Why anyone can sell a ten-pound note for a fiver (but probably shouldn’t)

Imagine you decide to go into business, selling your expertise and specialist services to whomever needs them – probably other businesses. Let’s say, for argument’s sake, that your specialist service is material-failure analysis using high-resolution imaging (scanning electron microscopy). You hand in your notice and set out, shopping list in hand, to purchase everything your new start-up will need.

Kitting up

First off, you spend £50,000 on a suitable scanning electron microscope plus necessary ancillaries (you could spend way more on an SEM package, but a relatively small bench-top model will do just fine). You spend a few more thousand – let’s conservatively say £5k – on office equipment and furniture, general office supplies, a basic business website, and some design and branding consultancy. And you find a nice little workshop unit to rent, which will be well-located for your business customers and provide the space you need to accommodate your business activities (a lab area and somewhere to do the office-admin stuff).

Boom – you’re ready to open for business! So, what to charge?

Well, in your old job, working for a university, your gross annual salary was £60,000. You don’t really want to take a pay cut, so based on a 40-hour working week and 45 working weeks in the year you decide to charge £33 per hour (£33 x 40 x 45 = £59,400; not quite £60k, but you’ll pay less in tax and NI as a self-employed sole trader). Simple! And you’ll be super-competitive too – your market research indicates that your competitors are charging way more than this. Ahhh, self-employed life is going to be so good…

“I feel like a toucan (wherever I turn I just see a big bill)”

Wait up though. Not all of that £33 – or even the bit that’s left over after tax – is going to go into your pocket. It turns out there are quite a few other things it needs to cover. Your little premises is costing you £5,500 a year – a pretty good deal, but it still needs to be covered. Utilities – heat, light, telephone – add another four grand to that. Your accountant wants a grand, and your website hosting and maintenance package is another £500 (cheap!). You’re going to be spending about a thousand on office sundries and miscellaneous stuff each year too. And another thousand on business insurance.

Hmmm, that £60k-ish annual salary is starting to look like less than £50k.

It gets worse. The SEM equipment should last about 10 years, so you’ll need to put aside around £5k every year (ignoring inflation) to cover eventual replacement. In the meantime, the maintenance package and warranty costs £1,000 a year, and that needs to be covered too.

Now your salary’s less than £45k.

Let’s not ignore capital costs. When you started out you spent about £55k on equipment, mostly your SEM machine. If you borrowed that money, then you’ll be paying about £4,000 a year in interest. If you spent your own money then you’ll be missing out on about £2,000 or more in interest that it would have earned. More expense!

And there’s another cost on the horizon, this time a big one. You don’t want to be working every waking hour, but there’s other stuff to do besides looking at broken bits of metal in minute detail through a microscope. Lots of other stuff. The phone needs answering. Invoices need preparing. Overdue payments need chasing. Admin, admin, admin, it all takes time – your time! And actually you could do with a bit of help with the microscopy work too – specifically sample preparation and report writing. So you decide to take someone on part time to help you. The total annual cost of employing them, including on-costs like employer’s National Insurance, will be £30k. Good job they’re only part time!

Now there’s just over ten grand left in the pot to cover your salary. Let’s hope no other unexpected costs crop up, or you’ll soon be working for nothing! Wait – where’s that leak coming from??

Bear with me, there’s a point to all this.

Re-thinking those fees

It’s become abundantly clear that your approach to costing just isn’t viable. When you work everything out, it turns out that to protect your £60k-ish annual salary you’ll need to charge at least £62 per hour for your services – let’s say £65 to be on the safe side. Double what you first had in mind. Ahhh, that’s why your competitors all charge at least sixty quid an hour for the same service – they have to! And if you’re going to be charging £65 this year, then you’ll need to up that to over £67 next year just to keep pace with inflation, never mind anyone getting a promotion or performance-related pay rise. It turns out that balancing the books in a business is tough – you had no idea just how tough! That old job in the uni is starting to look quite appealing…

So what’s the take-home from this cutesy little parable? Well, it’s definitely not ‘don’t go into business’. But whether you decide to set up on your own or you play a part in delivering your university’s business activities, do it with a full understanding of what’s really involved cost-wise.

Why this matters in academia

Universities provide a wide range of specialist services to business, enabled and supported by their extensive and advanced research infrastructure. Business customers don’t commission these services just for the joy of finding stuff out, or because they like giving money to universities. They commission them because they need them. (Moreover, it’s worthy of note that they can get quite generous tax breaks for qualifying expenditure on R&D, including that which is carried out for them by researchers and students in universities.) And, because they operate in the world of business, they understand all that stuff about paying the rent, keeping the lights on and even fixing the roof from time to time – all the stuff we commonly refer to as overhead costs. They know only too well the true cost of being in business. If ACME Microscope Imaging Co provides a good service for £33 an hour then customers will be queuing out the door to use it, right up to the point when ACME goes bust. But if those customers need the service then they’ll pay a proper fee for it, because they operate in the real world and they know what things really cost. They won’t be frightened off by commercially-realistic prices for a good service that they require.

Why then, in academia, do we so often express the fear that charging a commercial rate – often referred to as ‘full economic cost’ – for research and consultancy services will instill such terror in our industry customers? Is it because we, unlike those customers, don’t operate in the real world?

When we see full economic costs broken down they can indeed look a bit crazy at first sight. “What, the overheads account for more than half of what we’re charging them!” But overheads are simply the costs of doing business, and if they’re not fully covered then something has to give. As we saw above, either salaries have to be cut or the business quickly fails. Every business knows this. In universities, the full economic costing model is worked out and monitored by finance professionals, along similar – if somewhat more complex – lines to the above. And, say what you like about finance professionals, one thing they tend to be good at is numbers…

Of course, there’s a key difference here between industry and academia. In industry, the selling is done by the guy with the bright smile and the slick-looking suit. They don’t say stuff like “well the true cost is £10k, but my bloody business insists on sticking another £10k on that to cover their overheads.” Instead, they explain why £20k is a good price for an excellent service, and then hand over to their colleagues in the lab, workshop or wherever to deliver that service. In academia though, it’s usually the individual academic who has to act as both sales-person and the person who delivers the work. And while delivering the work is generally well within our comfort zone, selling our services is often much less so.

And on a serious note

I write this at a time when the UK university sector is deep in a financial crisis that seems to have no obvious solution. The FTSE100 index, by contrast, is close to its all-time high. I don’t dispute that businesses face their own cost and financial challenges, but I reject the notion that sound businesses will not pay a fair price for a good service. And I’m completely sure they know what ‘fair’ looks like. If you have confidence in the service you provide – no doubt you do – then have confidence that it’s worth a fair price that covers the total cost of delivering it. We do ourselves a disservice (and worse) if we sell ten-quid notes for a fiver.

The views and opinions expressed in this blog are mine alone and are in no way endorsed by my employer. Factual information and guidance are provided on a 'best-endeavour' basis and may become out of date over time. Web-links were correct at time of writing but commonly go out of date. No responsibility can be taken for any action or inaction taken or not in respect of the content of this blog.