Welcome back to the sixth edition of Seed the Way, a newly inspired newsletter where I share my adventures and explorations in software engineering leadership. Today’s edition is all about the VPE budget. It’s the beginning of March and probably like many of you, you are still waiting on your CFO to finalize your annual budget. Just kidding :)
In all seriousness, if you are in the VPE role today, you likely went through a budgeting exercise in the last few months with members of your CFO’s organization. I actually started my annual budget exercise back in October of 2022. Going into the December and January holidays, I had a pretty good sense of what our spend would be like for the year.
Having a good grasp on your annual budget by December is not the case for everybody. In today’s entry, I’m going to walk you through my approach to building my department budget.
I know that a lot of eyes, internally and externally are looking at the Engineering organization’s costs. Typically in an early or mid-stage company, the VPE budget is the largest in the company. By the time the company grows into late stage, post-IPO or private equity, Engineering is a more balanced cost center. The larger budgets tend to be in Sales, Marketing and Customer Success.
Take a Bottoms-Up Approach
I’ve worked with a handful of CFOs during my three adventures in being a VPE. Each one to a fault will tell me it’s not worth building a bottom’s up budget during the planning cycle. I think their intention is/was always positive, but the reality is there is a high probability of a back-and-forth that will take place. Without having the details of a bottoms-up budget, it really is difficult to make substantial changes.
What Goes Into the Budget: Start With the Biggest Expense
It’s not going to be a surprise to many of you, but the largest expense in a VPE budget tends to be people costs. In a typical software organization, people/staffing costs generally amount to 70-90% of the entire budget. These costs often include, but are not limited to salaries, taxes, benefits, variable costs (bonuses) and mid-year compensation adjustments.
I generally look at salaried costs in a couple of different ways. At a high-level, I will have a table that will show a breakdown of the line items (salaries, taxes, benefits and variables) month over month. I will include an additional row for the number of employees on the payroll for the month. This row is pretty important as I will use it for other costs, such as subscription seats for software.
The second way I look at salaried costs is in a detailed view. My spreadsheet will have each employee’s name, their start date, their salary and then the monthly salary cost. This view becomes quite helpful when I’m adding headcount throughout the year. I can use this view to see what my new expenses look like as we grow the team.
A software engineer at $120k a year projects on the spreadsheet at $10,000 a month. I may defer a new hire by 1 month or even 2 to address a short-term savings need or as a technique for moving up a different expense like a software purchase. You have to be careful with this type of budget change. An engineer at $120k starting 6 months into the year will add $60k to the current year’s expenses. On a 12-month budget the following year, the full cost of salary needs to be accounted for. Be careful when making budget adjustments that are favorable to the current year, but could create conflict in year two and beyond.
Program Spend (Opex)
Opex, short for operating expenses, refers to the ongoing costs that a business incurs to maintain its operations on a daily basis. These expenses are necessary for the company to function and include things like subscription software, professional services, training/education, travel, rent and a wide variety of one time expenses that unfortunately cannot be capitalized as a depreciating asset. Opex is typically categorized separately from capital expenditures (capex), which refers to investments in long-term assets like equipment or property.
My biggest program spend outside of people tends to be cloud infrastructure and software services. My non-capes software spend is a close second. Another big ticket item depending on your staff is professional services, employee training and education. Not enough companies make use of 3rd party resources in the various stages of startup life. Once a company moves out of seed, they tend to bias toward hiring internally. They come out of that bias when they move into the IPO or PE world.
T&E varies from organization to organization. Remote companies in a post-Covid era have placed a lot of emphasis on remote gatherings quarterly, twice a year or annually. This has given remote companies that in-office feel, but at a lower cost point of having to pay for rent.
Cloud Infrastructure and Software Services
When it comes to cloud infrastructure and software services, work closely with your FP&A team member, assuming you have one, or your CFO to ensure you have the right spend to meet the needs and demands of your customers. All of the major clouds, whether it be AWS, GCP or Azure have programs for committed annual spend, as well as programs for smaller customers that are simply looking to optimize their compute and storage through more economical means.
I encourage users of these offerings from the hyperscalers to do a few things. First, review your monthly spend with staff regularly. It’s very easy for the cost of a service or infrastructure component to get out of hand quickly. Review the costs and set time in your team’s schedule to audit and remediate wasteful spend.
Second, consider using the billing alerts accessible from the hyperscalers directly or make use of a 3rd party service that will track your spend. There are a number of vendors in the space that will give you better visibility in your cloud spend than the hyperscalers do by default. For pennies on the dollar, you can have telemetry and alerting on your cloud spend, which is definitely worth the investment.
Third, make sure to assess consumption of infrastructure and services with the looking glass of calibrating future growth and demand. Basically, I’m saying you need to forecast your current spend via consumption to your future spend based on future growth projections. The best way to do that is to be able to work with your Sales organization to understand pending growth on the platform, whether that comes from expansion opportunities or new customers into the ecosystem.
Fourth, as you look to grow your product offerings, don’t forget reliability, availability and scale, which is one of the core value propositions of these platforms. Early to mid-stage startups tend to deploy with a single availability zone in mind, as well as regional availability. As you move from mid-stage to late stage you need to consider a potential global or non-regional install-base. You also need to come to the reality that the stakes are significantly higher. Systems that fail or have repeated unplanned outages or even unplanned maintenance windows tend to be systems that customers lose faith in. Consider implementing an availability strategy early. Most cloud vendors can provide very low costs in the range of 15% to 30% additional costs to maintain reliability and availability.
Non-Capex Software
I guess there aren’t a lot of software options in today’s world that aren’t opex in nature. I can’t say I’ve discussed a perpetual software license in over 7 years. Most of your software purchases will hit your Opex budget.
Earlier I mentioned that your headcount number is a critical input for your budget. I often start my budget building what I call the Engineer’s Toolkit. The ET for short is a collection of software licenses like source code, IDE, drawing/visualization, video, communication, ticket tracking, knowledge management, paging/alerting and a whole host of other software licenses that *every* member of the team are allocated and expected to use them. As my headcount goes up, my costs stay uniform to the number of staff members we have at any given time.
I tend to favor working with vendors that give me the flexibility to either pay as we go depending on the number of seats we are using, or pay a true-up later in the year for the seats we expanded over time. I also have a few vendors that make us buy packs of 5, 25, 50 to 100 seats. I’m not a huge fan of these purchases as I feel like I’m potentially wasting money if I buy too many seats. My tendency is to buy less and expand with a co-term purchase.
Co-terming a software subscription refers to aligning the expiration dates of multiple software subscriptions so that they all expire at the same time. Co-terming can also help your company save money by allowing them to negotiate better pricing and terms for all of their subscriptions at once. It’s important to ask your ISV that you are buying from whether they support co-terming. Most companies will have the capacity to co-term over a true-up.
Consumption based software purchases are the kinds that you really have to keep a close eye. Most consumption vendors will offer a true-up. They will let you spend well beyond your contract with little to no guardrails. You really have to be careful. I would say my larger spends tend to come in this category such as observability, monitoring, logging, data transformation, ML/AI, data lake/warehousing and CI/CD.
I’m resigned to the need to review these expenses on a regular basis. The really good ISVs have transparency in consumption. The really good ones have native, built-in alarms that alert you when you’ve drawn down from a bucket of usage. Alternatively, some alarms when you hit limits for a given month and have entered overage land. If your ISV has consumption, but doesn’t offer these tools, consider asking them for the tools or find an alternative ISV offering. Your CFO will thank you later ;)
My best advice is to be pragmatic in your spending. I generally budget my observability and log spend at roughly ⅓ of my infrastructure spend. The ET costs are easy to calculate based on the predictability of your staff size at any given time. Work with your ISV to get the best pricing and features for what you need. One pet peeve of mine is when an ISV charges extra for SAML or SSO integration. Making a customer pay more for authentication at Enterprise scale is not a real good business practice. It shouldn't be something you charge extra, but rather should be a part of the platform.
Outside of regular monthly review, billing alerts and regular forecasting resets, make sure to have a good dialogue with your sales rep or CX rep on a regular basis. If I’m spending $60k or more, I generally ask the ISV to have a quarterly or biannual business review with me and members of my staff to see if we are getting value. I see the software purchase as a relationship commitment. I want there to be no surprises at renewal or even expansion.
Not all ISVs have the bandwidth to do regular reviews. They really need to make the time. Many of these companies are measured on churn, as well as LCV (Lifetime Customer Value), They want a multi-year relationship. They want to see the contract grow. If the only interaction they have with you and your team is at purchase and then renewal, there’s a high probability you will find another ISV or OSS offering to solve your problem.
Education and Training
Let me start with education first. Too many VPEs and organizations forget to budget for professional development of their teams. I suggest giving your team $100/month per person for education and individual training. You may offer your employees the option to subscribe to a book membership program like audible, kindle unlimited or Safari. They may subscribe to a cloud training library site on their own.
You may decide to bulk purchase. My recommendation is to set the budget and let them decide how to use it. It may seem like a lot mentally. At $1200 a year for a staff of 100 employees, that ends up being the cost of $120,000 engineer. It might seem daunting at first, especially if your team is larger, but it pays in spades. The reality is 20 to sometimes 40% of the staff doesn’t take full advantage of the expense. While you want them to make use of it, you will see that not everyone does, which is their loss.
I often will budget a training number for the department to use once or twice a year. This is for specialized training that we may conduct in workshop format or online CBTs (Computer Based Training) for niche areas like software security, accessibility or agile.
I recommend that you sit down with your leadership to identify the one or two areas where the team has the greatest blind spot or needs to improve upon. If the funds are available for this type of program, put it into your strategic plan with the intent of helping your team.
Professional Services and Contractors
You may have one or more members of your staff that you consider on the roster, but they are contractors or independent contractors. There’s a good chance you may need to count them in your unit costs for software expenses. In the companies I’ve worked at, we often issue laptops to the contracts which come pre-loaded with all of the tools that our staff make use of. Make sure to remember to count them in your unit economics.
When it comes to professional services, you may have one or more expenses that you need to account for in your budget. For example, as part of our annual security process, I bring in a 3rd party to threat model and pen test. You may need to budget to bring in contractors for a few months to jump start an initiative while you hire permanent staff or some form of staff augmentation. For example, I brought in specialists to help one of my teams write our first SalesForce application. We worked with a development partner for about 5 months while we made the decision to bring the work in-house.
When it comes to preparing for this expense, I encourage my readers to make the time to meet regularly with professional services vendors. Get to understand their ability to service your needs and at what costs. Ask them about their competitors if you don’t know them already. Talk to multiple vendors so that you can appropriately budget.
A Quick Note on T&E
Travel and expenses has changed a lot over the years. What hasn’t changed is that it’s the CFO’s first lever to pull when managing expenses. Some companies will create formulas for how much travel they anticipate their staff will take. These companies tend to forecast that your airfare will cost $250 round trip and that hotel costs will be $125/night. Good luck to that by the way!
I recommend that you spend some time thinking about who’s traveling, how often, where they are going and when they are going. I used to travel to the Bay Area twice a quarter. I can assure you that I couldn’t find a room on a Tuesday for less than $400 a night unless I was driving 20 miles to a meeting.
Work with your HR and FP&A teams to plan for pragmatic travel. If you are traveling to a remote office, work with the staff to scout out local hotels that can guarantee a rate to your company. We had a swanky hotel right next to our office that routinely ran $800/night. We guaranteed 100 nights of stay at a rate of $225/night, plus agreed to rent out conference space 1-2 times a year for meetings.
Costs are definitely on the rise for travel. If you don’t have to travel to a specific location for a meeting, but have more flexibility, it may be worth finding locations that are very accessible for short-direct flights. I’ve often found that a trip to Chicago or Dallas for folks on different coasts is significantly cheaper than having part of the team travel bi-coastal.
Forecasting and Reconciling
I’ve been lucky to have a team member from my finance team work with me as a FP&A business partner. In every company, the FP&A partner was introduced no earlier than the series C round.
Ideally you are meeting with this person monthly. There are two goals during this meeting. The first goal is to forecast next month’s spend on the items we discussed above. The second goal is to reconcile last month's forecast into actual to see what you did or didn’t spend.
As you can probably imagine, I’m very vigilant on my spending. I want to be in the black (under spending or spending to budget) versus the red (overspending) every single time. I gamify the experience with my team to see who can manage our budget better. There’s one key point. We have to be able to meet the needs of the business.
Often our forecasting discussions become a game of horse trading. We may need to accelerate a software purchase of one type. We may reforecast a new hire, another software expense or delay a professional services engagement. Every lever is considered as long as we maintain a lens of fiscal responsibility to our company and ensure that we give our staff the things they need to do their jobs appropriately.