Be Careful not to be Penny Wise, Pound Foolish

Posted on Nov 29, 2010 | 67 comments


Justyn Howard, founder of Sprout Social has a blog post that he’s written about his experiences of migrating from scrappy tools to more efficient ones (i.e. Using Balsamiq instead of SnagIt, Website Optimizer over just Google Analytics and FTP).

It’s a great topic, his post is well written and given that he’s going through it right now in his startup it’s worth reading his point of view on the topic.

Here’s my take:

Penny Wise, Pound Foolish
There is a British saying I always loved, “penny wise, pound foolish.”  I took it to mean, “making decisions with small amounts of money (pennies) that end up making bad sense for affecting larger amounts of money (pounds, as in Great British Pounds).”  I thought of it as people who cut corners on small costs but paid dearly in terms of lost productivity on expensive staff.  Penny wise, pound foolish.  I love this saying and what it implies and I use it often.  Startups often make this mistake.

I Love Scrappy
Don’t get me wrong, I do think an important sign from startups is their ability to keep a startup culture going for as long as possible and one sign of this in the early days is scrappiness.  Those who are old enough will remember stories about Microsoft that even as it was going through explosive growth Bill Gates still flew economy and the parking lot was first come, first served.  It was a sign of honor to see whose cars were closest to the entrance and whose were still there when you left.  Andy Grove, for many years the CEO of Intel, famously sat out in an open plan office.

And you all know the stories of the companies that assemble their desks from spare plywood or old doors, working in the up-and-coming part of town rather than in the heart of the financial district where all the nice office are.  It isn’t always necessary but it’s a mindset.

Like everything, I screwed this up in my first startup.  I had come from a world where I was nearly a partner at Accenture before starting my first company.  I was used to being allowed to fly business class and staying at nice hotels.  Our first big institutional round of VC was $16.5 million and we seemed likely to raise another $40 million within the first 18 months of operations.  So when I attended the Fortune CEO conference in Paris I stayed at the venue: George V (The Four Seasons) without much thought.

I took business class on the Eurostar over and justified it because I could get more work done on my computer at bigger tables.  It was probably true, but I created the wrong mindset – the wrong culture.  I was too much Accenture, not enough Startup.  I always say that it takes 18 months to un-train a big company employee from their bad habits when they join a startup.

I changed that quickly when the market shifted and I had to lay off more than 80 people – many of whom were friends.  We went “nuclear” and slimmed down to 33 people (yes, I know, still large by today’s standards but this was 2001), raised $10 million and we built a real company.  I learned everything I know about startups in these lean years: 2001-2004.  I felt like I had survived The Great Depression and I never wanted to go there again.

I started flying RyanAir or EasyJet (the European equivalents of Southwest Airlines) anywhere I went.  If I did have to catch a British Airways flight I was in the back of the plane near the toilets.  I frequently travelled to Frankfurt, Germany but found it much cheaper to stay 20 minutes south of the city in Neu Isenberg.  Scrappiness became a badge of honor.  It wasn’t enough to just stay in Neu Isenberg but I found a pizzeria that had rooms to rent above the restaurant for just 35 Euros / Night.  They were clean and since when I travel I’m normally in my hotel at 11pm and out by 7am wasting money on hotels seemed stupid.

Our company developed a cost-conscious mentality.  We switched offices to a cheap 1-year sublet of a company that had too much space during the dot-com boom.  After a year we played hardball and said we’d move out unless they gave us 20% off of our already low price.  They had no options and the truth was that I was willing to move in order to drive the costs down further.  We were on a path to prove to investors we could be profitable and driving every penny out of our cost structure mattered.

Cost conscious is obviously how most companies start – or should start.  I often advise young companies against the dangers of raising too much money too early in the company’s existence.  I know from experience – it helps fuel the wrong culture and it is very hard to rebuild your culture once it is set.

Scrappy for Scrappiness Sake is Dumb
But Justyn’s post touched on a nerve with me because I do see people take the startup, scrappy culture thing too far and he hit the nail on the head in advising people to think about efficiency and not just scrappiness.

Once a company has raised $2-3 million dollars I often advise them to get an office manager.  It seems like an extravagance but if the person also picks up scheduling travel, booking meetings, dealing with company admin and helping with basic accounting / financial tasks it can be a huge productivity boost.  And this is especially important since the people who get sucked into this admin the most are the founders – the people who you most want focused on high-value tasks.  I will quote one portfolio company CEO who said about his office manager, “Mark, this is the most important hire we made last year. I have freed up so much of my time to focus on the important stuff.”

Another area where founders sometimes spend too much time is accounting. In the scrappy phase it’s fun to be the person who set up QuickBooks and to watch every penny that goes out the door.  After you start to grow, you can still watch every penny but your time is much better spent on finding new pennies to come into the business than splitting hairs on how to best establish your general ledger accounting codes.

Hire a part-time accounting clerk to do the data entry and prepare the monthly books.  If you’re business has complicated accounting (like many ad network businesses) and if you’re raised enough money to warrant it – a great VP Finance is worth his/her weight in gold.  Even better if he/she can double as a VP Operations & HR.

In his post, Justyn mostly speaks about the toolsets you use to manage your products and those are important, too.  He’s right about the need to eventually get dedicated QA staff while not absolving programers of unit testing & usability testing.

Be Efficiently Scrappy, But Maintain your Startup Culture
In my own startup I went too far.  I kept trying to drive costs down and started making stupid decisions.  We attended a conference in France and I asked teammates to double-up on hotel rooms.  I doubled-up, too, so I figured it was fair.  My team wasn’t impressed and I think it had a bigger hit on morale than the cost benefits we got.  They were fine traveling RyanAir and then having to bus an extra hour to get to the event but they wanted their own room to crash in late at night.  A small refuge from a busy day of shaking hands and demo’ing products.  And I should mention that many of my sales staff were in their 30′s, not 20′s so this made it harder.

When I travelled to Frankfurt, the hotel in Neu Isenberg wasn’t good enough – I pushed to stay in a place that was 30 Euros.  I traveled out there with our then head of sales & operations (and my business partner) Stuart Lander.  We stayed in the middle of January in a “hotel” that turned not to have showers in the room – you had to walk down the hall to a community shower.  We literally had to walk outdoors in the snow to the shower alongside Turkish construction workers walking in leopard-print underwear.  I can’t make this stuff up!  I had reached bottom.  I had pushed too far.  It provided a funny life story but at the time it didn’t feel that way.  I’m lucky that I had Stuart with me as proof that this really happened.

It seriously was a visceral turning point for me that we had pushed things too far.

You need to always think about the trade-off between making your most valuable assets (your highest impact people) more productive and maintaining your startup culture.  There is no “right or wrong” as this will be a judgment call in each startup based on capital raised, stage of company, number of customers, complexity of your business, etc.

Some companies argue that having personal chefs allows their team members to stay more focused and productive on work, others believe it is an unnecessary extravagance and sets the wrong tone.  I’m frankly not really sure on this one but each company needs to think about what messages they send with the decisions they make.

Having the wisdom of having swung the pendulum too far in either direction I now pay close attention to this with the companies with whom I now work as an investor or advisor.  Constantly ask yourself whether you can improve productivity of your most important contributors by minor investments in other people, processes or tools.  Whenever you approve new expenditures ask yourself, “will this be perceived as being too extravagant for the stage of our company?”

These are always judgment calls but erring in either direction is a mistake.  Thank you, Justyn, for bringing up this important topic.

Photo courtesy of Pat Page via Flickr.

  • http://erickennedy.org Eric Kennedy

    So true. When it comes to managing costs, we all have innate biases to think in percentage terms instead of absolute amounts. Saving $10 on a $100 expenditure should be worth the same amount of time as saving $10 off of $1000, yet our behavior is often based on the size.

    Glenn Kelman had a great quip “It's the payroll, stupid” about how many startups will try to skip so much on rent that they hurt productivity:
    http://blog.redfin.com/blog/2010/02/the_garage_and_the_penthouse.html

    In April 2009, we at RealSelf.com foolishly extended our $1,100 lease on a one-room office next door to Dave Schappell's team at TeachStreet even after raising $2 million. (Dave has much nicer offices.) We had so many people in that room that productivity was easily reduced by 10% by all of the chatter, phone calls, and conversations. 10% of payroll was a lot more than our new offices cost, but our CEO was anchored to the $1,100 rent and it took a near mutiny to get over $2,000/month in rent.

    Be careful of anchoring — it can make you do foolish things.

  • http://www.repeatablesale.com/ Scott Barnett

    Could not agree more with every bit of this post. Nobody will ever tell you to stop spending, so if you set the culture of being frugal (but not cheap!) from the get-go, everybody will figure out how to participate.

    One practical idea we've been using for over 5 years – use Priceline to bid on 3 and 4 star hotels – if you put a ceiling on the amount to spend for a night at a hotel (we usually say $100 for cities and as low as $50 in the boonies) you can use find a really high quality hotel within that range on Priceline. It requires a little flexibility (e.g. you don't know exactly where you're staying, but you can pick a region), but these hotels will always have the amenities (gym, restaurant, etc) that make it a little easier on you.

    We've had “competitions” to see how low somebody can get a 4-star hotel. It's easy, and saves a ton.

  • Dave W Baldwin

    You may need to write one on bootstrapping when you're over 40. Those in their 30's DO need to think about the right type of chairs, for you will regret it in 10 years if you don't.

  • Dave W Baldwin

    Love the stories! We are lucky where those involved see the bigger picture moving forward and have been able to truly bootstrap on the cheap. What is funny about that is the sticker shock hits the other way where the low pricetag is concerned.

    I agree with the consensus that founders need to be frugile and make sure you are taking care of R&D…

    Otherwise, you can use the economy when the pricey isn't needed, saving to do the 5 star when it is needed to impress the customer/investor.

  • http://www.victusspiritus.com/ Mark Essel

    With a budget close to zero there is only scrappy. Still, I prefer indoor showers and only double up on rooms with my wife or close friends/fam.

    There are two ways to make more profit, grow your revenue or decrease your costs. I tend to focus on the former with efficiency and optimization as an ongoing process.

  • philsugar

    Spend freely on what's “strategic”, spend like a miser on what's “tactical” that is a very good way to put it.

  • philsugar

    We do that too and it really works. Too bad it doesn't work for cars. I've tried it a couple of times but you can get stuck with a really lame company and waste a ton of time.

  • http://www.repeatablesale.com/ Scott Barnett

    agreed – and it's not so great for airfare either, I had an absolute disaster flight using Priceline. Our way around that is JetBlue/Southwest and other discount airlines.

    Not sure if Mark had this in mind, but I would love to hear cost saving “best practices” from others to help scrappy startups save a buck!

  • http://t-machine.org Adam

    Thanks, Mark, this is a great topic. My experience on this one topic is one of the things I most value of all the stuff I've learned “the hard way” from startups; it's great to see people share it. Also, I've found it's something that many many founders lie about afterwards – most are too ashamed of the mistakes and the stories. So…thanks as well for sharing so honestly!

    For what little it might help other readers, off the top of my head (a disorganized list, sorry!) … from 4 startups and 12 years, sometimes as a decision maker, sometimes just an employee:

    Savings I regretted:

    – doing the accounts myself (in response to Mark's “hire an admin at $2m”, these days I hire an admin at $500k (or sooner, if we have revenue!). It's not just the (massive) time savings – they also reduce your founders' stress levels, improving their decision-making ability, and leading to huge overall improvements)

    NB: however, I value the fact that I *have done* legal company accounts – it makes you much much better at forecasting in future, and much more aware of the cashflow issues which otherwise surprise. So … I'd say “do it once, for one company (preferably not your own), and then never again” :)

    – offices so small that each time your neighbour leaned back in their chair, they smacked you in the side of your shoulder / back of the head (the CEO who enforced this – up until I supported an employee revolt – justified it “because that's what all great startups do to be successful”. I hope these days he reads Mark's blog :))

    – cheap hard-disks in servers + storing those servers in the office – when we moved office, someone (never found out who) knocked/dropped the pallette with servers. On arrival, all hard drives were dead. Huge loss in time to replace hardware + restore everything

    – disorganized (but cheap) office admin staff, who single-handedly cost the company $30,000 or more a year in “forgotten” payments, missed sales, mis-shipped orders, etc

    – under-paying staff: all the good people left as soon as they could

    Savings I celebrated:

    – hotel *deals*: except for conferences and small towns (where the hotels fill up) I always booked them last-minute (and these days hotels.com helps), and looked for the best price/value option. Usually you get a comfortable hotel at great cost, or a convenient hotel cheaply

    – full-back, adjustable office chairs (albeit cheap ones). Every other chair we bought got hated, broken, and replaced

    – using the EU distance-selling laws to “buy” a replacement computer, use it for 4 days until the original computer was repaired, then “return” the new one. I feel a bit ashamed of this, although the vendor bounced me into it (and was happy with the arrangement, since we continued to buy lots else from them)

    Expenditure I celebrated:

    – paying for “same/next business day *ON SITE* repair/replacement” for all our non-trivial computer hardware. LAN switches – not a problem, we could replace them in 20 mins trip to a shop. The 8-CPU, 32 Gb RAM desktop which the lead artists need to compose their work, because Photoshop crashes on every “normal” machine? – serious problem: you need a manufacturer engineer on site, with all spare parts, and you need them ASAP. Or you'll be paying $10,000 to replace the damn thing, because you simply cannot afford to wait 5 business days to have it repaired.

    – a very good backup/restore system – restore to live in under an hour, with *no* technical expertise, and with *no* requirement for finding software licenses, or plugging in physical hardware etc

    – flying (regularly) from UK to France in private (but cheap!) plane – cost 10% more than eurostar, but several hours faster, and arrive able to work … rather than miserable and exhausted. i.e. the cost was so small, it paid for the typically additional half-day in the office.

    – hours spent on finding the best supplier for “ongoing” purchases – e.g. per-person office-equipment. e.g. a $5,000-spec desk+chair+drawers … for $1,000 … is a big saving that repeats with zero effort each time you hire a new person

    Expenditure I regretted:

    – Patents. (this is from many years ago) Angels convinced me that “every” tech company needed them. I now know (from direct experience, and much money wasted!) this is naive at best, outright lie at worst. Rather, if you are the kind of tech company that needs patents, then it's already part of your core business plan/strategy. If “money made from patent licensing” doesn't appear on your 12-slide pitch deck, then you probably don't need patents; nearly always, if you *need* patents, you know a lot about them already, and it's not even a question you need ask. If VC's or Angels are telling you you need patents, spend more time on venturehacks, and see if you can work out what they're *really* trying to tell you ;)

    – expensive staff who demand cash. If it takes too much cash to hire them, their hearts are usually in the wrong place. Not their fault – they just want/expect/need different things. And soon enough they get unhappy and leave – or they drag everyone else down to their level of misery, and force you to fire them

    – founding a legal-entity company too soon: have a limited-liability X is “safer” from day one, but brings with it a vast amount of government interference. The paperwork alone can bury you. Nowadays, I wait until the last possible moment to found the company.

  • philsugar

    Another thing I've seen is people not spending money on tools and controls. Crazy.

    If I look at a P&L of a software company and don't see a big expenditure on software I know they are wasting huge amounts of very expensive time.

  • http://berislav.lopac.net Berislav Lopac

    Actually, “expenditure on software” is such a wide area that it can't be viewed as a whole — it's much more important to know which software was actually bought. If we're talking about a software-based startup, most of the actual development tools are actually free — from open-source platforms to base-level RDBMSs to Microsoft's software (through the BizSpark program) — so if the startup spends too much in that area someone's not doing their job.

    That being said, the startup should be generous when buying each individual developer's preferred tools; it's up to the CTO to find the best match between free tools and those that need to be paid for.

  • sbmiller5

    Totally agree here. I work for a professional services firm that just got new furniture. They did a great thing and asked the employee's what they wanted. The response was pretty much, I don't care, but I want a nice chair.

    …so what did they do…bought all new furniture, but are holding off on new chairs to spread out the cost hit…WTF, don't ask if you're not going to listen.

  • http://twitter.com/mattamyers Matthew A Myers

    There's another part to keeping a low burn rate, forced or not, is that it makes you be more efficient and think through things to understand their value — it helps you learn to prioritize and hopefully you have your priorities straight before you get your first bigger chunk of money; I'm assuming you would have convinced someone that you got your priorities straight for that money, but maybe not.

    Re: Scrappiness – I love staying in cheap hotels and prefer hostels when going to conferences. You meet such interesting people and it's always a good experience (if you let it be).

    When I was in NYC during the summer I had a bunkbed room shared with one other, and had a sink. Four people from around the world shared that room the 5 nights I was there. One guy from Japan, another from Australia, and two from around the US – and I kept in contact with others who stayed in the hostel but not in my room.

    I think the ability to be scrappy and comfortable is a strong character trait that you're able to deal, cope, manage yourself and situations. If you're not a people person and you're easily irritated you can't very easily do scrappy IMHO, and can't handle change as well. I could be wrong, but that's my experience.

    Me, I just need a laptop, internet somewhere, a bed, food, and some floor space to do yoga (a yoga mat would be nice) and I'm good to go; Having clothing and shower facilities would be beneficial for others around me…

  • http://www.stickyslides.com Jan Schultink

    Similar: “scrappy” freelancers/independents can now be more productive/professional than knowledge workers inside big corporates by spending on faster computers, bigger screens, premium software editions, cloud services and productivity tools without the shackles of corporate purchase policies.

  • http://creativculture.com Daniel Meller

    Hi Mark, Thanks so much for this great article, I put your “Penny Wise, Pound Foolish” advice to use this week and the outcome was fantastic! I run a startup in Beijing China and I wanted to advertise on a national forum website that I thought was full of potential users. Instead of shelling out the cash and hoping for success I contacted the admin, showed here how our site is perfect for her users, and she offered us a free test ad for a week. Sure enough, we had a great response and are going to pay to be on the site for the rest of the month. If the ctr continues, we just halved our current cpc. Thanks for helping us become efficiently scrappy.

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  • http://twitter.com/customerexplabs Jay Eskenazi

    Good post here – you've articulated a lot of points that people often take for granted and should rethink. People often think usability testing is something they don't need to spend money on, or that they can do internally w/untrained staff who were hired in a different job function. Don't skimp on usability! it should be part of your QA process and usability resources should scale w/your product development budget.