I do a lot consulting and contract work which is the major source of income for my small software company while growing the product side of the business. Consulting and contract work can provide good income for an individual or a small closely held company, but it doesn’t scale well because it’s hard to find good employees at the right price and the profit margins are often low. I recently came across a good article on softwarceo.com where Kyle Bowker, president and CEO of Nextance, discussed the consulting conundrum:
“It's a common problem for start-ups, many of whom are always ready to augment software sales with some degree of consulting revenues.
‘It's almost like an addiction,’ says Bowker. ‘You look at these early-stage companies and the revenue grows based on their consulting work, but if you look at the profitability and the margins, they're not there.’
That's because the margins are so low on consulting — just 20 to 30 percent by his estimation — versus the markup on software, which can run as high as 90 to 95 percent for a completed application.
That doesn't mean Nextance outright refuses to do any consulting. But the firm does limits the degree to which it takes on that role.
‘We do have a consulting practice, and we will continue to have that practice,’ Bowker says. ‘However, if you look at the Siebels, the PeopleSofts, and all those guys, their success was really driven around expanding their own ecosystems, and entering into third-party relationships for consulting services.’
In other words, consult if you must — but always look for a way to pass the consulting gigs off to partners, while you stick to creating software.”
There’s also a very good article about the consulting conundrum by Joel Splosky titled “Big Macs vs. The Naked Chef.”
“What does this mean for Fog Creek? Well, our goal has never been to become a huge consulting company. We started out doing consulting as a means to an end -- the long-term goal was to be a software company that is always profitable, and we achieved that by doing some consulting work to supplement our software income. After a couple of years in business our software revenues grew to the point where consulting was just a low-margin distraction, so now we only do consulting engagements that directly support our software. Software, as you know, scales incredibly well. When one new person buys FogBUGZ, we make more money without spending any more money.”
Consulting and contracting can generate income quickly for a hungry startup, but it’s often an uphill and never ending battle from there. I think the issue for a startup is not to get too sidetracked by “easy money” in the short-term only to give up a more profitable alternative.