Surviving Tough Times in a Service Business

Avoid problems, outlast your competitors, and pick the right places to make cutbacks.

The dollars and cents of service businesses, especially those that don't operate from expensive commercial space, tend to be easy to explain. When your overhead is low and the main thing you're selling is time, it's not hard to understand what you need to do to make money. When the economy takes a downturn, a house painter, roofer, electrician, lawyer, or other service provider whose overhead costs are a small percentage of gross sales can usually survive by cutting back quickly after experiencing a significant sales drop.

To earn a good income, an accountant needs only to sell a reasonable number of hours each year while getting paid promptly and keeping overhead expenditures under control. And if an accountant does poorly, the problem can usually be summed up in nine words: not enough clients buying and paying for enough hours. It follows that to fix things, the accountant will first want to improve marketing to bring in more work, and secondarily look at cutting overhead. Similarly, other service providers without high overhead, whether they are consultants, plumbers, music teachers, SAT tutors, exterminators, or massage therapists, should quickly be able to state how many hours of time they must sell at any given hourly rate to operate a financially successful enterprise.

If you can charge a substantial hourly rate, with little overhead, you'll normally be able to hang in there even if sales initially plunge as much as 40% to 50%. Of course you still need enough income to put bread on the table, but if your business is both established and historically profitable, it will probably survive. That's because for most quality service businesses, continued success depends on the accumulation of positive word of mouth. That's something that in hard times you might be able to leverage as part of a marketing plan to reach out to long-term customers, asking them for both their personal support and their help in recruiting others. (This may not be true if your business is the new kid on the block.)

If your company provides services that can easily be put off, however, you can face a customer meltdown in tough times. So if you paint houses, detail cars, install garage doors, landscape gardens, or cater business events, no matter how hard you are willing to work, you need a convincing survival plan. It might involve repositioning your business to deliver services that penny-pinching customers still are willing to pay for—for example, a veterinarian might contract with a city to provide services at the animal shelter.

Here are some tips to survive an economic downturn, and examples of what companies have done to survive.

Avoid Accounts Receivable Problems

You might also have a difficult time if, by industry tradition, your company does the work first and bills later. That's because when times are hard, inevitably some customers will pay late and others not at all. That's why it's often crucial to quickly revisit and tighten credit policies before bad debts mount. One way to do this is to require a substantial up-front deposit as well as appropriate progress payments. To help long-term customers adjust to your new rules, it's helpful to also extend a discount.

EXAMPLE: The Myers & Pedroilla law firm informs its clients that in recognition of hard economic times, it is lowering its hourly fee by $50 per hour. But because it's impossible to both charge lower prices and wait to be paid, M&P is simultaneously moving to a new billing routine in which clients are asked to pay half of the estimated cost of their legal task up front and the other half within seven days of completion. As a result, M&P loses a couple of significant clients, but when one of them goes bankrupt a few months later owing its new law firm $35,000, M&P knows it made the right choice.

A sales meltdown is more difficult to overcome if you run a service business with a relatively high overhead such as a hair salon, car repair shop, dry cleaners, car wash, or bed and breakfast. Like retailers, the cost of keeping the doors open and the business staffed can gobble up all of your declining income and more, resulting in a substantial loss.

Outlast Your Competitiors

Because in our 21st-century commercial world it's a lot easier to make money selling services than goods, most service providers have many local competitors. But chances are your business will survive if you outlast at least a good number of the other businesses that provide similar services. If your business can stay open until others close, you may even do better than you did when times were good.

How can you outperform your rivals? Start by making a list of your direct competitors. You have doubtless known most of them for years. But don't forget that when times are hard, many cash-strapped consumers look for cheaper alternatives. So if you operate an upscale hair salon and never previously thought of the local Supercuts outlet as a competitor, you may need to think again, depending on just how depressed your local economy is. Then make a short list of the strengths and weaknesses of each competitor. This might include their customer base, reputation, employee relations, cost structure, and marketing savvy.

Finally, come up with a realistic plan to outperform and outlast a percentage of your competitors. Once your plan is made, run it by your advisory board. Here are some examples:

  • Cedar Cleaners, whose business is hard hit by a recession, decides that, to keep its long-time customer base loyal, it has to run one sale per week (sleeping bags, drapes, formal wear, quilts, and so on) to keep volume up, even though profits take a hit. When, after a year of deepening recession, two other dry cleaning establishments close, Cedar is able to regain pricing power and return to solid profitability. Once the economy finally improves, Cedar has its most profitable year ever.
  • Two bed and breakfasts in the same seashore town combine marketing efforts, sending "three nights for the price of two" offers to their combined mailing lists, merging their websites, and even taking turns doing breakfast. On the website they provide loads of information to make it easy for people organizing weddings, family reunions, and small business getaways to book both inns at once.

Make the Right Cutbacks

Here are two quick and dirty profits statements for service businesses. As you'll see, each of these entrepreneurs has a good handle on the dollars-and-cents side of their operations, which allows them to make sensible cutback decisions when hard times require it.

House Painting Business

Able is a house painter with a small crew. Here is Able's statement based on what he regards as his normal business over several good years.

I'm a house painter with a three-man crew that I sometimes expand to as many as eight when I'm working two or three jobs at once. My wife Sid works as part-time bookkeeper and scheduler. To pay her and the crew and cover other expenses, such as the cost of my truck and equipment, and net at least $120,000 to support our family, I need to gross close to $300,000 per year. I accomplish this by charging customers $60 per hour for my crew members and $70 for me. I pay my less-skilled employees $15 per hour and my highly experienced foreman $24 per hour.

I spend time doing things that don't produce income, such as bidding jobs, maintaining equipment, and taking a vacation, so I bill only about 800 hours of my own time each year. So, to meet my income goal I need to charge at least 4,500 hours for my crew. When the weather and the economy are both good, I can do better, meaning Sid and I can earn the $120,000 we need to live on and put money aside as well.

Doing the Numbers in a Good Year

Crew (4,500 hrs * $60) $270,000
Able (800 hrs * $70) 56,000
Total Revenue $326,000
New Truck $30,000
Gas 600
Paint and Materials 10,600
Office 18,000
Marketing 5,000
Wages & benefits (bookkeeper) 30,000
Wages & benefits (crew) 105,300
Miscellaneous 2,000
Total Expenses $201,500
Net Profit (before taxes) $124,500

Now let's fast forward to an economic downturn. Able's volume falls by 50%, and to get this much work, he has to lower his bids by at least 20%, meaning that he now charges his time at only $50 per hour and his crew's at $40 per hour. What can Able do to survive? He starts by determining that he can't solve the shortfall by simply doing more painting himself. Since he is by far the best salesperson, Able needs to put time into marketing, including bidding on as many jobs as possible. He also knows he can't afford to cut the hours of his foreman, even though his hourly rate is higher, because doing so risks losing his most skilled painter, something that before long would surely damage his reputation for top quality work. Based on these assumptions, here is Able's hard-times amendment to his first statement.

To cut overhead, I moved the office into the basement. In addition, I decided not to replace my truck, and of course I hired less labor because I had fewer jobs.

Doing the Numbers in a Bad Year

Crew (2,250 hrs * $40) $90,000
Able (800 hrs * $50) 40,000
Total Revenue $130,000
Truck maintenance $2,000
Gas 450
Paint/Miscellaneous Materials 6,000
Marketing 8,000
Bookkeeper 30,000
Wages & benefits (crew) 51,480
Miscellaneous 2,000
Total Expenses $99,930
Net Profit (before taxes) $30,070

Even counting Sid's pay for bookkeeping, it's obvious that Able and Sid are now in financial hot water. They have some high personal expenses that are important to them: Their two children go to Catholic school, and when times were bright two years ago, they bought a new house with a pricey mortgage. They realize more changes are necessary.

To try to put our business back on its feet, my first step was to ask my crew whether they would temporarily work for 25% less. Because they would otherwise be unemployed they agreed, as did my foreman. This let me mail a flyer to my old customers offering a super deal if they would commit to repainting now. I picked up six new jobs and put my foreman and two painters back to work full time. This meant Sid and I now have an income of over $90,000, just enough to pay the school bills and mortgage if we scrimp on everything else.

Going forward, Sid plants to take a course in color theory and help me with estimating, including leafleting neighborhoods close to where we have a job, offering a free consultation and estimate. If this works out, I can spend more time painting and further increase our income.

Employees cost more than you think. If you hire even a few people, otherwise productive time and energy must be diverted to communication, coordination, and other management tasks, none of which makes the cash register ring. Recognizing this, it's important that each new employee you hire make a substantial contribution to your bottom line. If they do, great—your management efforts will more than pay for themselves. But especially in bad times, when profits fall or disappear, you'll want to reassess. If an employee doesn't make your business substantially more profitable, you would do better to stop wasting your own precious productive hours on managing that person. Better to look at contracting the task out to someone who does nothing else or concentrate on getting the maximum possible return for your own time.

Small Business Attorney

Scott is a lawyer who specializes in new business start-ups and helping existing businesses do the legal paperwork necessary to raise money to expand. He also handles other problems for his business clients, including bankruptcy. Here is his statement of how his profitability works in a good year.

During normal times I try to work a 35-hour week, not counting hours I spend keeping up on my field through reading and attending legal education classes. With five weeks off each year, this means I have 1,645 hours to sell. I share a nice office with two other lawyers; my portion of office rent, my one-third share of the salaries for our one full-time secretary and one part-time paralegal, and my other expenses are about $100,000. In addition, I spend about $25,000 entertaining clients, taking classes in continuing legal education, travel, and professional publications (books and online materials). Obviously, I have to cover this $125,000 expense nut before I pocket anything.

My goal has been to bill at least 80% of my 1,645 working hours (or 1,316 hours) at $250 per hour, bringing in just under $329,000. This leaves me with a net of about $194,000 after covering expenses and any bad debts, which are usually about $10,000. But because I have a couple of clients with continuing legal needs who pay up front for my time whether or not they use all of it, these deals net me substantially more than $250 per hour, so my net is actually closer to $224,000.

Doing the Numbers in a Good Year

Billable hours/Retainers $359,000
Total Revenue $359,000
Office rent and secretarial services $100,000
Entertaining 15,000
Publications, professional dues, classes 5,000
Business travel 5,000
Bad debts 10,000
Total Expenses $135,000
Net Profit (before taxes) $224,000

Now let's look at what happened when the recession hit. The first indication that Scott faced trouble came in the form of a large increase in his accounts receivables. Many clients who usually paid their bills upon receipt now paid in 60 to 90 days, and about 15% had stopped paying altogether. In addition, new or expanding businesses were hard to find, so a good portion of his business dried up. Suddenly he was billing only 980 hours per year. When you figured in the bad debts, his expenses had risen, and his net had fallen to less than $60,000.

Doing the Numbers in a Bad Year

Billable hours/Retainers $210,000
Total Revenue $210,000
Office rent and secretarial services $100,000
Entertaining 15,000
Publications, professional dues, classes 5,000
Business travel 5,000
Bad debts 27,000
Total Expenses $152,000
Net Profit (before taxes) $58,000

Studying these numbers, Scott decided that his major problems, in order of severity, were not getting paid for hours he had worked, not working enough hours, and unless he solved the first two problems, too much overhead. To put his business back on track, he devised this plan:

Send clients a strong signal that bills have to be paid on time, every time. Scott politely gave all clients whose accounts were overdue the opportunity to pay promptly in full at a 10% discount (or to call and arrange a mutually agreeable installment plan). In addition, he began accepting credit cards, giving clients another convenient way to pay. Next, for clients who were still in arrears more than 60 days, he began a campaign of friendly but firm letters and phone calls (and also adopted a policy of providing no additional services, except as required by bar association rules). The result was a substantial influx of cash. Finally, when two clients simply ignored his requests to pay, Scott sent them a letter threatening a lawsuit (and explaining their right to first go to fee arbitration under bar association rules). One client paid; the other went bankrupt. Going forward, Scott also decided that clients who habitually paid late would be asked to pay an up-front retainer for substantial jobs (a policy that would be sweetened by offering a 10% discount), with Scott putting the retainer money in a client trust account until he billed for the work.

Reduce fees 25% for all new work, as a practical way to share his clients' economic pain. To qualify for this "recession rate," bills had to be paid within a week of receipt. In the same letter, he told his clients that he was now handling business debt problems for clients, including lease renegotiations, advice on layoffs, debt collection, assignment for benefit of creditor plans, and business bankruptcy. The combination of these new services and his lower prices resulted in a 30% increase in Scott's business. In addition, he joined several online lawyer directories, listing business bankruptcy as one of his services. This resulted in a steady stream of new clients.

Reduce rent and entertainment expenses. With bad debts reduced and business on the upswing, Scott felt less need to radically reduce overhead. But he and the lawyers with whom he shared office space did decide to squeeze in one more attorney to share the rent and salaries. That reduced expenses by $25,000. In addition, he cut his annual entertainment budget by $8,000 and reduced his vacation to three weeks.

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