Why outsourcing companies are not suitable for startups

Sometimes companies need an additional task force for their development teams, especially in the early stages of companies like a pre-seed startup, where they might not have any engineers at all. In such cases, the primary concern is how to deliver the first product to the market as soon as possible. One of the reasonable choices would be to consider finding a development house from other countries to reduce costs. However, you need to understand how they conduct their business.

Let’s assume you are the CEO of an outsourcing company, and the tax rates in your country are 50% of the employee salary. In your first year, you can hire only a few engineers: one junior, one senior, and one tech lead. Their salaries are $1000, $2000, and $4000, respectively. Since you hire them as employees, you have to handle their taxes and insurance, which costs 50% of their salaries. Additionally, when someone wants to work with your company, you will charge them the cost of your profit (for easy math, let’s assume this is the same as your employee’s salary), employee salary, and tax. For example, if someone hires a junior, you will charge them salary ($1000) + tax ($500) + your profit ($1000). This seems like a great approach.

Now, you have hired three engineers from the market. Every month, you will pay their salaries and tax, whether you have a project or not. So monthly, you will pay $10,500. In most cases, IT projects will last 3 to 6 months, and the practical operation rates (the actual rates your engineers work for a client) would be from 50% to 80%. As most companies usually start with larger projects in the first half of the year and do smaller projects or improvements in the second half. Therefore, you can expect your operation rates to be 80% from January to June and 50% from July to December. December, in particular, is a well-known holiday season, during which no one will likely give you any tasks.

If you are lucky enough to get your first customer on the very first day of your year, you will receive $142,500 as your first-year revenue, and the profit would be $16,500. Then, you will realize that the profit is smaller than you initially thought. Even if you handle all marketing, sales, and HR by yourself, you can only achieve a profit of 12% from your total revenue. If you don’t have enough customers, you will definitely lose money.

Now, you start thinking about how to improve your business model and discuss it with your friends or CEOs. You realise that if you just hire 2 juniors and 1 senior and change their profile to senior and tech lead because they are great, the total costs would be only $6,000 instead of $10,500. You could improve your business without any other investment. Then, in the second year, your revenue would be $160,000, and surprisingly, your profit will increase to $88,000, making your profit almost 55% of your revenue.

Now, you know how to crack this business, hire more engineers, and expand your sales team. With this strategy, your company looks promising. The only matter would be finding customers and delivering projects within the timeframes. You should not be delayed; otherwise, you will lose your money as you can’t assign your engineers to other projects.

However, sometimes your plan will not always work, like this year when no one wants to give you any projects. In that case, you can’t just hire your engineers as employees; instead, you have them on standby and keep in touch. Later, if you get any project, you can hire them as contractors and charge the same rates to the clients. That would be a fantastic business model for you, as you won’t have any operation costs except your website, but the upside is huge.

Now, you just need to rent a nice view office in the CBD and give your clients the impression that your company is stable and good enough to handle bigger projects. In reality, all your engineers are not your employees, nor they have the same profiles you promise.

Let’s go back to your startups. If you don’t have your engineers, and you want to find an outsourcing company, you will most likely meet your outsourcing partners like what we just imagined, regardless of the company size. Then what will you actually get from this outsourcing company? It could be a contractor from another company or freelancer you never met before. Of course they could be decent engineers but they won’t care about the quality in your product, they will only think about the next project.

Now you’re ready to burn your cash into the air. Just imagine what you will get after 5 or 6 months later.