In-sourcing and Outsourcing

It often seems like it would be possible to grow a startup faster by outsourcing some of the key functions to an expert service provider. Sometimes, this is true, but often, there is less leverage than you might think – and there is undoubtedly a great deal of risk.

Startups seeking to move fast often look to outsource key functions in hopes of taking advantage of existing capabilities. Examples include outsourcing product manufacturing to a contract manufacturer or sales and distribution to a partner. Sometimes, this can be successful, especially if the product is simple and straightforward or if you are selling a product dramatically better than something similar already in the marketplace that your target customers understand.

However, what often makes a high-potential startup special is layers of uniqueness that add up to something new and different – which demands dexterity, focus, and control. For example:

• A while back, we were creating a totally new scientific instrument that demanded tremendous process refinement to manufacture successfully and cost-effectively. At the encouragement of our VC investors, we tried outsourcing to an ISO-certified contract manufacturer. However, it turned out that our little supply chain team of one could get better prices on components, our small team of assemblers could leverage specialized tools we developed to successfully build products that would stay in-spec and deliver for customers, and as we tried to align our production capacity with demand, we needed to be much more creative and nimble in the early days when we did not yet have much of a track record to estimate from. Ultimately, we unwound the relationship with the contract manufacturer (who had been the best of three that we did deep diligence on) and brought manufacturing in-house. All the innovations built into creating an instrument that performed with excellence and reliability at a fraction of the cost of the market leaders in the industry demanded the kind of dedication and focus that comes from a deeply committed team. As a startup, we couldn’t tolerate processes that demanded making unchangeable forecasts six months out, nor could we do the work of maturing and scaling up our production rate by unearthing the evermore nuanced dimensions that would produce a working product at the end of the line with a change control process that took weeks or months to cycle through. We needed to be hands-on to bring our innovations to life.
  
  
• Startups focused on developing innovative products often are tempted to hand those ground-breaking solutions to someone else to sell when it comes time to launch, thinking those sales organizations’ access to target customers will make the difference. However, when you add your novel product to a salesperson’s bag of other stuff, how will you get the attention that your innovation needs? Selling an innovation takes creativity and change management acumen. Often, your breakthrough product will require unique supporting information like:
  
  
  • Application information, case studies/references, and performance dataFast-evolving message development as you learn about the sales hurdles
  
  
  • The commitment to invest time and energy in developing a prospect’s understanding and willingness to take a risk on something new.

If you are doing something that directly addresses a customer’s pressing need, a small and creative dedicated team often led by founders is usually the place to start getting those initial sales when the customers’ risk of trying something new is high and the need for the startup to learn and develop a sales playbook that works is essential. Eventually, it may make sense to expand your sales team and incorporate sales partnerships, but usually only after making that first $1M or more of sales in a high-touch way that builds the proof points and a sales playbook for a wider launch.

So, when can you successfully outsource some portion of your business?

Fractional or outsourced support makes sense for business functions that are not your “secret sauce,” where leveraging a partner’s systems can be very efficient and cost-effective. Consider where you or an outsourced partner can readily define and leverage standard procedures. For example, many startups find the following areas can be a good fit for outsourcing:

• Accounting and finance support: GAAP accounting principles and broadly used Quickbooks software are readily modestly customized to fit virtually all types of businesses. Expert CPAs, accountants, and bookkeepers are experts at processing financial transactions, producing financial statements, and completing other common corporate administration work efficiently. The standardization and often less-than-full-time needs make this a great place to outsource to a fractional CFO firm, an accounting specialist, or other service providers.
  
  
• Website design and implementation:  While you must provide the content because you are the expert in your novel thing, leveraging a specialty house to do design, development, and implementation can often result in a more sophisticated “face” to the world. While there are plenty of tools out there that promise to stand up an “instant” website, once you have a more complex story to tell, it is worth getting someone involved who has invested time developing their expertise and efficiency since a marketing website is unlikely to be your high-potential startup’s core competency. So, even if you are doing web development, you don’t want your product development team focused on this easily outsourced work.
  
  
• Prototyping/low-volume parts manufacturing/cloud infrastructure:  The ability to manufacture or prototype certain custom parts often requires a significant investment in specialized manufacturing equipment (e.g., 4-dimensional machine tools) or highly leverageable infrastructure investment (e.g., cloud computing providers) that are hard for a startup to front. These resources can be “rented” to produce something you have designed. In these cases, you bring creative design and engineering expertise, and the outsourcing partner brings general-purpose tools and infrastructure to create what you need efficiently. The key is that the outsourcer is providing general-purpose capacity while you need only a tiny fraction of that capacity. The calculus changes when you reach significant scale, and investing in your dedicated capacity begins to make sense.

Remember that it is good practice to check to be sure a potential partner has done similar work before, has worked with similar types of companies before, and can provide good references.

What are the indicators of when you should keep a function in-house, at least for a while?

Start by focusing on where your company’s “secret sauce” resides:

• What intellectual property is the foundation of your high-potential, highly scalable business (patents, trade secrets, proprietary designs, unique business processes, etc.)?
  
  
• How novel is your innovative solution in the marketplace? For example, smartphones are no longer novel because smartphone manufacturers are competing based on specific features rather than needing to educate the market about a whole new product concept. A solution that requires educating your potential customers about what it is and how it works is a more complex sale.
  
  
• How important is speed and control to successfully developing, building, launching, and scaling your product(s)? If your innovations are centered on your product design, especially if it is complex or contains potentially proprietary software, then you want to keep such things close. If you are innovating in a complex, multi-dimensional way, keeping the work under your control is often critical to learning and adjusting quickly.
   

Keeping your “secret sauce” primarily within your team allows you to have control as you grow and leverage the deep expertise in your particular opportunity that your team can develop as you learn and iterate. By having team members whose exclusive focus is on getting it right specifically for your thing, you rapidly deepen your in-house expertise and the moats around your innovations, reap the benefits of a startup’s ability to problem-solve and make decisions quickly, and are all highly incentivized to focus and get the job done to accomplish your startup’s mission.

Depending on the nature of your business and your innovation, this can mean that at least a portion of your production/manufacturing/operations should remain in-house. Your initial marketing/sales team should consist of your founders who have been investing deeply in understanding your market opportunity and potential early adopters, and your R&D/new product development should be at least owned by your team even if they are outsourcing some components. Furthermore, if you are in a regulated industry, such as drugs or medical devices, you should be aware of what your regulators require you to be responsible for and how that cascades into your decisions about what you may consider outsourcing.

Concluding thoughts

For practical purposes, startups will always have to leverage at least some other organizations to move faster, accomplish certain tasks, and grow quickly. Simultaneously, they will be raising money and investing in those capabilities that make them unique, or that demand focused ownership because they are on the critical path to success. Striking the right balance is one of the critical startup leadership responsibilities.