Safe as Milk

Free Software consulting: marketing & business model

February 1, 2009 12:10 am Dave Neary General

Recently I gave a class for a friend of mine in Grenoble as part of an “Introduction to entrepreneurship” course he is teaching for a Masters in business studies. He asked me to explain my activity, how I set myself up administratively, and explain the business model and marketing plan of a services/consulting company.

I covered a lot of ground, and it was pretty interesting I think, so I’m reproducing the gist of what I presented here for posterity.

Make money giving stuff away?

After a fairly brief presentation of free software (what it is, some examples, why people are interested in it, the basic community mechanisms involved), I got my first question: how can you make money off something that you give away?

Having read “Free! Why$0.00 is the future of business” by Chris Anderson, I had some ready answers, and teased some more examples out of the students:

• Free razors: Sell more disposable razor blades
• Free newspapers: leverage higher distribution figures to get more advertising revenue
• Free music downloads: sell premium products like box sets, concert tickets, merchandising
• Free Internet services (search, email, film, photo management, …): Leverage the ability to follow behaviour patterns and high volumes to increase advertising revenue.
• Free first version, pay for upgrades: Used effectively in the drug trade. Get your users roped in.
• Free cellphones, monthly subscription: sell more of the high-margin recurrent product for the cost of the low-margin one-off purchase.
• Free flights, make money off sandwiches, alcohol, advertising, …

In each of these cases, you can see a basic process at play: free drives volume, to drive the sale of complementary goods. For a musician, concerts are a complement to CD purchases. The bigger your fan base, the more concert tickets you will sell, all else being equal. For free newspapers, advertising space is a complement to distribution.

In general the following rule holds for complementary goods: when the demand for a good goes up, the demand for its complements also goes up. And assuming a normal demand curve, when the price of a good goes down, its demand will go up. So all we need to make a feasible business model based around free software is to find natural complementary goods to the software. There’s no shortage: training, books, custom software development services, support, upgrades, magazines, other software for the platform, the hardware the software comes on, services related to the software’s function (think: photo development services for a photo management application, or web search for a web browser). And there are all the loosely related things that relate to this, like the HR consultants who specialise in finding experienced free software developers.

For me, I chose consulting services, and training. Due to my experience in the free software world, I’m well positioned to help companies who don’t understand the mysteries of how everything works to grow healthy communities, or to become good citizens of the projects they work with. I’m developing training courses on working with free software communities, and developing GNOME and GNOME Mobile applications. And I’m working directly with communities doing the stuff that needs to be done to enable the community to be effective.

Selling your wares

Next up, we discussed how someone might sell those types of services. Of course, your personal network is vital for this, and you need to be working all the time to grow that network, because you never know where the next opportunity might come from. I make a point of talking to whoever I’m sitting beside in airplanes, and not just because the flights go quicker that way. You never know who might be able to help you, and who you might be able to help.

On top of that, you need to build credibility with the people who will be paying for your services, and the people who will be ordering your services. In big companies, this will often be two different people – the person who wants you to come train their team is probably not the person with signing authority on the training budget. So you need to work to build credibility with both. You also need to have credibility with the influencers of purchasing decisions. A manager may ask the opinion of the latest intern to join the group who “knows this open source stuff”.

One good way to do this is to write and publish. Regular newspaper or magazine articles, a well-maintained blog, perhaps authorship of a book or two are all useful references for someone when they are trying to figure out if you’re any good. You should try to target publications which your targets inside your prospects read. If you’re aiming for the CIO, then he probably doesn’t read Linux Magazine, but perhaps you can be a guest writer in something like CIO or 01 Net? The intern, on the other hand, might well have a Linux Magazine subscription.

Another great way to build your network, and to gain credibility, is to give presentations in conferences. This is something you should work at – make sure you give a good presentation. If in doubt, practice live first, in front of the mirror is a good start, real people is even better. There are lots of resources out there on giving better presentations, I enjoyed “Really Bad Powerpoint” by Seth Godin, “Presentation Zen” by Garr Reynolds (and related site), “slide:ology” by Nancy Duarte, and “The Back of a Napkin” by Dan Roam (related site) (thanks to Stormy Peters for the last two references). Target conferences that give you a good chance to meet the people who will be buying your services, or at least who will be influencing purchasing decisions.

If you’re trying to build credibility as an expert in a specific area, you should also actually be an expert in the area. If you’re trying to make money selling support of Drupal, then you should probably be on a first name basis with Dries. Ideally, you will be an active developer on the project, and will be able to point to major features you’ve contributed.

And nothing works better as a marketing tool than having good references. When you have made people happy, they will get you more work. So make sure you are doing that.

How much do you charge?

One of the hardest things to do as a consultant is to figure out how much to charge for your services. And we spent over half of our three hour course talking about this.

The first way to figure out how much to charge can be called cost-plus.

You decide how much money you need, how much time you’re likely going to work to earn it, and divide to get a daily or hourly rate. They you add an amount you think that you can get on the market, and at the end of the year, this is your company’s profit. Profit is handy, since it’s what allows you to grow – to hire new people, take on new projects, and maybe move from consulting to a product-based business model.

A well-known rule of thumb (which Stephen Walli recently restated to me) is that a successful consultant will bill roughly 50% of the available time in a year. Some years will be worse, some years will be better. But between looking for new clients, down time between projects, and handling everything that you need to do when you’re at the head of a company, 50% is a good target to aim for.

The work year is 52 weeks, 5 days a week. Some people might say 6 days a week, but for me, with 3 kids, quality time on weekends is important. If you take 4 weeks vacation a year, and take away public holidays, you’re left with a working year of 230 days, give or take. So if you do well, you’ll be billing 115 days a year.

One of the advantages of consultancy is that the overheads are low. You don’t have to purchase or store stock, and your gross margins are close to 100% since you’re basically selling grey matter. That doesn’t mean you don’t have costs, though – lawyers, accountants, insurance (liability, health, social, life…), government taxes, social charges on what you pay yourself, travel to conferences, dinners and lunches with clients, computers, various subscriptions (cellphone, internet, phone), rent, furniture for the office, the list goes on.

For argument’s sake, let’s say that you want to make €3,500 per month, or €42,000 per year, before tax but after social charges. You will need to invoice in the region of €70,000 to €80,000 during the year. Assuming, as we have, that you will be invoicing 115 days during the year, you need to be charging between €650 and €800 per day. When you say this to students who would probably take a job very happily for €30 an hour, they can be pretty surprised.

There’s a second method to pricing your services, which we’ll call value-minus. It is the reason CEOs, film actors and professional sports stars get paid obscene amounts of money. In short, they’re worth it.

Why would a film studio pay $15 million to Angelina Jolie to star in a film, when they could have had someone else for a tenth of the price? Because having Angelina Jolie in the film guarantees you attendance. It guarantees you a successful press tour. If Angelina’s’ last three films all grossed over $100 million, then the chances are her next one will too – at least partly because she’s on the list of stars. The same thing goes for David Beckham – a club pays for him because the extra merchandising, bums on seats and (presumably) improved results will earn the club back more than they are laying out for him. And Steve Jobs can argue convincingly that part of the blockbuster profits that Apple is raking in are thanks to his stewardship of the company – and as such it’s normal that he be paid in consequence.

If you can put a dollar value on the money that you will earn or save a company by working with them, then you can sell your services for that amount less a dollar, and it is worthwhile for the company to hire you.

As a consultant, it’s hard to do that, though. How do you measure how much more effective a development team is after your training? Feedback is helpful, of course, but you will be measuring the team’s perception of your training, not actual dollars on the balance sheet. Performance metrics are important. Are the team getting changes upstream quicker after your attendance? Are there fewer days being spent on maintenance of local patches? How many fewer? “Reduced maintenance cost by 18% in the year following intervention” is a great headline.

It’s not always possible to follow up and get exact figures, though. To measure the effect of your services, you would need to be measuring before and after for the measurement to mean anything – and in companies that have problems working with free software, they’re not measuring anything, and that’s part of the problem.

But there are ways to infer the value of your services. I have to give a hat-tip to Andreas Constantinou for pointing me to “Million Dollar Consulting”, which opened my eyes somewhat to this.

To work out the value you might have for them, it’s useful to think of substitute goods for your products and services.

Substitute goods are goods which can be used instead of each other. Substitutes can be perfect or imperfect. One brand of car or another are close to being perfect substitutes, but taking the train, or riding a bicycle, might be other substitutes that address the same basic need of getting from A to B.

As a consultant you’re selling information in exchange for time. You’re saying “there’s nothing I know that your team won’t find out eventually on their own, but I can help you get there quicker”, or “you could hire a graduate and train him up for 6 months, or you can hire me now and I’ll be operational Monday”. Other consultants might be perfect substitutes for you (although of course you’d argue they’re not, since you’re so much better), but training, subscriptions to market analysis firms, magazine subscriptions, mentoring programs, or travel to conferences might all be substitutes, since they all address the same basic need – save the client’s time by getting him the information he needs quickly.

A good way to see what the substitutes to your service are is to follow the money. What budget would your services be coming out of? What else does the budget get spent on? Do your services replace or complement other things coming out of the same budget?

As an example, a company might decide that sending 10 people to OSCON for a week is the best way to get them up to speed quickly. 10 plane tickets + 10 weeks in a hotel + 10 expense reports + 10 registration fees might set the company back somewhere in the region of $30,000. So if your one week intensive training course saves them the need to send 10 guys to San Jose this August, you’ve saved them $30,000. You can charge $20,000 + expenses, and they’ll think it’s a bargain.

There is no right answer to the question of how to set your prices, and you’ll quickly find yourself adjusting your price depending on how involved or risky a project is – it’s unlikely that you will have a one-size-fits-all price. But thinking about the price of your substitutes can help you at least be in the range of market expectations.

Market expectations are intimately related to price. You will learn quickly that a lower price does not necessarily make you a more attractive option than your competitors. Price communicates something – skill. As a consultant, you want to position yourself as an expert, and experts cost a lot.

That said, if your competitors’ prices are substantially lower than the figure that you got out of your cost-plus calculation, you might consider looking for a different line of work, or revise your needs down. If you want more money than the market is willing to give you, the chances are you will end up disappointed.

So – there you go. Food for thought, and there are probably plenty of approximations there for people to jump on. I stand by the basic thrust:

• Base your business model on a complement to the free software you work with.
• Figure out who will be influencing buying decisions, who will be doing the buying, and who will be doing the paying, and figure out how to build credibility with each of them
• Price your services based on the value you give to the company, while keeping an eye on how much you get paid at the end of the month. Estimate value based on the market price of substitutes for your services.