Shahid Ansari calls it the “inflection point” — the moment a small business owner realizes his or her entrepreneurial enterprise needs a formal management structure.
“Early on, success comes with the fluidity of making decisions quickly, acting on gut feelings, and not spending time writing memos about what you should be doing,” says Shahid Ansari, a managerial and behavioral accounting professor at Babson College in Massachusetts. “It’s not desirable to have formal structures in place because they may inhibit you.
“Then suddenly, you get to a size where you cannot manage all your daily operations and you start losing control,” Ansari says. “When you reach the inflection point, you’ll know it.”
It’s at this stage that small business owners must decide which functions they will keep in-house and which ones they will outsource. How well they manage these in-house functions — or cost centers — will determine their success or failure.
Unlike sales, costs are an area small business owners can actively control. Too often, however, they don’t monitor their cost centers as diligently as they do individual purchases, and they don’t apply rigorous metrics to judge how each of these centers is performing.
Ron Newman, southwest regional director for the North Dakota Small Business Development Center, offers a stark example to owners who haven’t embraced the importance of managing costs.
“Say your business runs at a 5 percent profit margin and you take a $100 loss on an item you misordered,” Newman explains. “It will take you $2,000 in sales to make that up.”
Setting Up Profit Centers
At larger companies, there’s a growing move to turn cost centers into profit centers. Company departments are charged market rates each time they use the services of, say, accounting or payroll. At the end of each quarter, these cost centers are audited to determine if they are profitable.
“The legal department would be made into a law firm and start billing like an outside attorney,” Ansari says. “The theory is they’ll be more accountable and responsive to the customer, even if it’s an internal customer.”
Such arrangements actually create “pseudo profit centers.” For this solution to work, for the market to truly become a control mechanism, “you must give the buyer the freedom to walk away from the internal supplier,” says Ansari.
In-House or Out?
Small companies, Ansari says, can accomplish the same market discipline by outsourcing payroll or human resources. This also allows top managers to focus on their core strengths.
“Think of how much red tape goes with payroll,” Ansari says. “You don’t want the distraction of making sure W2s are filed when you face the complex problems of getting through to customers and making sure your product sells.
“Dealing with all that takes energy away from your core business. What advantage is there to running your own computer department? You have to ask if the outsider is much better equipped to do this than you.”
Another benefit of outsourcing? The company is not locked into a particular employee’s performance, says Irwin Rudick, vice president of the San Diego chapter of SCORE, a nonprofit business-counseling organization. “If you don’t like the person assigned by [your outsourcer], you can ask for another — or go to another firm.”
Contracting for services does have downsides, particularly if the outsourcing company isn’t responsive. Still, if you find you’ve grown so large that it makes sense to bring business activities in-house, then do, says Ansari. But keep in mind that you will then be stuck with a cost center with all its required oversight.