Community Section -
KPIs: Key Predictive Indicators
Ron Baker - 02/14/2010
On Friday, February 12, I conducted an 8-hour CPE course for the California CPA Education Foundation: Measure What Matters to Customers: Using Key Predictive Indicators.
There were approximately 25 people in the live audience, and for the first time (for me), it was Webcast to approximately 65 people.
This course explains:
- The essential and critical difference between efficiency and effectiveness.
- The Business of the Past versus The Business of the Future—a new business model.
- The difference between a performance and predictive indicator.
- How to establish KPIs for your business.
- KPIs for knowledge workers.
- Other interesting issues raised by the audience.
The Foundation Team did a wonderful job handling the technology, and moderating the questions from the Webcast audience. Since we show video clips, it has always been a challenge to pull off a Webcast, but this went smoothly.
You can view the entire program here. (Be sure to fast forward through the lunch hour, as they keep the camera rolling).
I hope you find it valuable and thought provoking.
And as always, any and all feedback is more than welcome.
Ed Kless - 12/23/2009
This is the second in a series of postings about my thoughts from sessions that I attended at the Information Technology Alliance’s Fall Collaborative (<-I love that word) held in Palm Springs. Since they are all not appropriate for this site, those of you who are interested can see the others as they appear at www.edkless.com.
Presented by Jeanne Urich of SPI Research. The highlight of my ITA experience occurred during this session when Jeanne acknowledged that a conversation that the two of us had at the spring ITA meeting has influenced her thinking and that she now believes that fixed price agreements are better for customers and consultants. Now to convince her to give up on these dozens of benchmarks! I think this will be a much harder task.
The study consists of 175 metrics, 20 of them deemed key performance indicators. The problem in my mind is that all, save one of the 20 are inwardly focused on the firm, even those in the “Service execution” and “Client relationship” areas are firm-based.
The problem as I see it with most benchmarking is that it focuses us on all the wrong things: the past rather than the future; internal rather than the customer; efficiency rather than effectiveness.
For example, one “customer” metric was about project completion success. The question was asked of the providers, “What percentage of your projects are completed on time and on budget?” The average answer was 74 percent. This more than doubles the number (35 percent) according to a study done by The Standish Group who asked the same question of customers. Needless to say, I side with customers on this one. Again, to her credit Jeanne acknowledged this flaw.
Many of the other metrics are based on the false premise that value delivered is equal to rate times hours, aka, the labor theory of value. This theory is demonstrably false and belief in it has been proven to cause harm.
I have sat in on countless benchmarking session and the reactions of the attendees is always the same: a) if they are doing better than the benchmark, they think they are OK and do nothing, and b) if they are worse than the benchmark, they dispute the data and still do nothing. Path (b) actually happened twice during the session!
My beef with all benchmarking in business is that while it attempts to appear scientific, it is not even close. To her great credit Jeanne is very careful about saying that these metrics are correlative not causal. Unfortunately, most people do not understand this distinction and are lulled into the illusion of control via data.
The findings are always similar and in many cases are nothing more than a bunch of truisms:
- Firms who market well have higher revenue. (Yet, marketing spend, even among top firms, is less than average across all industries.)
- Firms who close more business (win to bid ratio) are more successful. (The question is, what do they do differently that allows them to have a higher win to bid ratio? Win more or bid less?)
- Few firms grew revenue in 2009.
- Clear vision and strategy and taking care of your people are important in professional firms. Firms that focus on culture are rated as better places to work. (What kind of culture?)
Conclusions are almost always the same - “Increase revenue, lower discretionary spending.” Always a good idea.
Ed Kless - 09/29/2009
I was recently reminded of a great practice for all professional firms to get into the habit of doing, namely measuring discounts. Most firms I work with do not, but I think this is serious mistake.
I would measure discounts on all aspects of your business. For those of you who sell products in addition to services and knowledge this means measuring the amount of discounts you are giving in each area.
Many of you know I am not a big fan of measuring anything financial other than the basics, but I truly think measuring discounts will provide you with insight on how to become a better, more confident pricer.
Ron Baker - 09/26/2009
Pat Lamb posted on Lean Client Service, which inspired me to post a comment.
Then Pat replied in another post.
This led to another post, incorporating several comments from Legal On Ramp’s discussion board.
The debate is critical, and regular readers of VeraSage already know how much ink and mind power we’ve devoted to this topic.
Attacking efficiency is the equivalent of criticizing motherhood and apple pie, so my position is highly contentious. I believe this is good, since we only learn from people we disagree with. And, it illustrates how we have not yet come to grips with the consequences of no longer being an industrial/service economy, but rather a knowledge economy.
In that spirit, I thought it necessary to comment on Pat’s latest post, while expanding the discussion.
Here is my letter to Pat.
Hi Pat,
Fantastic discussion, thanks so much for provoking this much thought on what I consider a critical issue for professional knowledge firms.
We have two problems with this debate. The first is a linguistic issue. We all seem to be using a somewhat different definition of efficiency and effectiveness.
We believe all change is linguistic, so we should agree on terms. For example, you say in your post that I am one of the “leading thinkers on the issue of value billing,” but we at VeraSage don’t use the term “value billing,” since billing is done in arrears, whereas pricing is done up-front, before the work is started. There’s an enormous difference in these two approaches.
We also don’t believe law firms are “professional service firms” but rather “professional knowledge firms (PKFs),” terminology more in line with Peter Drucker’s famous definition of knowledge worker and knowledge economy.
So let me begin by defining how I am using the terms efficiency and effectiveness, which I take from Peter Drucker:
- Efficiency focuses on doing things right.
- Effectiveness concentrates on doing the right things.
Now many people argue that both of these are important, and up to a point I agree. However, past some point—which we argue occurs sooner on the graph in a knowledge firm than, say, in a factory—the two become mutually exclusive. I can cite hundreds of examples where a decrease in measured efficiency still leads to an increase in effectiveness.
However, I can’t find many examples of where an increase in efficiency has increased effectiveness (as defined here). I know Fred Bartlit says that “increased efficiency almost always results in increased quality,” but quality is not necessarily effectiveness as I’m using the term here. One could make an incredibly high quality cement life jacket, but it wouldn’t be very effective (this crack was made by Tom Peters with respect to ISO 9000 standards).
Peter Drucker believed that a business wasn’t paid to be efficient; it’s paid to create wealth for customers. A business could be highly efficient at doing the wrong things. Examples abound: buggy whip, dot-matrix printer, slide rule, and typewriter manufacturers, etc, all models of efficiency before they were decimated in a gale of creative destruction by more effective technology.
In fact, a company at the apogee of their measured efficiency is probably in a perilous position, which is why Google allows its professionals to spend one day per week working on projects that excite them. This is not very efficient per your timesheet or billable hours; however it has led to many of Google’s innovations—Gmail, Google Earth, Google Books, etc. Other companies such as 3M and Gore have similar strategies.
This is why Peter Drucker wrote The Effective Executive, and not The Efficient Executive.
But let’s get back to efficiency.
What, Exactly, Is Efficiency?
Efficiency is always a ratio, expressed as the amount of output per unit of input. Mathematically, it seems straightforward, as if there was one widely agreed upon definition of the components of the numerator and denominator. In an intellectual capital economy, however, it is a conundrum.
Take the denominator in the ratio. Which inputs should be included? If we are dealing with wine, we could count the costs of the grapes, the bottles, corks, etc., none of which would help us define—let alone value—the final product. As they say, it is much easier to count the bottles than describe the wine.
If we were dealing with Rembrandt’s efficiency, we could sum up the cost of paint, canvas, brushes, and even the amount of labor hours spent plying his craft. Would there be any relationship to the final value of the output?
We can calculate how many surgeries the cardiologist performs in a given number of hours, but it doesn’t tell us anything about the quality of life for the patient.
Was Einstein efficient? How would you know? Who cares?
Firms have learned costs are easier to compute than value, so they cut the costs in the denominator to improve the efficiency. This is the equivalent of Walt Disney cutting out three of the dwarfs in Snow White and the Seven Dwarfs in order to reduce the inputs, thereby making the resulting ratio look better. Since Snow White contained over 2 million painstakingly crafted drawings, this reduction would have been quite efficient—but hardly effective. The Two Little Pigs probably would have been more efficient, but nowhere near as effective.
The fact of the matter is, we do not know how to measure the efficiency of a knowledge worker. And this is true for a very fundamental reason, which leads to the second problem with this debate: The Grand Fallacy—that is, the idea that there is such a thing as “generic” law firm efficiency.
There’s No Such Thing As Generic “Efficiency”
Efficiency cannot be meaningfully defined without regards to your purpose, desires, and preferences. It cannot simply be reduced to output per man-hour. It is inextricably linked to what people want—and at what cost people are willing to pay.
Consider the example of a hammer in a poor country. It’s likely to drive more nails per year, since it’s most likely shared among more people and sits idle less of the time. But that does not make the poor country more efficient; it just proves that capital tends to be scarcer and more expensive in those countries.
During the Cold War, the old Soviet Union used to boast that the average Soviet box car moved more freight per year than the average American box car. Yet this didn’t prove they were more efficient. On the contrary, it proved that Soviet railroads lacked the abundant capital of the American industry and that Soviet labor had less valuable alternatives to engage in than their American counterparts.
Your automobile is not very efficient, since it’s idle a majority of the time. So what? When you want to go somewhere, it is incredibly effective, since it meets your purposes at a price you’re willing to pay. (I am indebted to Thomas Sowell, and his masterful book, Basic Economics, for these examples).
Princeton economist William J. Baumol asks this thought-provoking question: How would you go about increasing the efficiency of a string quartet playing Beethoven? Would you drop the second violin or ask the musicians to play the piece twice as fast?
Adam Smith explained how the specialization and division of labor were the major causes of productivity increases and the creation of wealth. However, even some of Smith’s insights are not effective in a knowledge environment. Shakespeare could not specialize in writing the verbs while a colleague wrote the nouns of his many works, even though this would, no doubt, increase “efficiency,” at least given the way firms currently measure that statistic.
Judgment vs. Measurement
Efficiency is always a measurement. Effectiveness, on the other hand, is always a judgment, which is far more important in a knowledge environment. Some of the comments on your blog post support this position, especially Fred Bartlit’s.
There is no generic way to “measure” the quality of legal output; it requires a judgment, based on the results it creates. This is one of Drucker’s major insights about the difference between a factory worker and a knowledge worker. If I’m placing tires on an assembly line it is much easier to measure my quality (and defects) than if I’m a lawyer writing a crappy brief, which will only be discovered by a judgment, usually from another lawyer.
I was hospitalized last year. My surgeon ordered a CAT Scan. The procedure was done very efficiently, as measured by outputs and inputs. I was in and out very quickly, comfortable, etc.
However, when my surgeon saw the scan results he “judged” the radiologist screwed up, didn’t scan far enough down my thigh. The measured efficiency could not inform him of this defect—it had to be judged. This defect led to a much longer hospital stay and other serious complications.
The scan was highly efficient, but it was nowhere near being effective.
I’m all for process, and you mention audits. However, judgment is still superior. Take Enron. The auditors followed the “processes” and the “checklists.” What they didn’t do is apply professional judgment by asking “Do these financial statements reflect the underlying economics of this entity?” The result was an efficient audit that was entirely ineffective.
Anthony Kearns makes an excellent point when he says: “In law...it will be difficult if not impossible to determine in advance where efficiency in process can be achieved without unsatisfactory compromises in quality.”
This is another way of stating what economists have known for centuries: there is no generic efficiency without respect to purpose, and what you are willing to pay.
Anthony also makes another excellent point about expertise driving efficiency (I would say it drives effectiveness), and this supports my argument even more.
When we are undergoing education, we aren’t very efficient as measured by a ratio of outputs divided by inputs. New skills take time to learn, and beginners make tons of mistakes. If all we cared about was efficiency we’d never educate our team members. But the only way a knowledge worker can become more effective is through education, so the cost of less efficiency is a price worth paying.
Scott Irwin’s formula is interesting: Effectiveness + Cost Control = Efficiency.
But I reject this, for the many reasons cited above. Too many companies focus on cost control and efficiency at the expense of effectiveness, which I believe is dangerous.
Gordon Bethune, former CEO of Continental Airlines, made this very point in his book, From Worst to First. He said Continental’s management culture was totally focused on driving down cost per passenger mile, by piling more people into the planes like sardines, cutting down beverage sizes, taking out pillows, blankets, and magazines, etc.
He wrote “you can make a pizza so cheap no one wants to eat it, and you can make an airline so crappy nobody wants to fly it.” This cost mentality was precisely why Continental filed bankruptcy twice in one decade before Bethune took over and began to focus on effectiveness.
Efficiency in a law firm, in and of itself, is not a competitive advantage. It’s the equivalent of having restrooms. If your firm isn’t using the latest technological tools that is incredibly inefficient; but if it is using those things, so what? All of your competitors are too.
The differences in firm revenue and profit cannot be explained by efficiency, only effectiveness in customer service, as well as the ability to create, communicate and capture value. Efficiency is a table stake—the minimum you need to be in the game.
Competitive advantage is built on effectiveness, not efficiency.
It’s not very efficient for Nordstrom to have pianos in its stores, as it lowers sales and profit margin per square foot (the efficiency metric for retailers). It is, however, incredibly effective to serenade your employees and customers everyday, creating an ambiance they want to come back for.
The ultimate manifestation of the efficiency mentality was Robert McNamara, president Kennedy’s secretary of defense from 1961 to 1968, thereafter becoming president of The World Bank. McNamara was an accounting instructor at Harvard Business School before World War II, then he served as a specialist in operations research projects with the U.S. government during the war. After the War, he was hired by Henry Ford II—along with the so-called Whiz Kids—to revitalize the sagging profits of the Ford Motor Company.
He brought a mechanistic mind-set to the War in Vietnam, trying to micromanage it by the numbers. He apologized for this ill-conceived strategy in his 1995 autobiography In Retrospect: The Tragedy and Lessons of Vietnam.
Blindly relying on measurements can obscure important realities. The ultimate problem with numbers and measurements is what they don’t tell us, and how they provide a false sense of security—and control—that we know everything that is going on. I think the mentality among many leaders in professional firms is “If we can’t manage it, let’s measure it.”
What is the Purpose of a Law Firm?
What are firms trying to accomplish? What is the goal? Is it simply to crank out more work per labor hour?
If that’s the case, then under the hourly billing model their revenue actually decreases. That seems ludicrous.
Is it to crank out more work per labor hour to increase firm capacity? For what purpose? To add more “F” customers? That, too, doesn’t make much sense.
As Kurt Siemers, CEO of Kennedy and Coe, LLC (a Top 100 accounting firm) says:
And since becoming more efficient is a zero sum game over time, we have been left with working more hours to earn more. The historical business paradigm of our profession found itself on a collision course with our commitment to the well being of our people.
Simply stating that a firm wants to be more efficient is meaningless. They need to define what they are trying to accomplish long before they can begin to consider the best way to achieve their objectives. This is, I believe, precisely what Fred Bartlit is saying, which I agree with wholeheartedly.
The ruthless quest for increased efficiency contains within it a grave moral hazard. It’s encouraging behavior from firm leaders that is driving out creativity, innovation, dynamism, customer service, as well as talent from the professions.
I know you are a big fan of Total Quality Service, Pat. So are we. In fact, I came to Value Pricing through TQS, as the hourly billing method is a lousy customer experience.
The giants in TQS, thinkers such as Karl Albrecht, Stanley Marcus, Walt Disney, J.W. Marriott, among many others, didn’t have much use for efficiency, knowing that dealing with people requires effectiveness. Karl Albrecht criticized TQM, Six Sigma, etc., for this very reason, and thought the mechanistic mentality it fostered killed customer service.
Doing the Right Thing, not Doing Things Right
Forget about efficiency. Worry about effectiveness.
Better still, focus on efficaciousness; meaning having the power to produce a desired effect. This term is used to describe the miraculous power of many drugs since it suggests possession of a special quality or virtue that makes it possible to achieve a result—exactly what we are trying to accomplish in law firms for customers.
In an intellectual capital economy, and within firms, where wealth is created using the power of the mind—as opposed to the brawn of the body—these characteristics better explain the value created by knowledge workers.
Yet all of the so-called “efficiency” metrics and protocols such as Lean and Six Sigma have their origins in the late 19th century time-and-motion studies for manual laborers in factories, not knowledge workers who don’t work to the rhythms and cadences of an assembly line.
Firm leaders need to stop looking at input-output tables based on labor hours. Rather, they should define what their purpose and strategy is so to be different than the competition in order to command premium prices.
I believe lawyers are more artists than technicians. By all means, put processes in place for the low value work that can be streamlined and is repetitive. But when it comes to the thinking, strategy, synthesizing information, and creating results, use your minds, creativity, expertise, wisdom, and judgment.
I can increase an artist’s “efficiency” by providing them with paint-by-the- numbers kits, but it will produce crappy art.
Do I have a higher opinion of lawyers than do those who have commented on this board?
What is Superior to Lean/Six-Sigma?
It’s one thing to light a candle in the darkness and point out flaws in the status quo, a function incredibly valuable if we are to improve our theories.
However, it’s also important to offer an alternative to the present darkness.
A Professional Knowledge Firm is not a factory, which is why I believe Lean and Six Sigma are the wrong talisman. Companies such as Google and Apple don’t use these tools; Southwest Airlines doesn’t even use them.
As a knowledge worker, I have seen far too many firms implement this type of thinking, turning their artists into a caricature of Charlie Chaplain in Modern Times, getting sucked into efficiency metrics, quotas, etc. I believe the price we pay for this is a lack of focus on effectiveness and customer service.
I, for one, don’t want to work in an organization that has a ruthless focus on efficiency. It’s not very inspiring or meaningful.
We offer the following cognitive tools as superior to Lean/Six-Sigma in a Professional Knowledge Firm:
- Key Predictive Indicators—measuring the success of the law firm the same way the customer does;
- Before and After Action Reviews—a concept developed by the U.S. Army and one of the most innovative tools that can be used in a PKF.
- Knowledge Management—knowing what a firm knows so it can be leveraged is one of the most effective ways to create wealth for customers.
- Project Management—we believe this is a critical skill for all firms, no matter how they price, even if by the hour. PM looks forward, planning capacity, resources, risk, etc. Timesheets look backwards. Timesheets have allowed firms to do a lousy job on PM (not to mention capturing value through more strategic pricing). By the time you see a problem on the timesheet, the milk has been spilled, the damage already done.
I have one final question: Is this debate efficient? What are people putting on their timesheets when they participate in these types of Social Media discussions, which are quite time consuming?
I don’t think this is efficient at all.
I do, however, find it very effective.
Thank you, Pat.
Ron Baker - 04/21/2009
Ron Baker - 04/08/2009
Another letter to the editor in response to the November 2008 Journal of Accountancy article, The Firm of the Future, has been published in the April 2009 issue.
This is one of the most frustrating issues that we continually have to debate—that is, the notion that timesheet are a measure of productivity. They are no such thing. They are the illusion of measurement.
I thought Victor’s reply was also compelling, being a partner in one of the firms profiled in the article.
How long is it going to take for CPA firm leaders to understand that there are better metrics for knowledge workers than the Frederick Taylor inspired timesheet?
Do they really think CPAs are the equivalent of factory workers? Do they not understand the difference between efficiency and effectiveness?
The lack of intellectual curiosity with respect to this topic is astounding, as it goes to the heart of how a firm measures and judges its success.
We believe those measurements should be based on how customers define the success of their CPA firm.
And there’s not a customer alive who does so by how many hours are logged on a timesheet.
If we get what we measure, isn’t it about time we measure what we want to become?
No one entered the professions to log the most hours on a timesheet. The leaders of firms who maintain this antiquated measuring device are doing their professions a disservice.
I understand that knowledge advances by what is known as knowledge creep, it’s a gradual, slow process. But the advocates of timesheets are stuck in the Industrial Revolution of the late 19th century, with metrics that are an idea from the day before yesterday.
Do they truly believe that no advances have been made in this field? If so, it’s sad, and it is ruining the professions.
This is probably a larger paradigm shift than hourly billing to Value Pricing, and I’d be curious as to people’s ideas on how to be more effective in getting this message out.
Ed Kless - 02/05/2009
As a fan of the Pittsburgh Steelers I was thrilled by the great game played by both teams on Sunday. The final score 27-23, Steelers. But let’s look at the game a little closer from the perspective of a old equation firm. Their analysis would look something like this:
For the Cardinals
- Total Net Yards - 407
- Total Rushing/Passing Plays (includes Sacks) - 57
- Average Gain per Offensive Play - 7.1
- Net Yards Rushing - 33
- Total Rushing Plays - 12
- Average Gain per Rushing Play - 2.8
- Net Yard Passing - 374
- Gross Yards Passing - 377
- Pass Completions/Attempts - 31/43 = 72%
- Average Gain per Passing Play (includes Sacks) - 8.3
For the Steelers
- Total Net Yard - 292
- Total Rushing/Passing Plays (includes Sacks) - 58
- Average Gain per Offensive Play - 5.0
- Net Yard Rushing - 58
- Total Rushing Plays - 26
- Average Gain per Rushing Play - 2.2
- Net Yards Passing - 234
- Gross Yards Passing - 256
- Pass Completions/Attempts - 21/30 = 70%
- Average Gain per Passing Play (includes Sacks) - 7.3
In virtually every offensive category (in italics above) the Cardinals come out ahead. Do you notice something about these stats? They are all effort based, even those that measure efficiency — average gain per offensive play, average gain per rushing play, pass completion percentage, and average gain per passing pay. Measuring and using these statistics to determine the outcome of a game is nonsensical.
The same thing is true about professional firms that measure billable hours, utilization, and realization. They are all effort based, not result based. A billable hour is not a result, it is not a touchdown. It is an effort, it is a pass attempt.
As with any analysis of data, while you can measure based on efforts, you cannot judge or determine the outcomes based on them. What is true for sports teams is true for professional service firms. Stop measuring the efforts, start judging (better yet have your customers judge) the results!
Ed Kless - 10/22/2008
I just read this brief story entitled Why the stock market does not reflect the economy. The story is not the important point here, the use of language is.
In the first five sentences, the writer uses three ”collective nouns:”
- “the market”
- “the economy”
- “Washington”
The use of collective nouns (and pronouns) is a KPI (key predictive indicator) of victimhood. Much of the news copy today is filled with them. In addition to those listed above, you will hear: the Administration, the White House, experts, researchers, scientists, et al. Sadly, these journalists like the one mentioned above are not the only ones to succumb to this disease. In our organizations, we say things like, ”Marketing just doesn’t get it,” ”Customer service is out to lunch,” and ”Sales really blew it this time.”
Do not fall prey to these grammatical Grendels. If you catch yourself using them, ask “Who in marketing doesn’t get it?” Get specific, don’t be a victim.
Ed Kless - 10/21/2008
Two weeks ago, I attended at Sage Leadership Academy Alumni Association retreat where the speaker was Doug McVadon of Dorrier Underwood. Doug’s topic was fascinating - new discoveries in brain function and their impact on what we know about leadership and communication - but, it was something he did before the class that inspired me; he gave the participants a Preval, a pre-course, self-evaluation.
This got me to thinking that as good as the Best Damn Evaluation is, it only gets feed back at the end. To rectify this, Ron Baker has begun some of his sessions by showing the questions from the evaluation at the beginning of the class. He said that this alone has created a noticeable change in the dialogue. The Preval marries these two great ideas together.
So with out further ado, I hereby present to you - The Preval! --> Personal_pre-valuation.pdf
Please feel free to download and begin to use it. If you have any feedback on it please either comment below or shoot me an .
I am grateful already for the feedback I have received on the beta version from Ron and Dan Morris of VeraSage, Apryl Hanson, a colleague at Sage, and Howard Hansen, mentor extraordinaire from Healing Leaders.
Ron Baker - 08/24/2008
Friends of VeraSage know that we have major problems with Generally Accepted Accounting Principles. We refer to the financial statements as the “three blind mice,” a term used by Harvard Business Review editor Thomas Stewart. Dan Morris and I teach an entire course entitled When Debits Don’t Equal Credits.
It’s also why I always enjoy reading Paul Miller and Paul Bahnson’s The Spirit of Accounting, their regular articles featured in Accounting Today. In the Aug 18-Sept 7, 2008 issue, they reprinted an older article they had written, proposing the following thought experiment: what if keeping score in golf was similar to GAAP?
The article is excellent, illustrating how—more and more—GAAP is becoming irrelevant. Where I disagree with the authors is they believe it can be reformed while I emphatically do not.
For a fundamental reason: Accounting is not a theory. It cannot be a source for “predicting the future,” as the authors say, because it is simply an accounting of the past. Data can only shed light on the past, it cannot peer into the future. For that, you need a theory.
Unless, of course, your theory is the future will equal the past, a perilous assumption in a dynamic, capitalist economy.
If you are a golfer and a CPA, you will enjoy their analogy. It may sound tongue-in-cheek, but it conveys a serious message: GAAP is deeply flawed. Rather than being supplanted, it needs to be supplemented with more meaningful information, such as Key Predictive Indicators.
All we can hope for blind GAAP is that someone yells “Four.”
Ron Baker - 07/29/2008
Excuse the salacious title, it’s not what you think. This past week I received two more emails with questions about timesheets, so All About T[imesheets] & A[nswers] seemed like a catchy title we could remember and refer back to often.
We have a lot of excellent resources on this issue throughout this Web site, so I thought it might be helpful to summarize our best ones in a single post, as well as answering the two emails.
There’s no shortcut through this topic, which is precisely why most firms haven’t ditched their timesheets yet. It requires that you take the time to read, think, innovate, and creatively apply the replacements for timesheets.
There’s nothing easy about any of this folks. We are very up-front about the commitment and courage it takes to make this change. If it were easy, more firms would have done it by now. But can you name anything worthwhile that is easy?
Let’s start with the two emails I received, because the first one asks a question that we have not dealt with as of yet. It comes from Carol, a CFO in an advertising agency:
Hello Ron,
You and I have met a couple different times over the last few years at 4A’s seminars. I’ve always been intrigued and inspired by what you have to say and try to implement a value mindset in our estimating and billing practices.
The one area that has always been a hard pill to swallow has been the ‘no timesheet’ issue. Not only does this practice allow for us to gage how long it takes to get something done, it allows us to predict staffing needs, inefficiencies, and most important for the purpose of my reaching out to you now, it allows us to record a WIP accrual every month of time incurred, not yet billed = revenue earned. The majority of our projects are just that, projects, rather than monthly ‘retainers’ with a fixed fee.
This may be a very naïve question, but if you could shed some light on it, it may be a life-changing event at this agency. The question is: If we don’t have reports that tell us how many hours have been worked on any given job so we know what to accrue for, (because we’ve abandoned timesheet entry) how would we determine the revenue accrual each month? Any alternative we seem to come up with only creates much more work for the finance team and seems to produce very guesstimated numbers at best.
So there is my quandary. Or at least one of them, I should say. Is there any knowledge you could share with me that might point me in the right direction and further my cause down the road to total Value compensation?
I so look forward to hearing from you and thank you for your time.
All the best,
Carol
Most of these questions, especially regarding forecasting “staffing” needs and “inefficiencies” are answered in the resources below.
The question we haven’t dealt with is how to book revenue without timesheets. As you know, timesheets are used for WIP [Work In Progress] reports, which is how most firms accrue their revenue.
Of course, do we really think that just because a firm “spends time” working on a project that it has earned revenue? Is the timesheet really the best measure of that process?
A better method is the percentage of completion accounting method. If a project can be broken down into milestones, you can then estimate what percentage of the job is completed at the end of any one accounting period. Rather than being based on time, you are basing it on the actual work that needs to be performed.
I’d love to hear how some of our Trailblazers are handling this, especially firms like Mark Bailey’s that do audits that may overlap between two years.
In any event, we at VeraSage are far more concerned with establishing an external price—commensurate with value. How you account for that internally, I believe, can be established utilizing good accounting principles on a consistent basis.
The second email is from Toby, a CFO for an engineering firm:
Ron,
I have been reading your pamphlets and find them to provide an excellent solution for changing the way Professional Service firms operate.
I have some questions:
I am the CFO at an Engineering Service firm. In our case many of the “jobs” are unique to each client. Do you have any examples of how this type of firm can apply the value pricing concept? Would we still use Fixed Price Agreements?
Also, I noticed that a “calculated price” based on “billable” rate assumptions was used by several of the examples you cite. It seems there can still be a value in keeping a billable rate handy. Am I missing something? Would it be reasonable to use the “billable” rate per person in arriving at the FPA amount?
Finally, wouldn’t we still need to report time (at actual paid rates) in order to measure the profitability of each client? (We would not be using a billable rate.) This would allow us to have information for use in renewal of the FPA, or give information as we price FPAs for new clients.
Any guidance would be helpful.
Thanks in advance.
Toby
Here’s my reply, which has been expanded upon for purposes of this post:
Dear Toby,
Value Pricing is ideal for unique jobs, since value is subjective. A pricer’s dream is to charge a price commensurate with each customer’s perception and actual value received—like at an auction.
It’s known as first-degree price discrimination, which is very difficult for most businesses to implement, but Professional Knowledge Firms can get closer to it since they meet with customer individually, especially since so many projects are customized and unique for each customer.
Advertising agencies are very similar to engineering firms, since their jobs are also very unique to each customer, and we have had ad agencies that have adopted Value Pricing (VP) and ditched timesheets. Our recent Trailblazer ad agency Fletcher Martin is one example.
See our Trailblazers section of the Web site for case studies from firms across the Professional Knowledge Firm (PKF) sector who have made the transition.
We don’t advocate a “calculated price” based on a billable rate, since that is cost-plus pricing. Of course, many people will compare a value price to a “billable” rate, just to prove that VP is higher. Once you do this a few times, you realize time tracking is superfluous.
There is no value in keeping a billable rate handy, since it’s an arbitrary rate. This is not to say you don’t do cost accounting. But the important point is to do the cost accounting BEFORE you do the project, not during or after. Toyota does this quite successfully, it’s know price-led costing.
It’s also important to remember that a “billable rate” is not cost accounting, since it includes a profit margin. No cost accounting theory that I know of allocates desired profit, just costs. To be true cost accounting, you must remove the built-in profit from the hourly rate.
As to measuring profitability of each client, there are other ways to do this without timesheets. After Action Reviews, and project management (which you engineers are excellent at, far better than the average CPA or attorney), are two such methods.
What Replaces Timesheets?
Here is a list of what replaces timesheets, based upon the empirical evidence from firms that have made the transition:
- Price-led costing
- Project management
- Key Predictive (not performance) Indicators
- After Action Reviews
- Before Action Reviews
- Fixed Price Agreements, Change Orders
- Chief Value Officer and/or a Pricing Cartel
The following is a partial list of resources dealing with each of the above.
Price-Led Costing
Cost-plus Pricing: The Democracy of the Dead.
How Much Are You Leaving on the Table Because of Mediocre Pricing?
Sellers Change Pricing Strategies, Not Buyers.
Hourly Billing is the Opium of the Profession.
My ACCA book, Burying the Billable Hour, in pdf.
My The Firm of the Future and Pricing on Purpose books.
Project Management
Our resident expert on Project Management is Ed Kless, who has written, and inspired, many brilliant posts on this topic. My favorites are:
The Triangle of Truth.
Elements of a Scope Document.
Elements of a Change Request.
A Critique of Project Management: A Means to Efficiency.
The difference between goals and objectives.
Defining the Word “Project.”
Ask VeraSage: Timesheets and resource planning.
How should professionals scope complex jobs, inspired by Ed and Chris Marston of Exemplar Law Partners.
Key Predictive (not performance) Indicators
No Timesheets vs. Utopia.
He Who Says “A” Must Say “B.”
No Timesheets? Is it Possible?
Ask VeraSage: How do you measure client profitability and employee productivity?
Ask VeraSage: Why get rid of timesheets?
Why we don’t need consultants.
Timesheets are Training Wheels.
A Firm with No Timesheet: O’Byrne and Kennedy LLP. A case study by VeraSage Senior Fellow Paul O’Byrne (one of the few things from him on this blog, be sure to read it!).
An Essay on Timesheets, by Paul Kennedy. This is one of the best explorations of this topic ever written. A must read.
The Yank Strikes Back.
My ACCA book, Trashing the Timesheet, in pdf.
My The Firm of the Future and Measure What Matters to Customers: Using Key Predictive Indicators, books.
After Action Reviews and Before Action Reviews
After Action Review—The Army Way. This post includes an excerpt from a US Army manual on how they conduct AARs. Highly recommended.
My books, The Firm of the Future; Pricing on Purpose; Measure What Matters to Customers; and Mind Over Matter all deal with After Action Reviews and Before Action Reviews are dealt with in Mind Over Matter.
Fixed Price Agreements and Change Orders
Why Your Firm Needs to Offer Fixed Prices.
Sample FPA and Change Order documents and other resources here.
Ask VeraSage: Fixed Price Agreements and Engagement Letters.
A Blinding Flash of the Obvious, which contains an example of a price menu from an Australian Trailblazer accounting firm.
If You Don’t Discuss Value, Expect to Discuss Hours.
Utilizing Change Orders in Your Firm.
My books cited above, including Burying the Billable Hour contain sample Fixed Price Agreements and Change Orders.
Also, my Professional’s Guide to Value Pricing, Sixth Edition (out of print), can be partially accessed from Google Books.
Chief Value Officer/Pricing Cartel
Your Firm Should Establish a Pricing Cartel.
Who’s in Charge of Value in Your Firm?
Ask VeraSage: Creating a Pricing Cartel.
Ask VeraSage: How does a firm implement Value Pricing?
Ed Kless’ Cosmo Quiz to determine if your firm is truly Value Pricing.
My book, Pricing on Purpose, also explores pricing cartels and the successful characteristics of a CVO.
If this is so rational, why haven’t more firms done it?
This is a great question, one which we at VeraSage have spent a lot of time trying to answer and understand. Here are some thoughts on why more firms haven’t trashed timesheets.
The Diffusion of a New Idea.
Old Dogs Don’t Create New Tricks.
The Answer to How Is Yes
We believe if you understand “why” to do something, the “how” becomes much easier—merely the plumbing. Since there’s no way to implement a bad idea, the “why” is critical.
Read Peter Block’s The Answer to How Is Yes for why this is so.
I know, this is overwhelming. But think of it this way: All you have to do is read it and implement it. We’ve done most of the hard thinking for you.
I will leave you with this analogy. Trashing the timesheet is a true revolution, perhaps not as dramatic as the signing of the Declaration of Independence, but a difficult objective to achieve across all PKF sectors nonetheless.
In his book, Peter Block describes the six questions that are always asked when people are confronted with significant change:
- How do you do it?
- How long will it take?
- How much does it cost?
- How do you get those [other] people to change? [we get this all the time: I’m all for this, but my partner(s) won’t go for it].
- How do we measure it?
- How have other people done it successfully?
How would Thomas Jefferson have answered these six questions?
- I don’t know.
- I don’t know.
- Possibly your life.
- I don’t know.
- I don’t think you can measure Life, Liberty, and the Pursuit of Happiness.
- No country has ever done it successfully the way we are proposing. Sign here.
Block suggests two better starting questions:
- What [type of future] do we want to create together?
- What is the price [we are] willing to pay to achieve it?
It is simply impossible to know how to do something until you attempt it. It is the leap, not the look, that generates the indispensable understanding and the necessary knowledge to generate wealth.
I hope you find this list useful, refer to it often, share it with others and most importantly, implement the ideas as hundreds of other firms are doing.
Along the way, keep us posted on your progress.
I hope to see you in our Trailblazer section.
Ed Kless - 07/03/2008
Under the heading of Ask VeraSage comes the following:
Over a year ago I posted on the difference profit per employee (PPE) and revenue per employee (RPE). Tonight, my wife, Christine and I had a dialogue about a case study she had written earlier in the day for a customer of hers.
The customer had stated, “RPE is my ultimate measure and all I can tell you is that since implementing the new system, it is up.” Christine then asked, “Is RPE a good measure of effectiveness or efficency?”
My gut reaction was effectiveness, but I am not so sure. Perhaps it is both, but here is where you, our loyal VeraSage readers, come in. What do you think?
Ed Kless - 05/05/2008
I recently read Beautiful Evidence by Edward Tufte. I will post a full review shortly, but there is one item from the book that warrants a post unto itself.
During some of our recent phone calls, Ron and I have lamented the staggering number of surveys that seem to be cropping up throughout the professions. Not that there has ever been a dearth of them, but recently there seems to be an over abundant proliferation. We even joked that they all say the same things.
Coincidently, Edward Tufte quotes from a study by Bernard Berelson, Human Behavior: An Inventory of Scientific Findings. Berelson apparently reached that same conclusions Ron and I did, only he was scientific about it. He survey 1,045 survey on human behavior and presents us with a brilliant executive summary of all the executive summaries. His three findings are as follows:
- Some do, others don’t.
- The differences aren’t very great.
- It’s more complicated than that.
There you have it folks, we can all eliminate taking and reading surveys from our to do lists. Let’s just refer to it as MOAES, the Mother of All Executive Summaries.
Ron Baker - 04/11/2008
I had a great conversation this week with Michael Stewart of Integrity Wealth Pty Ltd, outside of Brisbane, Australia.
I’ve known Michael since his days with Results Accountants’ System under Paul Dunn and Ric Payne. Then he was with Principa, and now is with Integrity as General Manager.
As of October 1, 2007, the firm eliminated timesheets. More empirical evidence that this is the wave of the future if firms are serious about operating effectively in an intellectual capital economy.
During our conversation, I asked Michael to provide me with a case study on his firm’s transition to becoming a Firm of the Future.
Here is his first installment, as he wants to add to the story in the future to inspire others:
Hello Ron.
Thank you again for speaking with me during the week. As is always the case when interacting with you, or your material, I left feeling further inspired; and also somewhat humbled—there is still much for us to learn and implement as students of pricing and value.
As agreed I’m sending this email now and if there is sufficient interest from the VeraSage community I’ll follow up with a more detailed case study. While getting rid of timesheets was just one step in an overall strategy to change our firm, it has proven to be a critical one. Not being an accountant myself I’ve never had to record my life in 6 or 10 minute units (and if I had I probably wouldn’t have lasted very long). So in some respects I don’t think I can really convey some of the differences it’s made to individuals within the firm. But I do know what it’s done for our mindset, how we promote the firm, and how both clients and team members react to a no timesheet model—and it’s all positive. Perhaps in a future email I’ll get one of the team to write their thoughts. As an example, Denise Gibbons (Partner) said to me recently “I used to make myself sick preparing bills for clients”. We don’t have to worry about that anymore, which in itself has to be a major win.
As a summary:
Practice Profile:
- 2 partners + 11.5 FTE (includes our financial planning division)
- 2006 revenue $645,000
- 2007 revenue $735,000
- 2008 revenue $1,180,000 (growth approx 50/50 acquisition/natural growth)
- Approx 400 clients in Accounting division
We are located in Clayfield, Brisbane, QLD, about 10 minutes from the heart of the city. Over the past 18 months we have been working to redesign the business on many levels in order to create a place that will attract team members. The partners, Denise & Mark, were very keen to implement many things but like most firms were struggling to balance client work with internal goals. I joined full time in October 2006 with my focus being on establishing the strategy and infrastructure that would attract team members and allow us to grow. For a firm of this size to hire someone who does little or no client work was a significant decision, both financially and in terms of mindset—the partners were agreeing to hand over the day to day running of the overall business so they could focus on client work and development of the team.
We made the decision to abolish timesheets as of 1 October 2007. We had been talking about it for at least 9 months prior to that and had committed in writing to the team we would do it. There were many discussions on whether we should keep timesheets at the same time to make sure, well, to make sure the sky didn’t fall in I guess; or whether we should still record total time on the job to identify scope creep. Finally common sense prevailed, we chose to back ourselves, we took the leap, and haven’t looked back.
How it works:
- All clients now receive an engagement letter with a fixed fee and a date for when their work will be completed. Typically the fee is based on last year + 10%. We review each job and the scope of the work before determining the price. Mark, the partner of the accounting division does the initial review. We then sit together and as Chief Value Office I challenge anything that has not seen a minimum 10% increase. (This is in addition to a 10% increase last year for most clients). Mark is right on the page with value pricing so he identifies any special work or areas in which we could add significant value. Though for most work it’s very similar year in year out.
- We must receive the signed letter back from the client before work begins. Naturally there are some long-standing clients where we respect the relationship and we haven’t bothered trying to force an agreement upon them. So long as they agree to the price we’re happy.
- We now ask for payment of invoice immediately upon completion of work, instead of 14 day payment terms. New clients often have to pay $1,000 upfront for us to review their work, then we quote on the scope and price of the work that needs to be completed. Again, the client must agree to all terms in writing before the work begins. We haven’t worried about moving to bill existing clients upfront. Instead we have focused on workflow—if we can get the job out the door quickly then we can invoice sooner. Then of course you need a system to chase debtors (receivables for our international colleagues).
- We initially set a minimum fee of $1,000 for new clients. We have since moved that to $2,000 and will soon be increasing to $3,000.
- We currently have just one KPI that has replaced timesheets—a monthly invoicing target. The entire accounting team are responsible for ensuring we make this target. I have set the budgets for the firm, Mark then looks at all upcoming work and selects the jobs to be completed each month. Then we just get on with it. If we make target, we know those jobs have been completed. Nice and simple.
- Monthly targets are based on a combination of what we have invoiced for the same period in previous years; what the firm would have achieved on a hours x rate x productivity model; plus any price increases, allowances for special work or value priced engagements etc. In a firm of our size it’s pretty obvious if people are working hard or not. If productivity or workflow is lower than we believe it should be, it’s usually more to do with planning, getting the right people doing the right work, and resourcing, than it is a lack of effort by the team. In other words we believe people come to work with the intention of working hard; we just needed to get the planning and infrastructure correct so their efforts turned into outputs.
To ensure I was happy with the monthly targets I conducted a financial analysis using Principa’s FirmPlan—I think it’s the best tool I’ve come across in relation to looking at the financial performance of a firms that record time. Within it I compared our numbers to some benchmarks, ran some what if analysis on impact of price increases etc. From there we picked an annual revenue figure, divided it by 12, made some adjustments to each month based on seasonal fluctuations, and targets were set. We have 15 years of history on what price our clients will pay for most of our work and how much work we can do in a given period—so even if that is based on a timesheet model it is a well established precedent and provides an easy starting point for getting rid of timesheets and quoting a fixed price before the work begins.
- It’s important I point out how helpful our team, in particular our admin team, have been in adopting this change. For the professionals it has made life easier. Though for Barbara (admin, reception) it has created work. Who gets engagement letters; who doesn’t; changes to the system every other week as we learn new things; extra work in preparing engagement letters; updating the workflow system etc. We continually communicate why we are doing these things and we are very grateful that all of this has been handled with a minimum of fuss and we are a better firm as a result.
Ron, there will be many other things to discuss and share: strategy, vision, client selection, pricing, marketing, recruitment, post job reviews, successes, failures, things we have no idea how to approach, examples of value pricing successes, and comments about “accounting utopia” (more on that story in another email). This email is to get the process started. On behalf of Integrity I’d like to say a massive thank you to everyone who has shared their ideas with us and myself over the years. We hope our contribution is helpful to others who are heading down this path.
Ron, please feel free to publish my contact details in case anyone would like to contact me.
Michael
Michael Stewart
General Manager
Integrity Wealth Pty Ltd
Integrity Chartered Accountants & Business Advisors
http://www.integrityaccountants.com.au
http://www.integrityfp.com.au
Tel: +61 (7) 3262-3533
Thank you, Michael, and we look forward to more details on your firm’s transition.
Congratulations to the entire team at Integrity for blazing the trail for your colleagues—and all of those reluctant consultants—to follow.
This is truly Firm of the Future 2.0.
Ron Baker - 02/14/2008
I recently wrote about Mark Chinn, a family law attorney from Jackson, Mississippi whom I had the pleasure of meeting last month in Orlando, Florida. Mark’s firm, Chinn and Associates, is one of our Trailblazer firms. He does 100% Value Pricing and is in the process of trashing his timesheets.
Mark has practiced for thirty years and is listed in Best Lawyers in America in Family Law and has written two books published by the ABA on running a family law practice and contributed to two other ABA books. He has also published an ebook, “Dumping the Billable Hour, One Lawyer’s Experience.” All of this, and more, can be found at the firm’s incredible Web site.
Mark picked up my two latest books in Orlando, Measure What Matters to Customers: Using Key Predictive Indicators, and Mind Over Matter. The other day Mark sent me this email, creating another HSD!
Ron,
I have just completed reading Measuring What Matters to Customers. I couldn’t put it down and finished it off in three days. As I was finishing it I had the mixed emotion of being pleased to finish your message, but sad the story was coming to an end.
You know I have kidded you about how academic Professional’s Guide to Value Pricing was. Well, Measuring ranks right up there as an academic masterpiece, which is important in this day and age when it seems that everybody is just writing what they think. You should have been a college professor and your book would be worthy of text at Harvard Business School.
I have been using business coaches for my family law practice for 20 years and I have read at least a hundred success and management books and I have lectured all over the U.S. and Canada and there are many previously unearthed gems in your book.
First, traditional numbers usually don’t help. I have been telling my advisors and support staff for years, “These numbers don’t seem to help. I can be enjoying an unbelievable trend and then...boom, no business” Or, “No, there are no seasonal trends, sure some people put off divorce during the holidays but sometimes the holidays prompt other problems.” Being told by you in no uncertain terms that there is no certainty is a blessing. Thank you. Other points of import:
- Each customer is different. (That’s what the last one insisted in his recent exit interview...that he was different). So, focus your efforts on each one, not solely on a system for pleasing all.
- We need to pick three leading indicators, and the team needs to do it.
- Team workers are “knowledge workers” and “volunteers” and it is important to call them that and treat them like that.
- With good team members management needs to get out of the way and not demoralize them with negative feedback or scoring; and we further need to eliminate systems and procedures which interfere with what they are doing. We need to release our grip on our systems and ask the team members what systems help and what gets in their way.
- Measuring the wrong thing accurately can throw you completely off. Take time to carefully analyze situations outside of the facts. Your example about the World War II Bombers was unbelievable. The first thought was that the returning planes needed more armor where the bullet holes were. But Abraham Wald came to the opposite conclusion: that the armor needed to be placed where the bullet holes were not because the planes that made it back had survived even though being hit where they were.
- Being efficient at something irrelevant is a sign of impending disaster.
- The real things of value in life cannot be measured, something my more introspective teammates have been trying to tell me for years.
It takes courage to go against the grain and that is what you have done. Keep up the good work.
Wow, thanks Mark. Don’t read Mind Over Matter, I’ll quit while I’m ahead.
You haven’t seen the last of Mark Chinn around VeraSage.
Thanks Mark. You are too kind.
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