This article was cowritten by Yu-kai Chou and Erik van Mechelen.
Paying Contractors late is NOT Savvy
Throughout the years, I’ve worked with many business owners who ask for my expertise in motivation design and gamification. However, I have been surprised by how many times business owners BRAG about how they pay their contractors last moment, or even later than the proposed due date.
“When money is in your pocket, you have all the control. These contractors depend on your money, so they’re not going to stop working for you just because you are paying them 1-2 weeks late. That’s good for cashflow management.”
But, I will make one point very clear:
Paying your contractors late is DUMB. It’s the opposite of being a savvy business owner.
Being an expert on human motivation and behavioral science, even though I procrastinate on paying other bills, I typically try to pay my contracts within 15 minutes of receiving an invoice.
Let me explain why this is important.
Why do people pay contractors late?
The reason why people pay their contractors late are manyfold. For some, they’re just handling too many moving parts and they don’t get to paying people until they must. But for others, they see this as a smart cash management strategy.
Business is all about managing cash flow. Cash is the life blood of a business’ operations. That’s why savvy business owners learn to maximize their cash power by trying to get paid early (even if it means giving people a small discount), while withholding cash until they absolutely have to.
The “time-value-of-money” concept indicates that $1 today is worth more than $1 a month from now. If anything, you could just invest it somewhere and get a small return. For a business, holding onto cash for longer means you could do a little bit more marketing, a little bit more sales, a little bit more R&D, or a little bit more inventory this month without feeling too stretched. This is important especially when you are harnessing the power of leverage, where every dollar can be utilized many times more its worth through credit.
The business author Michael Gerber (who has influenced my career a great deal) even writes in E-Myth Mastery, “Often you don’t even have to reduce the expense to get a [cashflow] benefit, for instance, when you can slow payment or pay over a longer period of time.”
I even have a friend who used to run one of the largest computer companies in the world a few decades back tell me how important cashflow strategies are. He told me that he eventually lost to Dell because Dell’s genius model was to collect cash first at an ultra competitive price for orders, then hold onto the cash for a few weeks. After a few weeks has gone by, the price of computer components would go down, and then Dell would quickly purchase the components, assemble the computer, and then ship it to the customers quickly.
My friend said he couldn’t compete with the prices Dell was offering because of this powerful model. Clearly there is a lot of Business Savvy in the art of collecting money early, and paying out money late.
Why paying contractors late is dumb?
All the above sounds reasonable and good. However, this is a clear example of Function-Focused Design over Human-Focused Design.