Author’s note: This is a working document. My thoughts on the topic continue to evolve. I would be grateful for your feedback, and where appropriate I will incorporate it into future revisions.
As I read through various trade magazines, blogs, and on-line discussion groups, I perceive a fair amount of confusion among my peers about how we should market ourselves — what services we should provide, how we should package and price those services, how we should build our books of business, and how we can stay competitive and profitable. As I noted in an earlier blog posting, many of us seem to be searching for an identity. I propose that small business IT service providers can be identified — perhaps in discrete groups, perhaps on a continuum — based on the nature of our relationships between ourselves, our clients, and our technology suppliers. Specifically, I suggest that service providers can be consultants, contractors, and/or vendors. I contend that the blurrier the lines between these categories, the greater the potential for confusion among service provider management and for tension between providers and their clients. I also suggest that trying to be both a consultant and vendor is particularly problematic.
The small business information technology services profession seems to be in a constant state of reinvention. Not too long ago, the profession barely existed. Those who were selling technology to small businesses were generally selling hardware or software. Profits were generated through markups on these hard goods, and any services that were provided were generally delivered by the manufacturers or their authorized dealers and were related to the initial installation and integration. Prices were high, the products were complex, the small business market was difficult and expensive to sell to, and small businesses were generally on the lagging edge of technology.
Over the past 20 years or so, a number of structural changes in the technology marketplace have fundamentally changed how small businesses can acquire and use technology:
- Competition and innovation have brought the real cost of hardware way down, and profit margins for many types of hardware are approaching zero.
- Inexpensive, high-speed Internet access has lowered the cost of marketing and delivering services.
- Software manufacturers have identified small business as a distinct market and have created programs specifically customized and priced for this space.
- Downsizing in enterprise IT departments, increasing interest in IT among college graduates, and the general move toward a service rather than production economy has created a growing talent pool.
As a result of these and other developments, there has been a significant expansion of companies serving the small business IT market. The businesses that have been formed to meet this demand tend to be small businesses themselves. Consequently, it has been easy — perhaps even too easy — for these service providers to change their strategies and tactics as they try to find a formula for success. This has led to great volatility in the marketplace.
As part of this search for success, service provider owners and managers have sought structural role models. They have compared themselves to lawyers, accountants, doctors, hospitals, insurance agencies, builders, utilities, and other professions and industries. And although IT service providers do share traits with these other businesses in many ways, they are not exactly like any of them. Furthermore, many of these industries are the ones most reviled by consumers. So emulating these other professions may not be wise, even if it’s possible.
As small business IT providers develop their internal and external identities, I think it can be helpful — and perhaps even morally or ethically necessary — to consider exactly what type of business they want to be. And as I see it, there are three fundamental types of service businesses: consultants, contractors, and vendors.
Consultants, contractors, and vendors
I can’t at this point come up with useful definitions of "consultant," "contractor," and "vendor." Instead, I am compiling what I see as the key differences between them, as shown in the following table:
|Primarily sells||Advice||Projects||Parts or ongoing services|
|Duty to client||Act as if part of management team||Fulfill terms of contract||Avoid gross negligence|
|Source of profits||Markups on labor, possibly sale of intellectual property||Markups on labor, subcontractors, and raw materials||Difference between total sales and total cost of goods sold (less focus on markups of individual cost components)|
|Typical unit of sales||Time (usually hour, can be month if on retainer)||Project (often flat fee, can be time and materials)||Part or service (can be time and materials or monthly fee)|
|Level of interaction with top management||High||Medium||Low|
|Interaction with staff||Medium (for research) or low (for strategic planning)||Medium (for front-office projects) or low (for back-office projects)||High (for front-line services) or low (for sales of parts)|
|Key to success||Staff skills and experience, reputation, relationship management||Accurate cost estimation and control, good project management||Replicable and scalable processes, sales volume|
|Primary motivation||Client’s success||Project quality||Bottom-line profit|
|How to become a multi-millionaire||Very difficult in small business market; impact on clients’ businesses probably won’t justify exorbitant hourly fees||Identify a market niche where demand greatly exceeds supply and where clients’ return on investment justifies high project fees; grow business by scanning for new opportunities||Keep labor costs low by automating and simplifying processes; build large base of repeat purchasers; acquire competitors or get acquired|
Certainly there are no hard boundaries between these categories, and it’s possible — even common — for a service provider who falls mostly into one column to cross columns on certain behaviors. For example, a consultant whose primary job is to improve a client’s communication system may act as a contractor when installing new technology toward that end. A contractor whose focus is installing accounting systems may act as a consultant if he helps the client choose between several systems that he is qualified to install. A vendor whose profits are generally derived from recurring revenues for hosted services may act as a contractor to help the client get the services configured at the beginning.
What’s the issue? Why are these categories important?
I am not terribly concerned when the lines between consultant and contractor or between contractor and vendor are blurred. It can make perfect sense for a consultant to do contracting jobs in order to avoid the overhead of hiring independent contractors. And it can make sense for a vendor to install its own products or services to ensure that the installation is done to their specifications. What does trouble me is the blurring of lines between consultant and vendor.
Consider why the small business IT consultant exists in the first place. He is essentially a substitute for an in-house IT department. Now imagine if a larger company hired a Chief Information Officer who announced on his first day at work, "from now on, we’re going to buy all our computer hardware from Superior Computers, which is owned by my cousin." It’s hard for me to imagine that company’s management feeling good about this policy. There is an obvious conflict of interest, and no matter how good Superior Computers’ products are there will always be a question about whether the CIO is buying those products for the good of his employer or the good of his family.
But many small business IT service providers — the ones I consider to be vendors rather than consultants — are going even further in that direction. They are both recommending and selling nearly every bit of technology that the small business needs, including hardware, software, maintenance, user support, backup and storage, telephone systems, custom programming, and on-line services. And to further cement their relationships with their clients, they are now bundling these goods and services together in long-term service contracts. These contracts make it difficult for a client to select any alternatives to what the IT service provider chooses to supply.
I think it is wrong for an IT service provider to become the "trusted advisor" to a client and then use that trust to sell a whole slew of goods and services that have been designed to generate profits for the service provider. I am NOT suggesting that anyone who is currently providing the entire range of services from consultant through vendor is necessarily doing so with evil intentions or that they are providing their clients with substandard services. Indeed, the people I know who are on the vanguard of the shift from independent IT consultant to comprehensive service provider strike me as extremely concerned with the quality of the services they are providing and I believe they have some genuine concern for keeping their clients’ overall IT spending in check. Nevertheless, I see this as an inescapable conflict of interest and I worry that small business owners may have difficulty in the future finding someone to provide objective opinions.
Where does SCHRAG fit in?
I will soon be entering my 12th year as an IT service provider, and I have been back and forth on the consultant-vendor spectrum. My first employer, The Telluride Group, was pretty firmly in the contractor category. We were skilled in installing and maintaining technology. We did some planning and advising, but the options we presented were generally those we were very comfortable with. Because everything we did was on a fixed-fee basis, we knew that it could be very expensive for us to propose a project involving unfamiliar technology. On the flip side, we were decidedly NOT a vendor. We resold almost no hardware or software, and what we did sell we passed along to clients at our cost, with no markup. One reason for taking this stance was that we could present ourselves to clients as being vendor-agnostic. Our product recommendations were not at all influenced by the profit potential they presented to us. (We were also operating at a time when new on-line vendors like CDW and PC Connection were aggressively pursuing market share, and their retail prices were often below our cost through distribution.)
When I went out on my own after three years, I stayed with the no-reselling policy. But I eschewed the flat-fee contract in favor of traditional hourly billing. I had several problems with the flat-fee approach. First, it required a great deal of time and effort to estimate how much of my time a particular project or support plan was going to require. Second, it meant that one of us — the client or I — was destined to "lose" in comparison to hourly billing. Finally, and perhaps most importantly, it set up a perverse incentive. Whenever support is provided on a flat-fee basis, the client is motivated to use as much support time as possible and the provider is motivated to provide as little as possible. By billing hourly, I could ensure that my clients got what they paid for.
After a few years of keeping it simple, though, I started tinkering. First, I started reselling. I found myself spending a lot of time scouring the Internet in search of low prices, and I found it hard to charge my clients $50 in consulting fees to purchase a $150 part. I also had a few incidents of clients buying the wrong parts despite my efforts to provide clear instructions. So I signed up with a couple of distributors. I stopped charging for the time it took me to procure the parts and started charging the MSRP. I knew that I was "overcharging" for some parts some of the time, but I made the rough calculation that my clients were at least breaking even overall. I also started signing support contracts that included flat fees for some standard ongoing services. I did this for a couple reasons. As my client base expanded, I found myself pulled in too many directions. I needed to cut down the number of clients I had, but consequently I had to ensure that the remaining clients were making a serious commitment to me. Also, as I invested in tools to automate the routine maintenance I was doing, and as I started working with subcontractors who were billing me on a flat-fee basis, I found it both difficult and unprofitable to continue to charge for these services by the hour.
So for the past two years, I’ve been a value added reseller and a managed services provider. And I’ve decided I don’t like it very much. I don’t like knowing that the trust and rapport I’ve built up with my clients allows me to charge just about anything I want for the products I resell. I need a more objective measure of what constitutes a fair price, without having to constantly research prevailing market prices. I don’t like offering some of my services (the "predictable" items like maintenance and support) on a flat-fee basis while offering other services (for "upgrades" and special projects) on an hourly basis. It’s too hard to draw the line between the billable and non-billable hour, and as a result I’ve given away far too much of my time.
And yet, I can’t go back to the straight time and materials model. If I tried to do pure consulting, without any contract or reselling, I would need a far greater number of clients because most small businesses just don’t need that much advice. And I want to provide my clients with a seamless, comprehensive set of goods and services. So here is my solution (at least for 2008):
- I am going to bill hourly for my time — all of my time. It is my goal to spend as much of that time as possible providing high-value services such as needs assessment, product research, business process design, group training, and so forth. But if my clients want or need me to get involved in infrastructure maintenance or end-user support, I will — at my standard hourly rate.
- To free up my time, I will use subcontractors for the routine tasks. I will be completely up front with my clients about who the subcontractors are, and where possible I’ll give them a choice about which subcontractors to use. The subcontractors will typically be charging me on a per-machine-per-month or per-user-per-month basis, or perhaps on an hourly basis for supplemental project work. I’ll add a fixed percentage to the subcontractors’ costs to cover the time I spend supervising their work, but I won’t charge hourly for my supervision time unless the job gets so complicated that I have to step in and do it myself.
- When reselling goods and services to my clients, I’ll add a fixed and disclosed percentage to my cost. Any commissions or rebates I get will be refunded to the clients unless the supplier specifically prohibits this (as Microsoft does from time to time).
I’m hoping that these policies will solidify my position as a consultant and general contractor and will get me out of the vendor mentality. (I do not mean in this essay to denigrate the work of IT service providers who are leaning toward the vendor camp. There is nothing disreputable about being a vendor, so long as you’re not pretending to be something else.) I realize that this model is not scalable or sellable and that I’m not going to be able to retire early. But I am hoping in return to have a clarity of purpose and the freedom to make decisions that I think are in my clients’ best interests.
Will the changes have the desired effect? I’ll let you know in 2009.
Have I accurately described some of the tensions that exist within IT service providers and between providers and their clients? Add a comment and let me know.