their own life, happiness and future sucess and wealth, can often be far more motivated and productive then your average corporate employee, willing to work greater hours and on evenings and weekends.

It is not uncommon for startup founders to be working 80-120 hours a week, 2x - 3x the typical amount required from a corporate employee, and while all 120 hours might not be efficent, if you've ever worked in a corporate environment you'd know that all 40 hours there aren't spent efficently either.

Total Employees Per Project

As a scrappy startup, you are most likely in a team of between 1 - 4 co-founders, with the average being 1.85 and as many as 45% being solo founders [ref]. 1.85 employees, at an average opportunity cost of just £43,000 per co-founder. There are no overheads for managing unpaid startup founders regardless of the size of the team that founds it, and so the cost per employee stays stable.

In a corporation however, project teams often include as many as 5 - 8 engineers, a delivery manager, a product manager, and an army of administrators, HR staff, middle management, upper management, management committees, personal assistants, receptionists, finance controllers, lawyers, auditors and more. All of which can be at varying salaries and all of which the project requires dedicated time from.

This means, that given an average team size of 5 engineers, with a single delivery manager and a single product manager, brings the cost per engineer up by an estimated £34,000 a year. Bringing their total cost of employment to around £120,000 GBP based solely on the additional employees required to directly run  a project within a corporation.

Even assuming that a corporate employee is just as motivated and works just as hard as a startup founder, this cost is still 3x the opportunity cost of each startup co-founder!

Meetings (AKA: The Soul Sucker)

Corporate environments often involve time requirements on all it's employees. Engineers are required to take part in standup meetings, weekly meetings, retros, HR meetings, refinement meetings, meetings of all shapes and sizes, including meetings about meetings, with often the only way to get out of a meeting being if you have another overlapping meeting.

Meetings take time, and when not managed correctly can have a massive impact on time and cost. Taking even the best case scenario for a software engineer in a corporate environment, a typical week might involve:

  • 4 stand up meetings at 15minutes each
  • Retrospective at 1 hour
  • 5 Lunch breaks, at 1 hour each
  • 15 coffee breaks at 10 minutes each
  • And 3 other random meetings, such as refinement sessions, HR meeting, department meetings, etc, at an hour each.

In total, this is 12.5 Hours of a 40 hour week spent in meetings. These timings don't include the time going back and forth to the actual meetings, time wasted for people to join, and time the meetings go over. And perhaps most importantly, nor does it include the time it takes to get back into the task the engineer may have been working on before being interrupted by the meeting, with estimates ranging from 10 minutes to 45 minutes to get back into "flow" after a disturbance.

But even taking the most optimistic view, and assuming all meetings last exactly as long as they are scheduled for and engineers can get back into work instantly, that is still 31% of the work week spent on meetings, lunch breaks, and other periods of time when engineers are doing something other than producing.

Do founders not take lunch breaks? Why yes, they do, however in my experience successful founders never waste time during their breaks, and it is not uncommon for them to eat while working, watching YouTube tutorials, or generally making better use of their time during such breaks.

In total, this brings the difference between the production costs of corporations to startups, at (optimistically) 4.4x. And that's before we include other activities such as emails, company wide events, and disturbances by other employees, which are all far from rare.

The "Enterprise Tax"

Ever go to the pricing page of a website to download a tool you need, or purchase a service, and notice the vast difference between the prices, with each plan seemingly adding little features, yet being priced at an unproportionally higher cost? That's the enterprise tax.

The enterprise tax is the increase in price vendors often add to their products and services which they target mostly at large enterprise companies. Features are often as simple as integrating single sign on, so that the IT department is more easily able to manage user access and the users do not have to remember additional usernames and passwords, however the price increase for this is often massive, with examples such as Postman increasing 125% for their enterprise version [ref], or Salesforce increasing by 500% between the typical plan taken by a startup and that by an enterprise customer [ref]. And yes, while it's true that many enterprises might negotiate the prices down, they definitely don't negotiate them down to be at the same price as is offered to startups, and nor is the negotiation cost free, as it takes valuable time and resources from the corporation.

Production Costs Conclusion

Overall, we see that even in a perfect world with no additional overheads per employee, and each employee working as hard and being as motivated as a startup founder, we still see that production costs are at least 4.5x the price within a corporation as it is within a startup.

When we next consider that some founders might work far greater hours, we see that the production cost might even be as high as 9x in some situations, where the £43,000 in opportunity cost for a startup founder might be equal to £387,000 in direct costs for a corporation to get similar output, and this is all before any indirect overheads.

More importantly however, all work is NOT created equally. And even with this already massive disadvantage, corporations are also riddled with inefficiencies that make decisions slow and error prone. In the next blog post, I will discuss some of these inefficiencies which can often see scrappy startups has a far greater advantage in simply picking the correct features to implement and avoiding rework or creating products which do not satisfy the requirements of their customer base.

Mahmoud Swehli

Mahmoud Swehli

Founder of Moodio

London, UK