Managing Virtual Functions

“Apple is already dead.” Nathan Myhrvold (1997)

Virtual Staff

A Harvard Business School survey showed that customer loyalty is closely related to employee loyalty. For every 1 percent increase in employee loyalty, customer loyalty to the company increases ½ percent.

Several surveys conducted in recent years by The Wise Marketer, The Guardian, and Computer World, demonstrate that while there is a direct correlation between employee loyalty/satisfaction and customer loyalty/satisfaction, employees aren’t especially loyal to their companies no matter what level of benefits the company provides. In order to attract and retain employees in the digital age, companies must increase benefits, compensation, and individual attention.

Your small business just does not have the time, energy, or financial resources to do that, and you certainly cannot risk customer satisfaction by having a disloyal employee. You need people you can trust, people you can empower to get a job done well—on time and with minimal supervision. That means staying non-employer and contracting with virtual staff.

Another dilemma with hiring employees is that when your company starts, it is impossible to predict workflow. Employees are a fixed cost to the business. They have to be paid even if they are standing around twiddling their thumbs. They are a serious threat to cash flow management early on in a company’s journey. Even in well-managed, cash-rich companies I could make a case for downsizing. So many employees do not contribute to profitability.

To get a visual of the difference I am speaking about; Compare starting a company to buying a new home. The home needs some basic repair work. You would naturally hire what you need, when you can afford it. The plumber comes in for an hour to take care of the leaking faucet. The roofing company spends half a day replacing rotten tiles. You would not hire a full time handyman, and have him stay in your house waiting for things to fix. Yet that is what so many new business owners do. They immediately hire help that they probably don’t need right away.

The Employee Process

Just one glance at what a start-up business owner must do when they hire their first employee should be enough to convince you to consider a more practical alternative for your time and money. If, however, you are determined to go the traditional route and hire a full-time employee, here is what you need to consider:

1. Obtain an employer identification number. When you hire employees, you must get an employer identification number (EIN) to use on tax returns and other documents you submit to the IRS. To get an EIN, you must file IRS Form SS-4. You can download the form from the IRS website at www.irs.gov. As part of the incorporation process online you have the opportunity to add this requirement to your package.

2. Register with your state’s labor department. Once you bring on employees, you will have to pay state unemployment compensation taxes. These payments go to your state’s unemployment compensation fund, which provides short-term relief to workers who lose their jobs. Go to http://workforcesecurity.doleta.gov/map.asp for a list of state unemployment insurance tax agencies.

3. Get workers’ compensation insurance. You should have workers’ comp coverage to protect workers who might suffer on-the-job injuries. Workers’ comp insurance is required in the vast majority of states, although some make an exception for very small employers. For more information on workers’ compensation laws, see The Manager’s Legal Handbook, by attorneys Lisa Guerin and Amy DelPo (Nolo).

4. Set up a payroll system to withhold taxes. You’ll need to withhold a portion of each employee’s income and deposit it with the IRS, and also make Social Security and Medicare tax payments to the IRS. For more information, get IRS Publication 15, Circular E, Employer’s Tax Guide from the IRS website at www.irs.gov. (You may also have to withhold taxes for your state. For more information, check with your state’s tax agency; you can find links to each state’s agency at the website of the Federation of Tax Administrators at www.taxadmin.org/fta/link.)

5. Have each employee fill out IRS Form W-4, Withholding Allowance Certificatwww.uscis.govwww.uscis.gove. On the W-4 form, employees tell you how many allowances they are claiming for tax purposes, so that you can withhold the correct amount of tax from their paychecks. (You don’t have to file the form with the IRS.) You can find this form at www.irs.gov. You should ask employees to fill out a new W-4 form each year if they want to change their allowances.

6. Fill out Form I-9, Employment Eligibility Verification for each new employee. U.S. Citizenship and Immigration Services (USCIS, formerly known as the INS) requires employers to use this form to verify that every employee they hire is eligible to work in the United States. (You don’t have to file this form with the USCIS, but you must keep it in your files for three years and make it available for inspection by officials of the USCIS.) You can obtain the form online at www.uscis.gov. Note that these filled out forms should be kept in a separate I-9 folder for all employees—not in each employee’s personnel file.

7. Report each new employee to your state’s new hire reporting agency. The new-hire reporting program requires employers to report information on all new employees for the purpose of locating parents who owe child support. Each state has a different new-hire reporting agency. To find the name and address of your state’s new hire reporting agency, see the State New Hire Reporting page at the Administration for Children & Families website (www.acf.hhs.gov).

8. Post required notices. Several government agencies require employers to post notices providing information on worker rights for their employees. For information on required federal posters, go to the Department of Labor website at www.dol.gov/elaws/posters.htm. The DOL’s “Poster Advisor” will help you determine which posters you must display in your workplace. In addition, you must comply with your state Department of Labor’s poster requirements. A list of state departments of labor is included on the federal Department of Labor’s website.

9. File IRS Form 940 each year. You must file IRS Form 940 to report your federal unemployment tax for any year in which you paid wages of $1,500 or more in any quarter or for any year in which an employee worked for you in any 20 or more different weeks of the year. You can find the form at www.irs.gov.

10. Adopt workplace safety measures. Almost every employer must comply with the requirements of the Occupational Safety and Health Act (OSHA) by, among other things, providing a workplace free of hazards, training employees to do their jobs safely, notifying government administrators about serious workplace accidents, and keeping detailed safety records. For information on these rules, go to website of the Occupational Safety and Health Administration at www.osha.gov.

11. Create an employee handbook. Although not required, it is an excellent idea to have a handbook describing your business’s employee policies and making it clear that employment is at-will unless an employee has signed a written employment contract.

12. Set up personnel files. For each employee you hire, create a file in which to keep job-related documents, such as job applications, employment offers, IRS Form W-4, performance evaluations, and sign-up forms for employee benefits. Medical records should be kept in a separate, confidential file, in a locked cabinet. And you should store I-9 Forms, which document an employee’s immigration status, in a separate file as well. For more information on developing a system for storing and maintaining personnel records, including state-by-state rules about employee access to their files.

13. Set up employee benefits. If your business has established employee benefit programs such as health insurance or a 401(k) plan, you’ll need a sign-up procedure so employees can enroll, name their dependents, and select options.

All of that takes time, money and focus, when you have so many other more productive things you could be doing.

The Legal Word on Consultants

Some unscrupulous companies misclassified employees as contractors in order to avoid having to pay unemployment, social security, state employment taxes, and Medicare. To tell whether someone can be classified as a contractor, the IRS provides guidelines, at www.irs.gov/pub/irs-pdf/p15a.pdf. In general, a consultant or contractor is someone who has their own business and more than just your company as a client. In other words, they control their work schedule, not you. If you hire someone for a specific short-term project, they would not be classified as an employee, but if you hire a long-term consultant for, let’s say, three days a week, some states would classify them as an employee especially if they only work for you.

The IRS does perform company audits. Back taxes and penalties can be significant, so it is important to understand the difference between a legal contractor and a legal employee. The point I am making in this chapter is that managing employees is demanding of your time and resources, whereas consultants and contractors can often perform their work unsupervised. Additionally the first few years of your company is a bumpy ride and you can only afford to hire what you need when you need it.

The Advantages of Virtual Staff

• Their attitude is more in line with “What can I do for you and your company?”

• They are already owners of a small business, so understand what you are going through and they can be a valuable source of experience if you let them be.

• They do not need you to provide office space, and meetings can be held over the phone and Internet as needed.

• They are 100 percent loyal to your company success. They have to perform well or you will not retain them or use them in the future. Therefore, they have a built-in motivation to work hard, do well, and provide value for money.

• Letting employees go is a complex, stressful, and expensive endeavor. Letting contractors go is a simple matter of not renewing their contract.

• They are consultants for a reason. They are usually experts at their job and obviously have the confidence to offer their services. To hire employees with that amount of expertise and self-assurance would be expensive, and you do not have the time to train people up anymore.

• They have an established network of other experts that may be useful to your business. Their network can save you a fortune you would otherwise spend searching for and interviewing candidates.

• They require only limited direction and supervision.

• They usually have template contracts and confidentiality agreements so you don’t have to expend time and money creating them. Some experts will advise you to hire an attorney to handle the contracts, but I tend to think that if the contract was good enough for one of their billion dollar clients, it is likely going to be good enough for my start-up.

• They take ownership in the success of the company. If they can demonstrate they were part of the successful growth of a small or new company, it is good for their portfolio.

• They bring no hang-ups to the company. You don’t need human resources, sexual harassment training, or performance and appraisal systems. You give them a task. They do it. You pay them.

• You can more easily scale up or scale back on their services as demand and cash flow dictates.

• Your relationship with them is more of a partnership than a reporting hierarchy.

• You do not need to supply health insurance or worker’s compensation.

• There is no need to report to the State.

• There are no tax consequences or administration costs because they are a direct expense.

In the last ten years, I have hired over sixty contractors for various projects. Some were hired to work a few hours, and others worked up to two days a week for a couple of years.  Some of them I never met face to face. I never once, however, had to handle anything like an employee dispute, sooth someone’s bruised ego, or boost anyone’s morale and loyalty. There was never an occasion to let someone go because they were cheating, or guilty of any type of corporate wastefulness. Instead, I shared with them the vision I had for a company, and whenever we got positive customer feedback, I shared it with everyone past and present. No matter their role or amount of work, they all had a hand in those successes, and they appreciated hearing it.

Virtual Accounting

Technology and inexpensive software are capable of making accountants of us all. I do not, however, recommend doing the bookkeeping yourself. Too much valuable time can be wasted when you should be concentrating on growth. Worse still, some small businesses ignore financial management altogether, pushing it onto the “must get to it one day” pile. That can be catastrophic. Very quickly, you can lose track of things as other aspects of your business demand your time. It is all too easy to lay invoices aside and then forget about them. Keep in mind the importance of cash flow to your survival. You must get the cash into your bank account as quickly as possible.

Many businesses fail through avoidable clerical errors like forgotten invoices. I recently received an invoice for work that was done on my house more than six months ago. What if I had moved or been foreclosed in that time? For a small monthly fee you can have a professional company keep your books, issue invoices and track payments, pay your bills, draw up your accounts, and provide tax preparation and advice as well as annual auditing support.

I used the same accounting company for many years, with a fixed fee-per-month arrangement that changed gradually as volume and demand dictated. Although I got to know the part-time team very well over the Internet and phone, we never met in person. The CPA was in Dallas, and the controller was in Washington.

- The accounting firm I have used covered the following tasks:

- Bookkeeping with CPA and controller services

- Monthly financial statements

- Bill paying (accounts payable)

- Expense processing and travel policy for consultants

- Accounts receivable processing

- Bank account management

- Annual audit reports

- Budget management

- Accounting standard operating procedures

Whenever I needed specialized services such as due-diligence support for deal making, they were there for me. They provided accounting procedures and travel expense policies so I could add them to vendor contracts. They took full ownership of the accounting function, and often did far more than I was actually paying for. As part of the service, the company also provided real-time access online to all my data as well as electronic back up. There are dozens of outsourced accounting firms to choose from and you can shop around to find one to fit your budget.

Virtual Manufacturing

If you are selling a product, then presumably you need someone to make it for you. For small companies, this is a risky area of the business. In a virtual business model, the hiring firm approaches a number of contract manufacturers with a design or formula. The vendors’ quote based on processes, time, labor, and material costs. Once you agree a price, the contractor acts as your firm’s factory, producing and shipping units on your behalf. Simple.

The first of many challenges, however, is getting production planning accurate at the outset. Come to think of it getting it right anytime is difficult and at the start it is almost impossible. Entrepreneurs are an optimistic lot, and often tend to over forecast demand. Often it takes longer to get where we expect. In reality there is no such thing as an accurate forecast, and just degrees of inaccuracy. The smarter entrepreneurs are simply the least inaccurate.

When I was younger I tried my hand at multi-level marketing, which amounted to selling soap powder to my friends and family. I thought I’d be good at it, so ordered plenty of inventories in advance of my sales efforts. It turned out that I had fewer friends than I thought and most were quite clean. So, I ended up with a garage full of soap, which I eventually had to discard. From a cash flow perspective, my optimistic forecast was a disaster.

A further challenge is that contract manufacturers typically work with large volumes and small profit margins. It can be hard to find a manufacturer willing to produce smaller lots. Smaller lots also cost more per unit to make, which can cause your product to be more expensive than the existing competition.

There is no bigger threat to the success of a business, however, than to have a temporary shortage of product. Customer loyalty is lost easily. Production planning becomes something of a balancing act, but for me the greater threat is running short of product.

Over the years I have encountered just about every possible contract-manufacturing problem. One company simply refused to make a batch of my product and left me with precious little time to find an alternative source. Another manufacturer went out of business for financial reasons. A third firm had so many quality issues, we failed batch after batch until we almost ran out of product. For me, it was the most stressful part of running a business, virtual or otherwise, and I learned the importance of mitigating the risks by considering the following:

-> Staff turnover is an issue at many manufacturers and your client account manager can change frequently. Production staff moves between projects and to other companies. That causes disruptions to the foundation of knowledge you put in place at the outset. At one of my manufacturers, I put a lot into the initial training but failed to develop a staff transition plan, one that would ensure the knowledge does not leave with the personnel. It is important to establish such a plan so that you don’t have to reinvest time and resources with every batch made. I ordered an initial two-year inventory production run. It took a lot of time and effort for the consultants I hired to oversee the production run, and to educate the technical staff to the appropriate methods. After the product shipped to our preferred distributor warehouse, I believed that I didn’t have to worry about manufacturing for a while. In short, I took my eye off the ball.

As the time approached for a new batch of product, however, I found that everyone involved in the first production run had left the company. I had to rehire the consultants and go through the same time-consuming process as if it were the first time they had manufactured our product. The experience led to two solutions. Firstly, I had the manufacturer make smaller, more frequent batches even at the higher per-unit cost. This meant that quality was not compromised between manufacturing cycles when there was more chance of someone still being at the contractor who was involved in making the prior batch, and could transfer knowledge. It also lessened my reliance on the consultants. We also amended the contract so that anyone voluntarily leaving the company had to pass along their knowledge during a transitional period.

-> For budget reasons, with my first company I initially decided to take the risk of going with a single manufacturer for our lead product. Unfortunately, one year later they filed for bankruptcy, and I had a short-term supply issue to resolve. Fixing things at speed requires hiring a lot of contractors. It is costly and you lose the ability to negotiate beneficial terms because time is of the essence and everyone knows you are in a bind. I barely slept for weeks. From that point on, I invested in a second vendor to act as a stand-by manufacturer. They were trained and ready, but kept in reserve. It cost me a monthly management fee, but the risk/benefit of the cost seemed sensible. When demand was increasing faster than the first vendor could keep up with, we triggered the back-up to help us out in the short term. They did a better job, and eventually we reversed the positions of primary and secondary vendor. It is worth paying a second manufacturer a retainer fee to be a back up in the event you hit problems with your main manufacturer but this tactic comes with a cost.

-> Always keep at least one manufacturing cycle of inventory on hand. If it takes six months from start to finish to make and ship your product batch, then have at least that much inventory on hand at all times. Even if some of it expires unused, it is better than running out of product and losing customers. Customers are hard enough to find in the first place and they will flee to the competition if you cannot supply them. Never run out of product.

-> One manufacturer decided the amount of business I provided for them was not worth their time and effort. They refused to make a scheduled new batch, even though the product was known by them to save lives. My contract with them had an eighteen-month termination clause, so legally they were forced to make another batch while I worked on getting a new manufacturer up and running. Include a termination notice clause in your contracts long enough to get a new manufacturer set up.

Benefits of Contract Manufacturing:

Cost Savings – The main advantage is that the company does not incur the cost or building and running a facility, staff, and equipment. One of our manufacturers owned state-of-the-art vial-making equipment that produced millions of units a month for a large client. For us, they simply shut the machine down for a day of cleaning, manufactured our small batch on the second day, and then after another day of cleaning, returned the machine to its full-time production. We were able to get almost the same cost per unit as the large client. For us to build a dedicated manufacturing facility would have cost millions, but they produced all we needed for just $30,000 a run.

Long Term Financial Benefit to Both Sides – A contract between the manufacturer and the company should be for several years. The manufacturer will know that it will have a steady flow of business until then. This is especially important to small and growing manufacturers. I quickly realized that potential acquirers of my companies required a long-term manufacturing contract to be in place, so I went with an initial term of ten years, but kept renewing it every two years. That way any acquirer had a long-term contract in place, which reduced their risk and, therefore, increased the value of my company.

Consistent Quality – Contract Manufacturers are usually audited frequently by larger companies and have their own methods of quality control in place that helps them detect damaged materials early on.

Economies of scale – Contract Manufacturers have multiple customers that they produce for, and often buy common raw materials in bulk, passing on a cost saving to you.

Risks of Contract Manufacturing

Production Delays –  Vendors often have to shut down for periods of maintenance or to update their practices and equipment. When they start up again, the bigger clients take priority. You can find yourself shuffled to the back of a long queue. This is another reason I prefer to manufacture more than I need. I sleep better at night by knowing that there is a cushion of inventory available to cover for unforeseen delays.

Lack of Presence – It is imperative that you have a good relationship with your contract manufacture.  Being small, it is easy to get overlooked and the onus is on you to keep your project at the front of their attention. A long time can pass between production batches, so make sure you send regular friendly emails and call periodically to check in with the vendor. This is another reason I like to share customer feedback with them. Manufacturers deal with negatives and multiple crises daily and hear a lot more criticism than they do praise. I always made a point of sharing any happy customer anecdote with my client-manager and then asked him or her to share it with anyone involved in our project. I also referred other companies and entrepreneurs to them, which was also a subtle reminder that my company was alive and well and not to be ignored.

Outsourcing abroad – Although taking manufacturing to low-cost labor countries has become very popular, it does bring along risks such as language barriers, cultural differences and long lead times. This could make the management of contract manufacturers more difficult, expensive and time-consuming. Some people believe that outsourcing abroad is un-American, but if your company goes out of business because manufacturing cost too much and customers refused to pay the price, of what benefit is that to the country? I always managed to find an American vendor, but I would have had no qualms looking elsewhere if it aided my survival as an entity.

Accounting and manufacturing are the two key functions common to most companies that can easily be outsourced. It is, however, essential to mitigate risks with a sound back-up plan and by taking steps to ensure product availability during production issues. In chapter nine, we will look at a third critical function for the virtual company: commercialization, better known in the virtual world as e-commerce.

Please share your success stories with virtual staff and functions. Did you have any difficulty adjusting from traditional employees to contractors?