Your Competition is Your Costs
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Welcome to Rework, a podcast by 37signals about the better way to work and run your business. I'm your host, Kimberly Rhodes, and I'm joined by the co-founders of 37signals, Jason Fried and David Heinemeier Hansen. Well, we always are talking about remaining profitable as a company and the importance of doing that. This week, we're talking about doing that through controlling your costs. Jason recently wrote about your competition. It isn't necessarily other people, but it is in your costs. So I thought we would dig into that

Jason, do you want to start? Give us a little bit of background about this write-up. And then I have a couple of questions for you guys about how you actually do this in business. Yeah, you know, this comes up all the time. You just hear about competition online and everyone's worried about what everyone else is doing all the time. And it's like, just make your own business work.

Like, that's it, primarily. I mean, of course, other people are, you could say, hurtling issues at you, so you can't make your own business work if everyone's taking your customers. But most arenas that most people are fighting in are quite large, with large numbers of people and big, huge audiences. The idea that everyone's going to capture everyone else and you're just going to be left alone, I just don't buy it most of the time. Of course, there are zero-sum markets everywhere.

Most of the ones that I see people talking about are not. There's plenty of room for plenty of people and you just got to make your business work. So if you're worried about the competition, but you have 700 people and you're losing tons of money, like,

Your problem is you, not them. Like, why do you have 700 people? Why are you losing so much money? And this comes up too when you talk about things like Hay. So Hay, of course, is a relatively small product with a relatively small customer base. If you compare it to Gmail, which has a billion users, we have tens of thousands of paying Hay customers. Now, for Google, that would be an abject failure to only have tens of thousands of paying customers. For us, it's fantastic. So it's because our cost structure is different than theirs. And so if you make your own business work and you make your costs work,

You can build a great business that just works for you. And you don't, in some ways, have to worry so much about what everyone else is doing. Because if you can make it work for you, it doesn't matter what they're doing. Everyone's trying to make it work for them. That's fine. So anyway, I always want to talk about this because I get so frustrated when everyone's just always pointing around and going, we can't beat them. We can't beat them. I'm like, well, what are your costs like?

Like, well, we got it. I'm like, you have too many people. You have too many costs. Like, of course, you're not going to beat them with the cost structure you have. So it just annoys me. It irritates me when people talk this way and worry too much about everybody else. Yet they're not pointing the lens on them, essentially.

One of the main fallacies here is the idea that not only are you in a commodity space, but that the customer is a commodity too. That any customer is the same as any other customer. And that's just not true. Out of all the customers, for example, who are looking for an email system, a large number of them, they're just looking for the cheapest email.

free. They don't really care whether it does this, that, or the other thing, or whether they feel better when they're using it. They're just not optimizing for that at all. That customer, not accessible to us. No matter what we do, simply by putting a price on hay, we've cut off a huge part of the market. But the market is bigger than huge. It's humongous, enormous, fantastic

large. It's literally everyone who is online needs to have an email service. So we can just focus on that part of the potential customers who would pay for it.

It's a small part compared to the billion plus users who would use Gmail. But when we focus on them, we're not competing about the same stuff. And this is when you think of a market, it's not just one glob, one big blob that you're competing with someone else against directly for the same individual. You're very often competing for slightly different profiles. And when you're able to hit that profile, sometimes the segment is too small.

If we were able to appeal to 50 people who wanted to use, hey, do you know what? We could control our costs all day long. It wouldn't matter. We could never make that a profitable business. But when you look at something like email or most other business domains, there are tens of thousands of customers, hundreds of thousands of customers, millions, if not billions of potential people who would use something like that. It is so much easier to realize, all right, we don't need them all. We can focus, as Jason says, just on the cost that makes this work

And then we're going to find a group of customers who are not like all the other ones. It'll work out just fine. And what's so nice about focusing on cost is that you're focusing on something that's within your control. When you're focusing on whatever the competition is doing, you can't control them. You can't decide what their roadmap is going to be. You can fret about it. You can stress about it. And

And what good is that going to do to you? Exactly. Are you going to do something different? Are you not already pursuing your best ideas? Are you not already working as well as you think you could? If so, again, you're just competing against yourself. Just do that. Just set your foot forward with your best ideas, with your peak competence, and

Now you've given it your all, essentially. And now you can focus on the things that are within your control, like building a product that you would want to use. We've talked about that in another episode. The B1 is for you. You build something that appeals to you. Hope that there are others like it and come up with an entire package that is functional because it's self-sustaining, because it's under control. The costs are under control.

Okay. So I do have a question for you guys about how you think about costs for the entire company, because obviously 37signals has multiple different products. Do you think about Basecamp expenses separate from Hay expenses separate from Once? Or do you kind of just jumble it all together since it's all under one umbrella company?

For the most part, it's jumbled, but there are areas, for example, support costs. So Hayes is only a hundred bucks a year, right? So it's, you know, about eight bucks a month or something like that. If you were to break it down, we can't spend, you know, $7 a month on customer service for something that we charge eight bucks for. So there's some areas in which we've made some adjustments like Hayes support is very costly. We're

relative to the price. So we have to figure out ways to bring that down. Basecamp, we're a little bit less concerned about that. So there are some areas like that. But personally, me, I look at the whole package, the whole everything we're doing. Does it add up to us making more money than we spend?

Like if we're good there and our margins are healthy, like I don't kind of don't care personally really where it comes from in a sense. You should know, but I'm not going to dial back costs on one thing and ramp up expenses on another one just to kind of make something aesthetically balanced in a certain way. But there are areas you have to know what your pricing is. You have to know what your costs are per product in a sense and make sure that you're not spending more than you're taking in. I mean, that can happen very easily. This actually was an issue for Hay for a while. We brought the cost down. I think we're like

three or 4% now for support costs that support that product when it was about twice as much before. And that'll add up and take your margin away. And once your margin's gone, you've got a bit of a problem there. So I think we look at some areas, but I mean, personally, not every little detail.

This is one of the few times where I think back to my business school degree. And I think it's a Michael Porter book. And it had this quadrant. Everything in business school is a quadrant. There's like, there's four spots here and we'll put something into it. Right. And the quadrant went something like, if you're running a company with multiple products, you can have products that are in different stages in their life cycle. They can be the thing that most people have heard about a lot is cash cow. It's a stable product. It's been around for a long time.

It's not necessarily growing all that fast, but it's producing a lot of cash because it is producing a lot of revenue because it's got a bunch of customers. Okay, so you got a cash cow. That's good. That's a foundation of most businesses that are durable is that there's at least one cash cow in your damn farm. Then you can have something like a dog.

also not growing, but also not contributing that much revenue, perhaps because the expenses are too high. So, all right, you got to balance something out. Maybe you have a dog or two dogs, but you like them. Like they're really nice dogs. They're little corgis, they're little whatever, just cute dogs and you want to keep them around. Fine. If you also have to cash cow, right? If all your business is a bunch of dogs and none of it is growing and it's barely there, you know what? Maybe that's a

pound or in pound or whatever it's called like that that's nice you can do that too you can't employ a lot of people you can't pay them a lot because you're constrained then you have your shooting stars which is a company or a business unit that's perhaps not that big yet but it's just it's growing fast it's not contributing a bunch to the bottom line and then as always goes these four things i forget what the last one is but when i think of it it's those three that stands out the dogs the cash cows and the shooting stars and you want to have something in your portfolio where a

For us, the cash cow is Basecamp. It's been Basecamp for a long time. Basecamp is what pays the whole party here. It pays for us to have some dogs. Those are the heritage applications that aren't growing anymore. And then some shooting stars, like something like, hey, and we can take the money from the cash cow and we can invest it into the new ideas. Because the normal way this cycle goes is at some point,

your cash cow is going to turn into a dog. That's just what happens in most businesses. At one point, Apple's iPod business was amazing. And then it quite quickly turned into a dog. And then Steve Jobs unceremoniously just took it out back and...

family-friendly podcast. Send it upstate. Send it upstate to live a nice life on a farm somewhere, and then you can buy the product anymore. So I think part of it is just to have that mix. But to have a mix, you've got to have a foundation. There's got to be one part of the business that's working so well that you can afford to have the shooting stars and wait for those to grow into larger businesses. And that, I think, really encompasses a lot of how we think about

here. Controlling our costs is giving us opportunities to be patient, to wait for an idea to perhaps one day turn into a cash cow. Maybe it won't be as big as Basecamp. Maybe it will, but we'll have the patience to see that to fruition. It's

If we did not control that and we were constantly sort of running right at the ragged edge, it doesn't take that much of a slip off or a dip for your cash cow before suddenly everyone is freaking out. Suddenly everything has to deliver this quarter or it's cut.

And I think that just becomes a very stressful place to be. And I think it's not a very enjoyable way to run a business. A great way to run a business is actually when you don't have to penny pinch everything. When you can, like Jason says, just like, you know what, overall, it's good enough. That's a really relaxed place to be. I think when you look at the amount of time that Jason and I spend on the minutiae of tracking all this, it's not a lot.

We have Ron Manning counting our beans. We have one person mainly in charge of counting the beans. And then Jason and I will look at something like once a month.

Are the beans still like roughly in the right place? Do the beans need to go somewhere else? Is there some problem with the beans? If there is, we can engage in that. That's quite rare. If you think of an overall pie chart of how Jason and I spend our time, how much of the time is spent on the bean counting part? It's a pretty small part. And it's our control of cost that allows that to be true.

The other thing I would add is technically we could put together a P&L for each product, but we don't sit down at the beginning of the year and say like, how much are we going to spend on hay? How much are we going to spend on base? That's not what we do here.

We don't do it that way. We look at things when things don't look right. We look at things a little bit ahead if things aren't starting to feel right. We look at trends. But for the most part, we've intentionally built a business, perhaps by luck, you might even say, that has healthy margins, which allow us to be a little bit mushy, a little bit loose,

and to experiment with a lot of different things to see what's gonna hit and what isn't gonna hit. But yeah, we're not looking line item by line item at every product and we're not doing it at the beginning of the year and we're not doing it that way. We do assign different teams to different products

That's true. And there's costs there. One product may have three product teams. Another product may have one product team, but we're not adding up that number. We can. The math is there. It's not hard math to do. We have a relatively small company. It's all pretty clear, but it's just not something we're doing when we're thinking about what to build and how to build it and how to improve it.

What's funny, though, is at this time where I both have and enjoy this relaxed notion of how we're proportioning things individually, I also just personally have an aesthetic attraction to cutting out needless costs. That just is like cutting out needless code. The more...

superfluous stuff we could take out, the more I know, like, you know what, we could take that money and we could spend it on something else, or we could just take it and put it in our margin. That's our rainy day fund. That's the fund that allows things to dip sometimes, to go through a plateau, to do all these other things. So it's kind of just stashing something away. And I also think a business that is well optimized from a cost perspective is generally a more clearly thought out business.

There's some sharpness to it in the same way as when Jason and I sit down to write something. We're like, you know what? There's too many words here. This paragraph would be tighter if I caught a third of it, if I killed some darlings here. And I think you can look at your business in the same way that it needs sharpness.

continuous editing it needs continuous pruning that does take some bigger to do that occasionally as not for everyone i think i probably care more about the line items than jason do in some regards and i'm just more on like the technical side this is why we got out of the cloud for example me just going through line items and go this is not right this doesn't feel right is it

About saving the money, not so much in that moment because, all right, we return $1 or $2 more. What does that matter? It's about ensuring that that margin is safe for the long term. And then also just that things feel proportionate, that they're in harmony. We're not blowing just...

massive amounts of money on something that's a dog that's not going to go anywhere. Like, you know what? We should move it around. But you can, I think you can hold both of those ideas in your head at the same time. You can be a little bit of a hard ass in terms of the aesthetic properties of, are we just wasteful here? I hate waste. I mean, I have it to the point where sometimes I walk into other people's business and I start seeing things and I go like, I don't know if that's not an efficient way to do things.

And then I bite my tongue. It's like, do you know what? This is not your business. Just shut up and enjoy the coffee. Right. So there's some of that that's just there. And then at the same time, you can have the looseness of it. That is not everything has to be run by the bean counting. Not everything has to add up right away. I think this is perhaps one of the things where I've taken more cues from Jason over the years is this idea that a lot of things that are really important, we actually can't count. We can't measure.

And what we can measure is our expenses. So I go to what I can measure. Oh, we can measure the expenses. Yeah, but what do you get back? Like, is it worth it? We had this discussion about our meetups. I think we talked about that recently where it's very easy at a meetup and you go like, oh, can we just cut a little here? Can we cut a little there? And if those cuts then end up resulting in a meetup that doesn't feel great,

It's the most expensive meetup in the world because it's failed its fundamental purpose, which is to bring everyone together and to energize them and get them fired up. Like that's the thing that that has value. You shave just enough away and now you've reduced that value not by 7%, but by 100%. It is worth nothing. Or even worse than that, it's perhaps worth something negative. I think that's the stereotype of a bean counter is someone who can only see cost and can't see value.

But you know what? It is possible to do both things. It is possible to see costs and then also have an anchoring in value.

And Jason, I know you recently posted about our meetup expenses over the last couple of years. So I will link to that in our show notes so people can see it. Two areas that I thought of in terms of expense reductions for us over the last couple of years, one, the cloud, David, which you mentioned, but also getting rid of our office. Was that a looking at the line item kind of decision that you went in that direction? I mean, kind of, sort of. First of all, we didn't really use the office very much. So we had a 10-year lease.

We did a big build out. We spent a million bucks building the office out and had a 10 year lease. And we got into this area in Chicago when the rents were relatively low. It wasn't a very popular area. By the time our lease was up, it was quite a popular area. And I think the renewal was like two or three X or something like that. The aesthetics of it didn't make sense. We didn't use it very often and it was way too expensive.

We did for a short period of time, begin looking at other office spaces though, and then go, no. And then this happened during COVID. We're like, we're not going to get another office space now. It's ridiculous. It's silly. We don't know what's going to happen in the world. So we didn't do that. So we actually ended up in a sense, spending more annually on what the office was for. The office was primarily for meetups actually. So we brought everyone to Chicago and

And we didn't have to pay for a venue because we had everyone in Chicago in our office space. We had to pay for airfare, of course, twice a year. But I think the meetups now have eclipsed or surpassed the cost of the office. But what it was for me was not so much the rent spend. Again, it was kind of the aesthetic, like this is not worth it. It's not that an office couldn't be worth it.

In fact, we looked at this incredible building, this Louis Sullivan building in Chicago that I was really hoping to get. We're going to buy it, actually. I'm glad ultimately we didn't, but we were close and I felt like that would have been worth it. We'd had the real estate, it was a very special place, very cool thing, would have been a great venue for us. But to spend like 40 or something thousand dollars a month ultimately on this other space we had for like four people to show up every day just made no sense.

So it wasn't that we didn't have the money. It's that it wasn't worth it. To David's point about the value, the value wasn't there.

And now what's cool is the side effect of that is that we don't have an office, which is we save money on rent, obviously. But now we also get to explore the world a bit more. So twice a year, the whole company gets to go to different cities around the world, which is a wonderful thing that we were not doing before. So loosening that up, letting that go allowed us to now go to Amsterdam, go to Barcelona, go to Miami, go to Montreal, go to New Orleans, wherever we're going to go next. Right. So now we get more out of it by not spending for the other thing.

I think what's key to me, too, is a sense of proportionality.

I don't care, really. Are we spending $200,000 on it? $2 million? $20 million? All those numbers can be correct. It's not like there's an absolute number that is right. But there's a proportionality to it that when we looked at that old office and we saw that on any given day, the average number of people who came in was like three. You go $25,000 for three people a month.

that's like a big chunk of their salary. Like even if just as a thought experiment, you just said, do you know what? The three of you can't come to the office anymore, but you could get the choice that your salary is increased by 50%. How many of them playing with their own money with skin in the game would go like, no, no, no, that's totally worth it. I would forego 50% increase in my pay to have an office.

None of them would. And I think that's why the aesthetic component is so dear to us in some way. We're playing with our own money. We're not playing with investor money. And I think this is one of the big differences as to whether you're an owner of a business or you're quote unquote merely an operator. If you're operating someone else's casino here and it's not your money, you're going to have a very different relationship to cost, I think. And you're not going to be able to get that gut instinct, that gut taste.

of whether something is proportionally worth it. That gut taste is uniquely calibrated by the idea that you get to keep what's left over. And as owners of the business, Jason or I, we get to keep a large part of what's left over. We also have the 10% profit sharing plan, such that all employees at the company get to keep a slice of what's over. And that gets you skin in the game. Then you start thinking about these things. For many years, especially early on, I had a ratio key.

That basically said, if we spend $1,000 on that, that is going to be this exact number of dollars out of my pocket I could have spent on anything else that I wanted to. I could have gone racing. I could have bought a new computer. I could have all these other things I could do, right? And that sense of having some direct relationship to cost, I think, is just like a cheat.

It's like a lot of the nuanced analysis you'd normally have to do. You can just skip all of that and go straight to the proportionality test. Does this feel worth it? Would I spend my own money on this? Oh shit, I am spending my own money on this. Hell no. No, no, no. We're not spending my money on this. Okay. Last question before we wrap up. Are there pieces of the business that you think

entrepreneurs overlook in terms of expenses? I know the cloud obviously is a big savings for us this year. Are there other areas that you're like, yeah, people usually overlook this portion of their budget? I would say this is such a blanket statement. So it's like,

But theoretically, I would say most companies have more people than they need. I'm not advocating everyone should lay people off. I don't like that either. But like, sure, it's more about on the front end. Like when you hire, hire very carefully, hire very thoughtfully. You don't want to overhire because then you have to take the pain.

But I do think most companies are probably a bit bigger than they need to be. And I think they would benefit by being a little bit closer to the bone and having fewer people and having more constraints. And that's one area. It's also, in many cases, the biggest cost center, especially in the tech world where salaries are very, very high. So I think that's one of the areas I would say, again, not to go cut your company in half, but when you hire people, be very careful about adding people.

What I think is interesting about how big should the company be is that it's very rare that you get these back-to-back tests. Like, could this company be half the size? Usually that's a traumatic experience. I think, or I guess it'll always be a traumatic experience, but it'll be a traumatic experience because something happened to the company, as in it lost many of its major accounts. And all of a sudden there simply just isn't revenue to do it.

We've used the Elon example in the past, which was perhaps the most unique A-B test of this, where you take, here's a major platform that's existed for many years. It has a stable baseline. And someone comes in and says, I wonder if it could do with just 20% of its employees.

And somehow it could. There's a long discussion we won't go into as to the business prospects of that that came from the ad sales that collapsed from it. But sort of the operating of the business, that's a fascinating fact. And I think it could work in both directions. You could also imagine, for example, as we did at Once Upon a Time, what if we had doubled the number of people? Could we just be vastly better and get way more than double back? We could get four or five X back. So I think this sense that

Wherever you are right now has this propensity to anger you. Like, this is the right place. We can go 5% below, 10% below, or 15% above that, when in reality...

It's all up for renegotiation all the time. We just don't allow ourselves to think in those levels. What if we had 80% left? Like that was the craziness of Elon in his case. And in other cases, you could go the other direction. I'd say number two is when it comes to software companies is absolutely how much money they spend on their computing.

And this is why we got out of the cloud. Literally because we went through our expenses and saw, yep, salaries is number one. That's the biggest line item. And then line item number two is how much money we sent to AWS every month. There was something in that that just struck me as fundamentally disproportionate. Like what we run should not be that expensive. In fact, I remember when it did not used to be as a percentage, as large of a percentage of our spend.

What really actually radicalized me on this point was doing this specific analysis on Hey. Hey is a much more expensive application to run than Basecamp because each individual user on Hey, like this is their own personal email, and they might get gigabytes of that stuff all the time, like thousands of emails every day. You don't get thousands of messages in Basecamp every

day as an individual user. And we had launched, hey, in the cloud, everything was on cloud. And the amount of money we were spending, I think at one point we made it up something like $30 out of the $100 we were spending went to AWS. So we'd taken $100 from the customers and we'd go like, hey, here's AWS, here's $30 of that. Like, what?

That feels totally disproportionate. It was way out of line with what we'd ever spend on base camp. And we'd go like, all right, fine. It should be a little out of line. It's more, but it doesn't feel right. And now we've reduced that by over half. And now we're at something I think like a

$10, $12, or something else like that. That feels, ah, now we're touching something here. That feels more proportionate. That feels about right. But it came from looking at something specific and then going, it's not right. So that's why we started the whole cloud exit thing. And then we realized, once we started unwrapping the hay thing, oh, we can also unwrap this thing, and that thing, and that thing. Now we're getting out of all of it, the latest thing being S3, and there were even more savings in that pocket, right? This is also sometimes what scrutiny can do. You

You notice one line item and it goes like, doesn't pass the smell test. That's a little stinky over there. And so you take that apart and you go like, wait, hey, have you seen the other line item next to it? That kind of also doesn't feel right. And you start just unraveling all this stuff. And before you know it,

there's a bunch of lineups you'd like to have a look at and you'd like to look through. I remember last point on this, this was not in the same category as the other two, but our SaaS costs. I went through what do we pay in our subscriptions to other people for SaaS software?

And I saw some of those line items, most notably Datadog, which was an analytics platform we had used for just a little bit. And I think when we signed up, we had spent something like, I think our initial bill was $45,000, which already I remember at that time was like, Jesus, that is expensive. And then I saw the renewal. And I think the renewal was going to be $83,000.

I'm like, no, that's preposterous. It is absolute preposterous. We're going to pay someone $83,000 to run their software on something that

That was really nice, but kind of partially optional in some regards. It felt like such an extravagant luxury in a way that like, I don't know, if you're freaking Google, fine, $83,000 spare pocket change somewhere. Not for us. $83,000, again, I'd do the ratio, right? Like how much? What? That's a ton of money. So we ended up cutting that as well. I think actually for companies that aren't in software business,

Their SaaS budget may very well be one of the top three, top five spends that they have in their company. And if you go through that line item by line item, you might be sort of disgusted in a way that the sticker price never would. Oh, it's only $12 a person. Yeah, but you're using 27 tools, dude. And...

Don't do it per month. Do it per year. 27 tools times your 175 employees times 12 months. Like what? Crazy numbers, crazy numbers. And you never pay that off. That's the other thing. You never pay it off. So you're not paying it down. You just keep paying it in perpetuity. That's the

The thing. Sometimes you're like, God, this is expensive, but I'll be done in a year or two or three. Okay. Like a renovation project in a house like this is expensive, but like the kitchen will be done in four months and we're done. That's not what SaaS is like. And that was actually how we, in part, came up with the idea for once. It was the radicalization of hearing what people were spending on their Slack bills.

and hearing things sort of casually just thrown out there. Oh yeah, we spend like $12,000 a month. Like, wait, what did you say? What did you just say? 12,000 a month? Are you, what? For a chat system? For a commodity software product that has had no meaningful innovation that matters to you in the past 10 years, you're spending 12,000 a month? And forget that even, like 1,200.

even 300 a month on that. Yes. Yeah. Yeah. Yeah. So this is, this is where the aesthetic component comes in that like, I can actually get offended if not outright disgusted on behalf of other people. I can hear about it and go like that. No, we have to change that. This industry cannot operate like this in all domains forever. Yeah.

Well, I will link to Jason's write-up, Your Competition is Your Cost, as well as David, you have a recent write-up about savings with the cloud. I'll link to all of that in the show notes. Rework is production of 37 Signals. You can find show notes and transcripts on our website at 37signals.com.

Bye.