Chapter 11: Organizational Design

After your business starts to grow, what kind of employees and independent contractors should you hire? What about outsourcing to India or the Philippines? What is the best organizational design? Start with the goal of $200,000 of revenue per employee.

Your business is starting to make money. Now what? If you’ve read Timothy Ferriss’ over-hyped The 4-Hour Workweek[1], the answer is “get out as fast as you can.” I can’t disagree more. 4-Hour Workweek spends a hundred pages talking about the author’s exploits running around the world (without a laptop), enjoying the best excursions life has to offer. The book has a few gems, like getting someone in India with a heavy accent and unknown telephone number to keep calling your boss, or how the author won a fighting championship by pushing his opponent off the platform repeatedly (thus disqualifying his opponent through a rule loophole).

The commonality between The 4-Hour Workweek and Maui CEO is that both books preach that you can have a different life. The difference is that I am not the kind of person who is in the position or even wants to run from a business I just created the week before. We all want our jobs to be more than J-O-B-S, and we want more play time; our identities are often tied up in our work successes, and this is OK. Many of us are divorced, have kids in school, less-mobile family members, and friends and routines we actually enjoy in one location.

With that in mind, let’s design your organization with flexibility and good decision-making processes. Ultimately, you might like to have yourself out of the business’ day-to-day operations and available only for escalations—this allows you to move on and start another business. Sounds good to me.

The first inclination is to organize from a customer’s perspective. I like the intention, especially if we were a customer-oriented business. We could divide the tasks/ interfaces up between pre-sale and post-sale, and organize around those divisions. However, as I championed in Chapter 1, we want to have the Discipline of Market Leaders[2], and since our goal is to have little or no post-sale activities with a previous customer (other than positive word-of-mouth), this customer perspective-centric design just does not work for us.

We want an organization that is flexible, scalable if we grow quickly, and is low-cost where it makes sense. I give you the starting goal to have $200,000 of revenue for each employee. By employee, this means a person who is on your payroll as either a part-time or full-time employee. In the U.S., small businesses are often confronted with the choice: employee or independent contractor. If the person is an employee, you (the boss) direct their entire list of activities and tasks—you control their 40 hours completely. You also have the unpleasant pleasure of paying lots of taxes (primarily payroll), funding health insurance, providing meal periods and rest breaks, setting up a 401K, and so on.

As a result, small business employers tend to prefer having “independent contractors” instead of employees. If that person working for you is an “independent contractor,” you don’t have to pay for all the freebies and taxes; you just pay the person an hourly wage and let them deal with most of the paperwork (such as paying self-employment taxes). If you pay an independent contractor more than $600 per year, you do need to send them a 1099. I’m no employment lawyer, but as far as I know, the definitions and requirements (and how courts and administrative reviews have interpreted them) differ slightly between States[3].

Starting Point for Organizational Design (before outsourcing)

Here is how I organized a $1M Maui CEO business in 2002:

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Including myself, I had five employees, one independent contractor, and then outsourced the remaining functioned I needed. Let me outline my key learning from this design: I’ll start at the top and work my way down.

John: the CEO needs to guide the ship. You need to lead and be clear and concise in your instructions and assignments. Importantly, I learned to give each person below me exact guidelines on when they had authority to spend money or commit us. For instance, if we shipped an item to Kansas and the customer said it was scratched, Sheila was authorized to pay for local repairs up to $250, no questions asked.
Sheila: the most important person is the one who answers email and is the first person your customer comes in contact with (whether via email or phone call or otherwise). This is your key hire. This person can live anywhere, and needs to sound like a competent angel on the phone. They will need to gain technical expertise around the product you’re selling, but once they get in the swing of it, WOW, this thing really works.
Nuray: I found that, as CEO, I wanted to be in charge of the marketing activities. Avoid PR firms; we spent somewhere north of $25,000 for the “best” small-business oriented PR firm we could find, and got virtually nothing out of it. Likewise, our advertising spend was almost entirely wasted; we found a huge positive ROI on Adwords, otherwise spending money sponsoring external events, advertising in magazines, and so on was a total waste. I also wanted to deal with our international OEM partners.
Marissa: the administrative function is an interesting one: many of the routine administrative tasks (basically, running errands for the CEO) can be successfully outsourced to India or elsewhere. However, you cannot ask one employee to man the customer email account five days per week. They get too bored and annoyed; they also need a day to do “special projects” to keep them interested and feel like an import part of the org (since almost everyone else is working on various other “special projects”). So, I had my administrative assistant process email on Fridays and other times as backup to cover vacation days, etc. I just don’t believe you can answer customer inquiries with an outsource company. Things like logistics, yes, and we will get there soon. Also, the assistant picks up the occasional check from customers who didn’t use escrow or bank wire; waters the plants and feeds the dogs when you’re traveling; and so on.
Jennie: the financial analyst I had was excellent; she had an MBA and had worked in Finance at HP. This function can be outsourced.
Jim: web-site activities creep up on you, and this need is underrated. This too can be successfully outsourced.
Payroll: I used Paychex and they were able to handle all the payroll filings and multiple states. As implied earlier, one of the benefits of a corporate structure is benefits that accrue to you as the owner. One of those benefits was having an unusually high amount of contributions available through a profit-sharing plan—run and managed by the payroll entity. These contributions show up as expense items for your company (which reduces their taxable net income)…and you get a nice owner perk. Payroll can be outsourced on Elance; ask about their knowledge of tax-deferred retirement and profit sharing planning in our context.
Legal: I would not outsource legal work, yet. Getting a nasty-gram from a law office half-way around the world does not inspire fear in the recipient. I actually think a 10-20 person firm is the right size to work with. Think about this from the person receiving the letter: if the stationary has 100 people’s names on top, the recipient thinks “they’re paying $350 per hour; I’ll send a few letters back and forth and run up the bill—that’s a victory in itself.” In contrast, a letter received from a sole practitioner—who probably barely makes rent—also doesn’t have the desired effect. The recipient probably thinks there’s a lack of motivational firepower on the other end. Here are some cases I had to use legal help:

- Referral of the accountant: ask for the accountant who has been audited several times by the IRS, but never lost. That’s your guy.
- Collections
- Inventory problem
- Activities mentioned already, like corporate minutes

Accounting: as much as I would like to use Quickbooks, I used a genuine accounting firm to do the books. This helped me know that there was no fraud within the company. Also, if you ever wanted to sell your business (much less have an “equity event”), accounting documents from a reputable firm really legitimize your business.
Other: things such as business cards, marketing collateral, and so on are certainly outsourcing candidates on the front end (design). I have some beautiful business cards I got in the Beijing suburbs, for instance. But with shipping, savings are negligible. So, have as much as you can out-sourced and then have a local printer (or whomever) finish the product.

Labor model – before and after outsourcing

Today is an exciting time where right-sourcing gets lots of news. Right-sourcing to me means balancing the lower cost of wages, usually because of global labor pools that are cheaper, against the pain in the ass it takes to have something done in said labor pool. I’m not trying to pick on Mr. 4-Hour Workweek, but seriously, certain things in our small business cannot be outsourced. I want to spend some time on India specifically in a minute. Let me now cut to the chase and tell you which functions I believe can be outsourced in a $1M Maui CEO-type of business.

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As you can see from the chart above, I’ve been able to change the number of employees from five to two; the number of independent contractors (local) stays the same; and the rest is outsourced (locally or internationally). I’m assuming you the CEO are an employee, and talk about why in a future chapter (in summary: more benefits to you, including divorce protection). The phrase “burdened” labor rate refers to what you make per hour plus the approximate hit the company takes for benefits and taxes. The labor rate does not include these charges if the labor type is independent contract or outsourced.

Your e-mail person is so critical—and I mean the person with whom the customer interacts the most—I don’t think you can outsource that to India. In my model, I’ve removed the logistics from that person’s responsibilities and outsourced the logistics themselves. You open up an email account that says either tracking@[bizname.com] or status@[bizname.com] and these emails get automatically routed to your person in India….who provides daily updates that are waiting for your e-mail person when they start their day.

I also think you realistically need your own local person for administrative tasks that you don’t send to your virtual assistant. Some of these tasks are personal in nature where physical presence is required; watering your plants, picking up the occasional check from a customer, taking your kids to lessons or waiting for your car at the shop, and so on. Where physical presence is required, you need someone there. Since this isn’t a full-time job and therefore you don’t “direct” the person’s entire work-day, you can make them an “independent contractor” and save lots of overhead.

I’ve tried to be conservative in my calculations, and based on my own experiences and what I actually paid people, today’s networked economy allows for a $1M business to save about $100,000 in labor costs. I understand it’s a flawed target for the purists, but you just went from $200,000 in revenue per employee to $500,000 in revenue per employee. You can throttle your own salary up or down to keep the company just barely breaking even (lower taxes). Finally, outsourcing allows you to not only reduce costs, but the opportunity to redesign many of your business processes to find both direct cost and productivity savings.

Pretty much everything else can be outsourced…but to whom?

Outsourcing to India

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India has a highly educated, English-speaking workforce. There are 500,000 engineering new graduates annually[4]. A financial analyst working in India would, in 2003, be paid $1,000 per month versus $7,000 per month or more to her counterpart in the U.S.[5] There are cracks in the armor. First, McKinsey & Co. estimated that just a quarter of India’s computer engineers had the language proficiency, cultural fit and practical skills to work at multi-national companies[6]. As the “better” workers take jobs with big multi-nationals, you’ve got to wonder how good the solo virtual assistant is going to work for you.

Problems with India

I am worried about India for two additional reasons: escalating salaries and water. A July 2007 article in the Wall Street Journal says that small tech firms, who were leaders in sending work to be done by computer engineers in India, are now considering either bringing those jobs back to the U.S., or outsourcing to lower-cost locales[7]. Software engineers, whose U.S. wage inflation is under 3% according to Moody’s Economy.com, are seeing their wages in India go up by 15% – 50%.

Intel’s own CEO is quoted as saying “the wage inflation rate for engineers in India is four times what it is here[8]” and I know from personal experience at Intel that employees in Intel will oftentimes leave for a better job—with their salary being tripled by the hiring company. There seems to be an emerging “endowment” affect—the rise in compensation gives parallel rise to the mindset that you must job-hop to get the raises that you deserve by endowment.

If wage inflation drives jobs out of India (as employers look for lower-cost labor pools), where will these jobs go? For high-tech, like web-site development, the most likely candidates (in order of low-cost to higher-cost) are Russia, Philippines, Malaysia, and China[9]. Mauiceo.com was designed by a company in Bangladesh.

Finally, I am personally worried about how India’s water problems will affect their future ability to provide sustainable services. This comment is a bit out of scope here, but inexpensive Japanese pumps have facilitated excessive aquifer drilling in India[10]. Simply put, India is consuming more water than comes in rainwater and the Himalayan glacier river-flows. With irregular monsoons; varying crop patterns and pollution; the political climate surrounding Himalayan water and Pakistan; and slow conversion of the population to urbanization, the shortfall in water is likely to be very acute and is likely to get worse over the next two decades. Water has become either saline, or contaminated with nasty things like iron and arsenic[11]. So, Indians pump water out of their back yards and fields faster than it is replenished, and the water table continues to drop. If this were China, water policy would be primarily national; India is in contrast a democracy and we see the economist’s “tragedy of the commons”[12] being acted out.

Virtual Assistants

If you’re just learning about virtual assistants (VA) from me, perhaps you should get out more. Hollywood stars have them, small businesses are starting to experiment with them, and there’s even a Virtual Assistant Day (May 18).

I’ve mentioned Timothy Ferriss’ 4 Hour Workweek in less than glowing appreciation; his section on VA’s is, however, an enjoyable read. Here’s an example: his India-based virtual assistant is named Honey. Mr. Ferriss describes his task for Honey:

“For some reason, the Colorado Tourism Board e-mails me all the time. (Most recently, they informed me about a festival in Colorado Springs featuring the world’s most famous harlequin.) I request that Honey gently ask them to stop with the press releases. Here’s what she sent:

‘Dear All,

[Ferriss] often receives mails from Colorado news, too often. They are definitely interesting topics. However, these topics are not suitable for “Esquire” [something he’s working on]. Further, we do understand that you have taken a lot of initiatives working on these articles and sending it to us. We understand. Unfortunately, these articles and mails are too time-consuming to be read. Currently, these mails are not serving right purpose for both of us. Thus, we request to top sending these mails. We do not mean to demean your research work by this. We hope you understand too. Thanking you, Honey[13]’”

As I illustrated above in the organizational design section, you can save money by outsourcing certain administrative items to a competent VA like Honey. Since the VA’s may move on to bigger and better things, you should hire a firm that manages VA’s, instead of putting all your trust and training in one person—who can and probably will move on. The firm concept also manages payment collection and should have security processes in place to protect your personal and credit card information. These assurances would not be available if you utilize a one-person band—the VA’s visiting uncle could steal your credit card number and then who has to deal with the hassles? You do.

I’m going to recommend that if you have enough of the kind of tasks to support a VA, look in the Philippines first. Like India, English is spoken widely in the Philippines; however, having personally visited both countries multiple times, and having had a Filipino employee directly report to me, I find that I have a slight preference here. Back in December 2006, I outsourced exactly the same project to a team in both the Philippines and India. My cost was $225 in the Philippines and $400 in India. Both projects, once returned to me, had their strengths and weaknesses, but it did give me one strong data point.

In my opinion and experience, the person of Filipino-decent is slightly easier to understand over the vagaries of i.p. based telephony; is equally well-educated but has a more natural cultural fit with Americans on the phone; and is slightly less expensive. If you need charts and graphs, research or quantitative analysis, then India would be preferred. Alternatively, if you’re looking for the classic VA-type activities, then post your eLance listing but limit it to the Philippines first, or keep it open worldwide but strongly consider my advice. If you travel to the Philippines, stay at the Shangri-La in Makati City (near the Manila airport); if you want to visit VA firms and actually hire one of them, you can setup payment via Chase Bank, which is very strong there, instead of paying with credit cards to save even more money.

[1] Timothy Ferriss The 4-Hour Workweek (Crown Publishing, 2007).

[2] Michael Traecy and Fred Wiersma, The Discipline of Market Leaders: Choose Your Customers, Narrow Your Focus, Dominate Your Market, (Perseus Books Group, 1997).

[3] In California, the guiding statute is CA LABOR CODE SECTION 3350-3371. See also http://www.dir.ca.gov/dlse/FAQ_IndependentContractor.htm

[4] Wall Street Journal Tues July 3, 2007 page A15

[5] Pete Engardio, Aaron Berstein, and Manjeet Kripalani, “The New Global Job Shift,” Business Week, February 3, 2003, p. 50.

[6] Wall Street Journal Tues July 3, 2007 page A15

[7] Wall Street Journal Tues July 3, 2007 page A1 and A15

[8] Wall Street Journal Tues July 3, 2007 page A15

[9] See Chris Gaither, “US Workers See Hard Times,” The Boston Globe, p. A10, November 3, 2003.

[10] See When the rivers run dry (Beacon Press) by Fred Pearce (2006) pg. 35

[11] See Water Wars (Riverhead Books) by Diane Raines Ward (2002)

[12] Garrett Hardin, “The Tragedy of the Commons,” Science, Vol. 162, No. 3859 (December 13, 1968), pp. 1243-1248.

[13] Timothy Ferriss. The 4-Hour Workweek (Crown Publishing, 2007), p. 116.