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Ed Kless - 08/30/2010
My friend and Sage business partner Gary Crouch from CS3 Technology in Tulsa, OK sent me this story from the Tulsa Business Journal.
The article details the fact that a local company Fee Technology Inc. has acquired a patent for “a mathematical process for creating a direct relationship between the prices charged to the cost structure of a business.”
Correct me if I am wrong, it is called cost-plus pricing and the patented process is called multiplication.
Ron Baker - 08/26/2010
Last Saturday evening I received this email from Ken Morrison of Provision Accounting Group in Richmond, British Columbia.
This is definitely an HSD.
Ron,
I am an “older” chartered accountant in Richmond British Columbia (forty years in the business). I have two younger associates (29 and 34) who are preparing to take over. A staff of six for a total of nine. We have been very successful over the last four years marketing (the old guy young guy combo is deadly).
But Nathan (29) found your site and challenged us on the value pricing concept, scrap timesheets etc., we have now instituted the fixed price agreement for all new clients and are going to transit existing clients over the next months. Much of what you advocate we were doing, culling poor clients etc but the fixed price agreement and value pricing is revolutionizing our business.
I personally am for the first time in forty plus years am free from needing to rationalize my pricing to an hourly rate and can price value. It is changing my life.
The one other change I have made is that since we are giving the client a fixed price and a cash back guarantee we are asking for quarterly payments on all accounts. For example, if the fixed price is $5,000 and the year end is December 31, we ask for $1,250 on June 30, $1,250 on September 30, $1,250 on December 31, and the final payment on March 31, which is our latest deadline for completion of the work.
You can imagine how this is reducing our work in progress and account receivable balances.
The old guy is ready to scrap timesheets now, the young guys are holding back.
Thanks for your leading the change.
Ken Morrison
Thanks Ken.
Congratulations and keep us posted on your progress. I can’t wait to publish your Trailblazer case study after you’ve eliminated timesheets.
Ron Baker - 08/21/2010
Regular readers of VeraSage know that we are all enormous fans of Jay Shepherd, founder of Shepherd Law Group, blogger at The Client Revolution and Gruntled Employees, VeraSage Trailblazer, and (I’m honored to say) author of the Foreword to my forthcoming book, Implementing Value Pricing: A Radical Business Model for Professional Firms.
At the beginning of the month, Jay sent me a thought-provoking email that he has graciously given me permission to share.
Needless to say, when the subject line reads “a mental breakthrough” from a thinker such as Jay, you have my undivided attention.
Hey, Ron,
I was just reviewing Chapter 16 of your manuscript. (Love it.) This weekend, I had a mental breakthrough that really originated in part from something you’ve been saying for quite some time. Let me explain:
First, in early May, I was blown away by Simon Sinek’s TED talk on starting with why. (I think I forwarded the video to you.) I found the Start With Why concept a game-changer. I immediately downloaded the book [Start With Why].
Coincidentally, I was at the same time reading Switch by the Heath Brothers. (So I was delighted when I saw your Verasage meeting reading list.) For the past three months, I’ve been struggling to figure out what my and my firm’s “why” was.
At long last, I think I finally found it.
My “why” is “to fix the practice of law.” My firm’s “why” is “to innovate (in fixing the practice of law).” Everything we do, everything we’re about is grounded in relentlessly innovating. Looking back, that’s the message of both my blogs—The Client Revolution and Gruntled Employees.
Fixed prices is just a “how,” under Sinek’s framework. I’ve been making the same mistake that TiVo made—selling the “how” instead of the “why.”
Fixed prices is an important “how” for us, but it’s not the only one, and it’s not the thing that’s going to make companies bang down the door to sign up with us.
But if we instead focus on the “why,” it not only helps us stay on message in our marketing, but it also identifies whom we want to market to. Innovators. To paraphrase Sinek: “If you’re the kind of company that’s all about innovation, boy, have we got a law firm for you.”
And bringing it back to Chapter 16: I once wrote a post or article or something (could have been an SPU [Solo Practice University] gig) in which I mentioned that law firms didn’t really start using hourly billing until the 1950s or ‘60s. My point had been to challenge the notion that hourly billing has “always been the norm.”
In a comment, you pointed out the research that you discuss in Chapter 16 of IVP: that law-firm hourly billing was started in 1919. Since that didn’t really mesh with my point, I’ve kind of ignored that fact. But now, suddenly, I get it.
“If you’re the kind of company who’s all about innovation, why are you using a law firm whose billing model was invented in 1919?”
I think this was the point that I was missing: that hourly billing is antiquated. I’m going to start incorporating this notion in my writing and marketing right away.
As always, much thanks for your great work. Hope your summer’s going well.
Best regards,
Jay
We are defined by what we believe, not what we know
Jay’s breakthrough is absolutely correct. Value Pricing is merely part of a larger change in business models, which is driven by a firm’s strategy and positioning, which ultimately is driven by a firm’s “why” (or purpose, if you prefer).
Innovation is crucial, which is the point of my Great Moderates in History? post.
At the end of World War II, English writer and prominent socialist H.G. Wells wrote:
Human history becomes more and more a race between education and catastrophe.
Wells was a socialist who believed knowledge alone would create a more peaceful world.
But surely before they became the aggressors in World War II, the German people were among the best educated in the world—with their universities to become the model for America’s—and the Japanese among the most literate.
For as valuable as knowledge and education are, it is imperative to bear in mind that man is guided far more by his beliefs than his knowledge.
How else does one begin to explain why people fly airplanes into buildings full of innocent people?
In a business context, this is Simon Sinek’s point when he says “people don’t buy what you do, they buy why you do it.”
Rabbi Daniel Lapin makes this point quite cogently in his book, Thou Shall Prosper, helping his readers understand how the world really works:
You are best understood and appraised by others on the basis of the things you believe rather than on the basis of the things you know.
For example, during the twentieth century, Jews again learned the importance of this principle. They learned that what the Germans of the Third Reich believed was far more important a guide to their actions than the things they knew. After all, Germany was a society whose universities had produced the world’s most accomplished scientists, like Max Planck, and great philosophers, like George Hegel.
Germany was a society that had produced writers like Heinrich Heine and musicians like Ludwig van Beethoven. Nonetheless, it was their beliefs about a superrace and the genetic inferiority of Jews—beliefs that had little to do with facts&mdashthat won they day and changed the course of history.
Most of the really important adventures on which you embark depend on belief and faith. For instance, when you marry, you seldom do so on the basis of incontrovertible facts: You don’t walk down the aisle knowing for certain that you are going to live happily ever after in a state of permanently wedded bliss. And you don’t enter the state of matrimony knowing everything there is to know about your spouse. You marry on the basis of belief and faith.
...For an entrepreneur, starting a business far more closely resembles marriage...Faith is key (Lapin, page 183).
Indeed, all enterprise is an act of faith, a faith in the future, faith in the ability to humble yourself before others and solve their problems, create real value, investing in an unknown future where predetermined returns are uncertain—supplying before you can demand.
Hence, all organizations are built and operated on a worldview—what Peter Drucker called “The Theory of the Business.”
We are ruled by are theories and worldviews far more than we are willing to admit.
Accumulated knowledge certainly guides this theory, but ultimately any business is a leap into the unknown future.
This is what George Gilder means when he says “Knowledge is about the past; entrepreneurship is about the future.”
Ed Kless and I have been having discussion recently about our “why,” and it’s not an easy question. Take a look at what Ed believes, from his blog:
I believe that small business is where the vast majority of the wealth of the world is created. I help small professional businesses recognize that they do this through developing and sharing their knowledge. It is a great model. Do you want to know more?
I founded VeraSage, along with Dan Morris and Justin Barnett, to bury the billable hour and timesheets in professional firms, which is not a bad “what,” but it doesn’t answer why?
Well, because I believe that the time accounting regime is a servant that has transmogrified into a tyrannical master that lessens wealth-creation and service to others, humiliating and denigrating the dignity of knowledge workers everywhere.
The VeraSage Declaration of Independence is my verbose “why.”
Your Why should start with “I believe...”
We’d love to hear your “Why,” and have the opportunity, like with Jay, to post your mental breakthrough.
Ron Baker - 08/21/2010
I’ll be hosting a Webinar for CPA Leadership Institute on Wednesday, August 25 from 1 pm to 2:40 pm (Eastern Time).
The topic is: Cross-Selling: What is Your Firm’s Lifetime Value to its Clients?
You can learn more at the CPA Leadership Institute’s Web site here, and even get a detailed outline of the Webinar, in pdf, here.
This topic takes me back to the late 1980s, when I began to seriously study Total Quality Service, as it was then called by Karl Albrecht in his book, The Only Thing That Matters.
This book had an enormous influence on my thinking (it’s one of my Top Ten Best Business Books), because it was TQS that led me to the study of Value Pricing.
It was an epiphany when I realized that billing by the hour not only generates lousy customer service, it’s also a lousy customer experience. No one likes to be surprised by price.
Studying TQS leads you into customer loyalty economics, and one of the metrics is always “What’s the lifetime value of a customer to your firm?”
The logic being that you need to sometimes ignore the math of the moment and make an investment in the relationship. This is also where the billable hour fails miserably, as pointed out brilliantly by VeraSage senior fellow Paul Kennedy in his essay on why timesheets are damaging to customer relationships and lifetime value.
But I believe there is a more important metric: What is the value of your firm to your customer?
This forces us to think about constant innovation, and offering services that can help customers through the various stages of their lives and business—from womb to tomb, so to speak.
I hope you’ll be able to join us for the Webinar, but if not read the Kennedy essay and any book by Karl Albrecht.
Ron Baker - 08/20/2010
Our Australian colleague John Chisholm wrote about The Australian Legal Affairs Section of August 20th being primarily devoted to the problems and hopeful demise of the billable hour.
All the articles are worth reading, but the one that caught my eye was devoted to Lavan Legal, the Perth firm that is on track to eliminate timesheets in approximately two years.
This is a 200+ lawyer firm. So much for the argument that only smaller firms can achieve this transition.
John also reports that next week’s Legal Affairs Section (it runs every Friday) will also have more articles dedicated to this topic.
Obviously we are nearing a tipping point Down Under.
Good on Ya Aussies!
Ron Baker - 08/20/2010
Dan Morris - 08/11/2010
I am extremely honored to be an invited guest on the morning show hosted by Steve Wark and Leonard Wright on Las Vegas’ hot talk station KMZQ 670 AM. I will be taking part in their weekly program called Financial Fridays. I am to be interviewed on the concept of Intellectual Capitalism: Why Entrepreneurs are Great for America. This will be a very upbeat segment and I am to be interviewed for a full hour. You can listen via the Web at the link above and you can call in.
Like any excellent VeraSage program, I will have full academic freedom to speak my mind. There will be no “taboo” topics. I am sure we’ll discuss politics, ethics, sex, and heck....maybe even religion. I’ll be discussing why leaders have an obligation to have and maintain firm ethical foundations - not just at some times, but all the times, everyday. How Congress fails the Kantian tenet of having to live by the rules and regulations forced upon the Citizens. How our Country is so full of Grace that we really help those struck by disasters. Why even though we are blitzed with populous media about how bad everything is that in reality we are “way OK”.
How lucky we are to live in such a miraculous land where we can be a complete stranger in a new city and at 3 AM, walk into a bakery and order a customized sandwich, hand them a shiny (in my case dull and overused) piece of plastic and walk out with a meal and full stomach. No government Czar is required. Simply engaged people interested in their own lives yet open to servicing others. What a great country.
Please join us on Friday - and enjoy the show.
Dan
Ron Baker - 08/11/2010
Our Australian VeraSage colleague John Chisholm wrote a thought-provoking piece about customer service (though he used the word client and I’m too lazy to change it).
It’s a great reminder that a firm’s service proposition should be designed around its best customers, not all of its customers.
Here is John’s take on it:
Most firms have client maintenance, client service, and client development programs for their major and most important clients. Most firms understand that the 80/20 Rule applies to them (80% of the revenue comes from 20% of the clients) although I am not sure how many firms understand the more critical 180/20 Rule (180% of the profit comes from 20% of the clients).
But what does it mean to be a major or first class client of a law firm? Or are all clients of your firm first class clients?
I suspect not as the reality is all clients are not created equal and some clients are much more valuable to you than others so to treat them all as equals is not good for your business.
If you agree that all clients are not borne equal and that all clients value different things differently a good place to start might be to actually ask your first class clients what is important to them and how they would like to be treated and served.
What could I expect to receive from my law firm if I was really a first class client (apart from larger invoices) that second or third class clients might not receive (does my law firm tell its other clients they are in fact second or third class clients?).
Assuming a law firm ever thought I was a first class client (unlikely) and asked me those questions, I might respond along the lines that I would expect:
- Everyone in the firm from the Receptionist downwards would know just how important I am;
- Whoever I am dealing with knows my business and that I am not wasting time ( or worse money) over and over again explaining things yet again to another lawyer I am expected to deal with.
- I would expect my law firm to transfer its tacit knowledge freely around the firm.
- I would have access to be best and brightest the firm has to offer.
- I would have preferential treatment such that other clients might be “bumped” for me as I am given priority.
- To be kept up to date with what is happening in the legal and business world that could affect me and my business.
- Some commercial introductions perhaps and invitations to key events.
- The firm might ask my opinion and input on things that affect the firm.
- No surprises—in service, timelines or price.
- To pay first class prices for first class service and advice.
- Real coffee.
It goes without saying that any client—whether first class or third class—is entitled to assume a minimum level of service and technically correct legal advice, but if you have clients paying first class prices and your law firm can’t service their expectations and what they value, I am pretty sure these days they can find another firm that can.
Ron Baker - 08/11/2010
Another article in Lawyers Weekly on the Perth firm Lavan Legal and its quest to rid itself of timesheets.
Lavan was mentioned in a prior post, which also linked to a local article on the firm.
Dean Hely, the deputy managing partner, said the firm established a pricing committee as of July 1 and is aiming to move away from time-based billing to showcase its innovation credentials.
He also noted:
You do get used to timesheets but the thought of not having timesheets is like the lawyer’s utopia.
Of course Utopia means “no place,” but there are firms out there without timesheets.
I’m not about to claim they are all utopia, but we do know it’s possible.
Another law firm is profiled in this article in The Lawyer:
CMS Cameron McKenna has launched a marketing campaign to promote its alternative billing structures, which include a ‘pay what you think its worth’ option, to clients.
This firm has also established a pricing team.
Since pricing is a separate function, we are big advocates of turning it over to people who are good at it.
Poor pricers should not be allowed to price.
Congratulations to these two firms. More cracks in the dyke of the obsolete billable hour.
Dan Morris - 08/08/2010
VeraSage Founder, Dan Morris, will lead the 1st Tweet Chat sponsored by CalCPA (http://www.calcpa.org) this upcoming Thursday, August 12th starting at 10:00 AM (Pacific) (GMT -8). Readers, friends, and even challengers, are invited to participate with fellow professionals using the Twitter Hash Tag : #cschat1. This will be an excellent opportunity for participants to ask questions and receive answers and links to resources to improve their customer selection and retention activities. Additionally, Dan will lead discussions and provide resources for terminating toxic customers that are polluting firms and dragging down earnings and ruining a firm’s spirit of service.
Ron Baker - 08/07/2010
A recent article in Lawyers Weekly reported on the results of an online survey, with 200 Australian lawyers responding.
Alhough obviously not a scientific survey, when 43% conclude that timesheets are “intolerable” and greatly contribute to them not enjoying their work, it at least gives us a vector of people’s feelings on the effectiveness of this measurement device.
More encouraging, 20% of respondents “said they see timesheets as part of an outdated business model which needs to change, while 10% said they find them ‘stressful.’”
“Only 8 per cent of respondents said they do not have any issues with timesheets, while 19 per cent said they don’t like them, but can live with them.”
Encouraging results. And no, we here at VeraSage didn’t vote early and often.
I recently gave a talk at the ABA Legal Rebels program in San Francisco. It was a six-minute format, where you had to have 20 slides, timed to transition every 18 seconds.
This is one of the hardest formats I’ve ever attempted. That Winston Churchill crack about (paraphrasing here) “If you want me to speak for eight hours, I’m ready now; if you want me to speak for 10 minutes, I need two months,” is so true.
The one comment that got the most attention, based on Retweets and feedback I received was this: “The timesheet is the real cancer in the legal profession; the billable hour is a symptom.”
We can’t bury the billable hour until we bury the timesheet. The two are inextricably linked.
Logic and settled economic theory says that hours are not an effective measure of a knowledge worker’s value.
Then he who says A must say B.
Hours, then, are not an effective measure of knowledge worker efficiency or effectiveness. Period. You can’t have it both ways.
Some lawyers in Australia, and certainly in the USA, are beginning to see the light.
(Note: The videos of the ten presentations at the ABA Legal Rebels session will be posted over the next couple of months).
Ron Baker - 07/27/2010
Thanks to John Chisholm, some of Australia’s legal firms are taking Value Pricing seriously and establishing value councils, while a few are placing the timesheet on the dust-bin of history.
One of those firms is the Perth firm Lavan Legal, with 20 partners and 200 team members. It has appointed a 10-person pricing committee. As this recent article in The West Australian makes clear, Lavan is planning to trash its timesheets.
John and I have had the pleasure of working with Lavan, and the managing partner, Greg Gaunt, and the deputy managing partner Dean Hely, are both visionaries in the legal profession.
Lavan does major litigation, and although they are still making their way towards pricing this work based upon value, early results are encouraging.
There’s another firm in Perth going down the same road, as well as other firms throughout Australia.
Another firm with an innovative business model is Marque Lawyers, founded by Michael Bradley. I’ve had the pleasure meeting Michael and he truly has a Zen perspective on the practice of law—a refreshing and optimistic point of view about the future.
Michael was recently interviewed by Lawyers Weekly, where he linked timesheets to depression in the legal profession.
Two other articles in Lawyers Weekly discussed the VeraSage Institute’s Quest to bury the billable hour and trash timesheets: Take timesheets to the gallows and The man on a timesheet-killing mission.
Earlier this year in May, The Honorable Wayne Martin, Chief Justice of Western Australia, delivered a speech on the perils of both the billable hour and the timesheet. You can read the Judge’s speech here.
Obviously, something is going on Down Under.
It’s not enough to advocate that firms move to Value Pricing. The timesheet must be attacked as well.
After all, it is the timesheet that is the ultimate cancer, because it is the wrong measuring device for intellectual capital.
Thinking that we are measuring the efficiency, let alone the value, of knowledge workers by denominating everything into hours is simply ludicrous.
It’s the equivalent of arguing that Jonas Salk’s polio vaccine is valuable to the extent of the time it took him to develop it. Or that we could make Einstein more efficient if he had only completed a timesheet. Otherwise, how would we know he was on budget?
With firms like Lavan and others in Australia, true business model innovation is taking place.
By ridding their firms from the hegemony of timesheets, these firms are showing real change is possible, not just lip service about “alternative fee arrangements.”
If you are still are tracking time to justify your firm’s pricing, or to measure the “efficiency of your team,” you are billing by the hour and not doing anything new since timesheets were introduced in 1919 to the legal profession.
You are simply “selling time” just as much as any union employee. The world has changed since 1919.
Real innovation will only come when timesheets are trashed. And Australia may just be ahead of the United States, at least in larger firms.
Congratulations to Lavan Legal, a Trailblazer Firm in the making.
Ron Baker - 07/14/2010
Evolutionary biologists have proven that the more adapted (i.e., comfortable) you are in your existing environment, the less able you are to adapt to environmental changes.
Struggle is good for us. Rigidity is what organizations manifest when they are faced with either superior competition or outdated business models.
This is the history of business. New ideas, inventions, and business models from the tinkerer in the garage change the world, while rendering obsolete the existing modes of production, infrastructure, and business models.
The automobile replaced the horse and buggy, the calculator replaced the slide rule, and the personal computer replaced the typewriter, iTunes replaced CDs, and so on in a never-ending “perennial gale of creative destruction,” as described by economist Joseph Schumpeter.
Harvard professor Clayton Christensen writes:
Generally, the leading practitioners of the old order become the victims of disruption, not the initiators of it.
Change and creativity always take us by surprise. If it didn’t, we wouldn’t need it, because we could simply plan on it and incorporate it into our existing strategies and processes. Nassim Nicholas Taleb makes this very point in his book, The Black Swan:
We do not know what we will know. Invention and creativity is always a surprise. If we could prophesy the invention of the wheel, we’d already know what a wheel looks like, and thus we could invent it.
The professions, however, have been slow to adapt to the realities of an intellectual capital economy. Never before has this mentality been such a hindrance to success in today’s rapidly changing, globalized marketplace.
Business Model Innovation
In a meeting with professor Clayton Christensen, former Intel CEO Andy Grove made the point “that disruptive threats came inherently not from new technology but from new business models.” Perhaps this is why Grove titled his own book, Only the Paranoid Survive.
I am defining a business model as follows:
How your firm creates value for customers, and how you monetize that value.
Clayton Christensen’s partner in his consulting firm Innosight is Mark W. Johnson, author of the compelling book Seizing the White Space. He points out that most successful innovative business models are forged by start-ups.
Johnson studied approximately 350 business model innovations in the past ten years, with more than 30 percent being enabled by Internet technology. Fourteen companies founded since 1984 have entered the Fortune 500 between 1997 and 2007 through business model innovation, including:
- Amazon.com
- AutoNation
- eBay
- Google
- Qualcomm
- Starbucks
- Yahoo!
Thinking about the history of innovation, creative destruction, and business models in the context of professional knowledge firms, in combination with the radical business model proposed by VeraSage—from “We sell time” to “We sell intellectual capital"—the diagram provides an interesting look at where any firm can be at a given point in time. Since competitive advantages are built based on effectiveness, not efficiencies, I have chosen to highlight each as the axes of the diagram.
Luddites: Firms that resist technological advances and other innovations that are merely table stakes risk being Luddites. They have both low efficiency in doing things right, and low effectiveness at doing the right things—not a bright future.
Fortunately, not many firms are in this category. If you are here, you are dead already and the funeral is a mere detail.
Buggy Whips: Usually when an industry is at the apogee of its efficiency, it is at risk of being made obsolete by new technologies or business models. As Peter Drucker said, no amount of efficiency gains would have saved the buggy whip manufacturers from the automobile.
Innovators: As George Gilder wrote in Forbes, “Knowledge is about the past; entrepreneurship is about the future. If creativity was not unexpected, governments could plan it and socialism would work. But creativity is intrinsically surprising and the source of all real profit and growth.”
Innovators are firms that are willing to invest some of today’s profits into tomorrow, while at the same time sacrificing efficiency for effectiveness.
Innovation, creativity, and Total Quality Service are the antithesis of efficiency—ideas such as Google Time (where Google employees can spend 20% on innovation), experimenting with new ideas, investing in education, all reduce efficiency metrics.
But if firms do not make these essential investments they are simply coasting on their existing intellectual capital, and in today’s economy, knowledge becomes obsolete more rapidly.
Humpty Dumpty: This is a precarious future. This represents firms that are highly efficient and effective.
I am arguing if you are here, you better be sliding back to the Innovators position and start sacrificing some of that efficiency for innovation and making the firm more valuable to its customers.
Humpty Dumpty eventually falls and ends up like the industries mentioned under Buggy whips. Efficiency is not the answer. Effectiveness is.
Firm of the Future or Firm of the Past?
Embracing a new business model requires leadership and vision. It requires knowing you are doing the right things, not just doing things right.
It requires focusing the firm on the external value it creates for the customer and simultaneously building the type of firm people are proud to be a part of and contribute to—the sort of organization you would want your son or daughter to work for.
It requires a sense of dignity and self-respect that you are worth every penny you charge, and you will only work with customers who have integrity, whom you enjoy, and respect.
It requires an attitude of experimentation, not simply doing things because that is the way it has always been done.
It requires less measurement, less fear, and more trust. It requires boldness and risk-taking—there has yet to be a book written titled Great Moderates in History.
As science fiction writer William Gibson quipped, “The future is here. It’s just not widely distributed yet.”
Skeptics will call for an incremental approach, which is how they maintain the status quo.
But how will these optically challenged skeptics make incremental changes to an existing business model that is already dying? By making it incrementally less dead?
The late economist John Kenneth Galbraith wrote, “All successful revolutions are the kicking in of a rotten door,” not—I would add—merely oiling the hinges to make it swing more efficiently.
There is no limit to what we can achieve, as long as we do not lose faith in ourselves. It is the difference between remaining a firm of the past, or, like a chrysalis, emerging as a firm of the future.
The choice is yours.
Ron Baker - 07/13/2010
I’ve been having a dialogue with a consultant for the last two years, and we recently had a very interesting discussion on intellectual capital (IC).
I thought you might find it of interest, since IC is what the professional knowledge firm is all about.
Our exchange focused on whether or not it is possible—or even desirable—to attempt to value IC, and perhaps placing that value on the financial statements, or a set of parallel statements.
Doug was not advocating this approach, just questioning the validity of doing it, and what the impact would be. I’ve had many other discussions with consultants and CPAs about, for instance, placing the value of a company’s brand on its balance sheet.
Should we account for IC, like GAAP accounts for transactions? Should IC be on the financial statements?
We both conclude no. Here’s why.
Hi Doug,
We do use IC as an integral part of a professional firm’s business model, which is why we refer to them as Professional Knowledge, not Service, Firms. PKFs sell IC, not time.
As for measuring IC, I find the work of others in that area interesting, and have met my share of firms that offer formulas and frameworks to value IC. All fascinating, but I’m still trying to answer, “What’s the point?”
Some insist they want IC to be put on the firm’s financial statements, which will and can never happen, since accounting is designed to capture value after a transaction, not value it before hand.
You certainly could devise parallel financials for IC, but again, what’s the point? The argument is to force managers to think about it, value it, etc.
But it seems to me that this is the “What you can measure you can manage mentality,” and with IC, effectiveness is always and everywhere more important than efficiency (the latter of which is always a measurement, where the former is always a judgment).
Since value is subjective, any formula or model for IC will be flawed from the get go. Not that it’s not a worthwhile exercise, such as how Interbrand values the world’s leading brands, but it’s the illusion of accuracy and precision. I’ve seen companies pay well over IC value calculations because value is subjective.
So, I come back to what’s the point of this? What’s the service being offering by valuing IC? What’s the value of doing so? I don’t think it’s as obvious as IC folks make it out to be. As you know, I wrote an entire book, Mind Over Matter, on this topic, but didn’t try to value IC—it can’t be done with any reliability.
Thanks Doug, look forward to your thoughts.
Ron
Thanks very much, Ron.
This is exactly the kind of response I was hoping for—informed and critical. I’m slowly committing Mind Over Matter to memory, so I have deep respect for your opinions.
I have a lot of skepticism myself. I take your point about accounting being the trail of the past. I have heard the argument that by putting NPVs on assets, is bringing the future into the present, and isn’t it true that IC is exactly about the future, and that is why [we need] a breakthrough in accounting? It is supported by IASB standards on intangible assets and impairment, which also track with FASB standards 38 & 38.
But the IC side intrigues me, because so many people believe there is such a need to recognize (and quantify and monetize) your subtitle (intellectual capital is the chief source of wealth). I think this belief is even more strongly held in the wake of the debacle over people pumping up risky underpinnings (lousy mortgages, among others) into highly leveraged clouds of crap. A wealth creation engine based on human knowledge, experience, relationships, performance, and results seems like a more positive economic foundation. But how to capture, how to harness?
Thanks again for your quick and thoughtful response. One of these days I’ll buy you a beer, or a glass of your favorite wine
Cheers, and great thanks,
Doug
Hi Doug,
I understand the argument, my problem is knowledge is also a social construct—it simply cannot be quantified, tracked, and put into a formula.
There is certainly value in valuing IC for a business sale, and indeed that is what happens. This is why accountants call the sales price over the book value “goodwill"—just a word that describes their ignorance, i.e., their inability to value an enterprise, only capture it after a transaction takes place.
But even formulas for IC won’t capture the subjective value of an enterprise. How many times have you seen a company pay way above a company’s value, as assessed and computed by business valuators? It happens a lot, and that’s because value is subjective.
And no, I do not think putting NPVs on assets is bringing the future into the present. Accounting can’t do that, and even if there existed formulas, they would be full of errors and inaccuracies.
Here’s another reason: knowledge is actually about the past, whereas entrepreneurism is about the future, and you can’t capture the Black Swans of entrepreneurialism by formulas. No amount of sophisticated IC formula could have predicted, captured, or harnessed eBay or Google. It takes the
risk-taking of entrepreneurs to create new wealth. Anything we can capture, measure and harness is almost by definition about the past that is already dying.
I’ve come to the conclusion that we’ll never be able to measure IC. So what?
We know it’s there—like dark matter in the universe—but there are too many variables. It’s spiritual, not material—meaning you can’t measure it.
To believe otherwise is the materialist fallacy—that everything needs to be measured to be understood. It doesn’t work—see the USSR, Cuba, North Korea and any other communist country.
This doesn’t mean we should ignore IC, only that trying to measure and value it is futile—like plunging a ruler into an oven to determine its temperature. It’s the wrong device.
There’s lots more to say on this topic, but it does make my brain hurt.
Ron
Doug made the final salient point about IC, what Joseph Schumpeter called the Creative Destruction of capitalism:
The key point is that the value does not arise from the accounting of it, however elaborate the accounting scheme might be, but rather in the context of a marketplace that is focused on performance and results, enhanced by a skunkworks generator, etc.
Would love to hear your opinions on this topic.
Ron Baker - 07/12/2010
I received a wonderful email last week that reaffirms my faith that VeraSage is making an enormous difference in the professional sectors, around the world.
I’ve long believed that if we are going to get firms to adopt Firm of the Future practices, we must get in front of Young Professionals, the leaders of tomorrow.
One such leader is Art, from New Zealand, who sent me the following email, providing an enormous HSD—High Satisfaction Day.
Dear Ron
You may be surprised to receive this email but I felt compelled to write to you and pass on my sincere appreciation as I finished your book, Mind Over Matter, in one evening and it profoundly changed the way I view my future and see the world. I believe your book had a profound effect on me as George Gilder’s Wealth and Poverty had on you back in 1981.
The ironic thing is that I am also an accountant and am studying towards my final CPA exam in October. I stumbled across your book at the university’s library while I was wondering around, browsing Peter Drucker’s books
To top it up, Peter Drucker is also your favourite Management writer. No one here at my workplace even heard of Drucker while I have been reading his books since my university years. And as far as Drucker’s principle goes, the one that I have been living with on a daily basis is, “The best way to predict the future is to create it”.
Ron—I wrote a long email but my key message is to express my gratitude for your ideas and example. Thank you Ron and I wish you all the best.
Best Wishes,
Art
Art was then kind enough to write the second review of Mind Over Matter on Amazon.com, which reads:
I stumbled across a copy of Mind over Matter while studying for my CPA examination in the library. I borrowed it and finished it in one evening. I am a young professional who has been thinking about what he wants to do with his career and hence his future. This book, luckily, does not tell me “what” my future should be, but instead it made me think about the “why” of my future direction in life.
A young professional, particularly those who are serious about their careers and self-development, should read this book for many reasons:
- This book will challenge your current worldview about professional knowledge industry and the role your “intellectual capital” can enhance your capability as a future leader.
- This book draws from the world’s greatest thinkers and economists, combining with the author’s proposition, to provide a rich discussion about what it takes to be a first-rate knowledge worker in the 21st century.
- The author’s own life story will serve as an inspiration for many young professionals to “fly higher” and be brave enough to live their dreams and not settling for anything less.
I am so grateful to have found this little gem and I hope you will feel the same after reading it. The most amazing about being human is our mind, and this book tells you why our mind needs to be trained to achieve its potentials.
Thanks Art, I look forward to following your career path. I know you will make a dent in the world.
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