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.
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.
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.
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.
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.
Long time ago you answered my Carthage question and with my current company we tried a few times to sell fixed price packages.
Some clients bite it although many ask us to switch to the hourly rate. What I observe is that it’s easier (read, they’re used to) for the clients to get quotes and compare hourly rates than match and analyze various criteria from different service providers. Sometimes it gets even worse: the client wants an hourly rate but at the same time to cap the SOW [Scope of Work] with the total allowed maximum sum.
That leads to the very same ethical issue when project managers effectively get the red line and mentally the mission to bill the client as close from the bottom to the limit as possible. I tried to put all the cards on the table: propose the hourly-based project plan, come up with the estimation and then bid with the fixed price which is lower? Surprisingly even in such cases some clients ask for the hourly rate motivating that they can easier pass it through the budgeting group and legal.
I’m ready to accept the hypothesis that we run into the clients which don’t understand the value-selling benefits, maybe we don’t articulate enough, maybe they don’t trust the approach for some reason but certainly in our case such clients are majority in our pipeline.
What do you advise to undertake?
Thanks,
[Name Withheld]
Hi [Name Withheld],
I think the last part of your fourth paragraph answers your question.
It’s obvious the firm isn’t doing an effective job articulating its value proposition—by that I mean, comprehending, communicating, and convincing the customer they must pay for value.
Don’t despair, this is common, though not to the level your letter seems to suggest. It’s usually a minority of customers, not a majority as you say.
You need to stop talking about hours completely, and just tell your customers you don’t price that way. It’s unethical.
No client can tell you how to price—that is your decision. Also, your firm doesn’t do timesheets or track time. You have better things to have your knowledge workers do—such as add value and provide outstanding customer service to customers. Then what will the customers say who want to see hours? Force you to do timesheets? Then they aren’t the right customer.
If you’re not willing to do the above, Pricing on Purpose will never become a core competency in your firm. There’s simply too much empirical evidence from all the firms out there that customers love this approach. The push back we get is from firms, not customers. I know this for an absolute fact, since I’ve spent the last four years speaking to customers across all professional firms and they all say the same thing: they want certainty in price, period. It’s how they buy everything else.
Do you have people pricing and selling who aren’t good at it? Then upgrade their skills or remove them from pricing.
Blaming it on the idea that your customers don’t prefer fixed pricing is a cop out and simply doesn’t comport to human behavior and the laws of economics.
The only other thing I can think of is your customers do not trust you; and that’s not a pricing problem. That’s much deeper. I hope this is wrong?
Either you want to do this or you don’t. Your customers are not an excuse.
I hope that helps.
Ron
Of course, we welcome the thoughts from other firms that have made the transition from hourly billing to Value Pricing.
We have all heard the famous saying, often referred to as the McKinsey Maxim, named after the famed consulting firm: “What you can measure you can manage.”
This bromide has become such a cliché in the business world that it is either specious or meaningless.
Specious since companies have been counting and measuring things ever since accounting was invented, and meaningless because it does not tell us what ought to be measured.
Besides, has the effectiveness of management itself ever been measured? How about the performance of measurement?
Measurement for measurement sake’s is senseless, as quality pioneer Philip Crosby understood when he uttered, “Building a better scale doesn’t change your weight.”
The Triple Crown Criteria
In his book, From Worst to First, Gordon Bethune details how he was able to turn around the failed airline (which had filed for Chapter 7 bankruptcy twice in the preceding decade) between February 1994 and 1997, turning it into one of the best and most profitable airlines in the sky.
It is a remarkable story, and it illustrates the importance of utilizing leading key predictive indicators (KPIs) to focus the entire organization on its purpose and mission.
Bethune basically tracked three leading Key Predictive Indicators (KPIs), known as the “Triple Crown Criteria” in the airline industry:
On-time arrival
Lost luggage
Customer complaints
What makes these three KPIs leading is that they measure success the same way the customer does. And that is critical because, ultimately, the success of any business is a result of loyal customers who return.
None of the three indicators would ever show up on a financial statement, but, as the airlines have learned over the years—by testing the theory—they have a predictive correlation with profits.
Is there a Triple Crown Criteria for PKFs?
Now that there are well over a thousand firms that have trashed timesheets, VeraSage Institute is proud to announce, based upon empirical evidence, the Triple Crown Criteria for Professional Knowledge Firms.
We are emphatically declaring that the following three KPIs are all your firm ever needs to track to predict future customer loyalty and buying behavior.
Think about it: If an airline can run on three KPIs, why can’t a PKF?
An airline is far more complicated than any PKF, which is what makes KPIs so powerful: they are measurements (or judgments) guided by a theory.
But the theory is the senior partner. It’s not just measurement for the sake of measurement. It’s measuring—and judging—what actually matters, to customers.
It’s defining the success of your firm the same way the customer does, just like with the airline KPIs.
The Three KPIs
Turnaround Time
Michael Dell likes to refer to the time lag between a customer placing an order and the company assembling and shipping the finished product as velocity.
We believe professional firms should also be diligent about tracking when each project comes in, establishing a desired completion date, and measuring the percentage of on-time delivery.
As Ed Kless always points out, a firm can measure “time spent” or “duration.” The latter is the only thing that matters to the customer, hence that’s what needs to be tracked.
This prevents procrastination, missed deadlines, and projects lingering in the firm while the customer is kept in the dark.
Imagine installing 360-degree webcams everywhere in a firm. Also imagine customers being able to log onto a secure Web site, type in their names and passwords, and the appropriate web camera would find their project and give them a real-time picture of it, probably laying on a manager’s floor or credenza awaiting review.
Would this change the way work moved through a firm? Would this hold the firm accountable for results, not merely efforts?
Customers don’t want to hear about the labor pains—they want to see the baby.
FedEx and UPS do exactly this; and in fact some law firms utilize intranets that provide their customers with real-time access to the work being performed on their behalf.
This one metric would go a long way towards mitigating most of the reasons customers defect from firms (not kept informed, feel ignored, and so on).
Value Gap
This measurement attempts to expose the gap between how much the firm could be yielding from its customers compared to how much it actually is.
It is an excellent way to reward cross-selling additional services, increase the lifetime value of the firm to the customer, and gain a larger percentage of the customer’s wallet.
Marriott International uses predictive analytics through its Hotel Optimization program. Marriott has developed a revenue opportunity model, comparing actual revenues as a percentage of optimal prices that could have been charged. It attributes the narrowing of this gap, from 83 to 91 percent, to this metric.
One CPA firm made this calculation part of its partner compensation model. What actions can your firm take to close the value gap?
High Satisfaction Day™
I am indebted to John Heymann, CEO, and his Team at NewLevel Group, a consulting firm located in Napa, California, for this KPI.
When John’s firm held a retreat for the purpose of developing their KPIs, the suggestion of High Satisfaction Day (HSD) was made.
An HSD is one of those days that convinces you, beyond doubt, why you do what you do. It could mean landing a new customer, achieving a breakthrough on an existing project, receiving a heartfelt thank-you from a customer, or any other emotion of exhilaration that makes you happy you got out of bed in the morning.
Sound touchy-feely? John admits it is; but he also says the number of HSDs logged into the firm’s calendar is a leading indicator—and a barometer—of his firm’s morale, culture, and profitability.
Is this too Simplistic?
No.
Compare the above KPIs to what most firms are measuring now—billable hours, utilization, realization, write-downs, write-offs, and other internally-focused metrics that have nothing to do with how the customer defines the success of their firm.
These metrics have zero predictive ability when it comes to future customer behavior. They are lagging indicators, not leading.
Stop measuring things that don’t matter, and focus on what does. The above three KPIs will work in any PKF—period.
VeraSage stands by this Triple Crown hypothesis for all PKFs.
Prove us wrong.
We’ll enjoy losing the argument, because it means we’ll learn something new.
I met Len Pepe back in 1997 when he was a partner at BDO. Len took to the Value Pricing message like a fish to water, even providing a blurb for the very first edition of my Value Pricing book.
We reconnected recently, and Len has moved to another firm in Boston: CCR LLP. We’ve been exchanging emails on his attempt to implement Value Pricing in the firm.
Most firms have an internal champion that is incredibly enthusiastic about VP, and it’s not always a partner (although Len is).
We understand how hard it is to transition to VP—I like to say the concept is revolutionary but the implementation is evolutionary.
Len recently sent me the following email:
Ron,
Tomorrow I have my Alternative Billing Arrangements Task Force meeting and then I have to report to the Equity Partners.
Do you have any words of wisdom as to:
Other CPA firms that this has worked successfully for in this area— as I know how well it works for Law firms (Jay Shepherd and Chris Marston).
Do you run a simultaneous time system to see where you are with profitability for the na-sayers?
Will it work as well for audit departments as it would for tax departments?
Any insight is appreciated—it’s coming down to putting up or shutting up for me.
Thanks my friend,
Len
Here’s my reply:
Hi Len,
Here’s some Words of Wisdom guided by experience:
If the firm is serious about making pricing a core competency (this is what we mean by Pricing on Purpose), appoint a Value Council and a Chief Value Officer (CVO).
Don’t call it “Alternative Billing,” as billing is always done in arrears, after the work has been performed.
Instead, call it Fixed Pricing (with the client anyway, hence the Fixed Price Agreement term), because pricing is done upfront, before the work begins.
There are literally thousands of firms that have successfully implemented Value Pricing, some of their stories you can find on VeraSage under “Trailblazers.”
There’s a top 100 accounting firm that has also appointed a Pricing Panel and a CVO and has about one-third of its revenue under VP (but it hasn’t gotten rid of timesheets—yet). There are also law firms, advertising agencies, IT and consulting firms where VP is being used.
You can access an article I wrote for the Journal of Accountancy article profiles four Firms of the Future:
You can also access an article I wrote for the Journal of Accountancy on Pricing on Purpose, which also includes 11 Exhibits firms can use to aid implementation.
A simultaneous time system is almost inevitable, because very few firms have trashed timesheets before, or at the same time as, implementing VP.
But between you and me, I do believe trashing timesheets is the only thing that will make a firm better at pricing. As long as timesheets exist, we look back to time to measure price—precisely what we are trying to get away from.
VP will work in any department. In fact, it’s not department-dependent; it is customer-dependent.
I don’t think a firm should allow different pricing based on departments, especially if the customer experiences more than one service. Imagine being billed by the hour for one thing, and given a fixed price for another.
We are doing VP for the benefit of the customer (to give them certainty, a “no surprises” rule), and thus that experience is created one customer at a time, not one department at a time.
Although VP is revolutionary, its implementation is evolutionary—one customer at a time. We always suggest to firms that are serious, but are not ready for a value council and/or CVO to do all of its pricing, the following steps:
Each partner do five Fixed Price Agreements over some time period (one to three months)
No partner gets to price their own work. You have to bounce every price off someone else. I’m a wimp when it comes to pricing my services, but I’m brave as a lion when pricing Len’s because I know how much value Len creates and I hate to see him give it away.
Be vigilant about scope creep and using Change Orders. It’s very rare that any but the simplest engagement is not going to have scope creep. When it happens, you must discuss with the client, and agree upon the price.
The Golden Rule is: No surprises to the client. In fact, many firms offer a price guarantee: if the client ever receives an invoice that was not agreed upfront, they don’t have to pay. This forces us to price everything, no exceptions, before we do the work.
Perform an autopsy (After Action Review) on every FPA done, using the questions from the JofA article above (in one of the Exhibits).
Does that help?
Good luck Len!
Ron
Any other suggestions for a quick-start to VP for Len would be greatly appreciated.
Hat tip to Jay Shepherd for pointing out the Wall Street Journal article, “Raise Your Prices!,” which Ed wrote about yesterday.
I finally read all of these articles this morning. They are all excellent, but one in particular stands out: “The Myth of Commoditization,” by Michael Schrage, a research associate wtih MIT’s Media Lab.
As readers of VeraSage know, we vehemently disagree with the notion that any product or service is a commodity. It’s a cop-out.
Greg Kyte is the self-proclaimed “Champion of the Dissenters.” This is his third entry explaining why I’m wrong about VeraSage’s Quest to bury the billable hour and timesheet.
I have to admit, he’s starting to make a compelling point, causing me to rethink our entire approach. Perhaps there is a place for billable hours and timesheets?
Oh, Ron Baker, your naivety is so cute—the way that you regularly promote the fabrication that billable hours and timesheets retard people’s creativity. So untrue; so precisely wrong.
On Friday, an audit manager at my firm had an inspired proposal to boost our firm’s profitability. One of our clients with whom we have a 25-plus-year relationship has been required by its lender to have its financial statements reviewed rather than compiled for 2010. My colleague invited the client to lunch to discuss how this new requirement will affect them. We paid $60 for the three of us to go to lunch for an hour and a half, and—here’s the inspired part—both the manager and I billed the client for our hours. My rate is $200 per hour. My manager’s is $150. Ron, we just sold a $20 chicken marsala for $525! That’s a 600% return! That’s beyond a “fist pump price”; that’s a pelvic thrust price!
I know you won’t believe it, but this plan was hatched without any Google time. The creative force was the fact that she was ten hours behind her billable hour goal. The billable hour: a wellspring of creativity!
Greg Kyte is the self-proclaimed “Champion of the Dissenters.”
Here is Greg’s second contribution in defense of the billable hour and timesheet.
Ron Baker, you were wrong once again. The night before last was one of the biggest nights of the year for my firm. You and the rest of the VeraSage flunkies could have had a piece of it too, but I guess you ditched the timesheet an hour too soon.
You see, we have an annual tradition during the heart of busy season. Everyone in our firm is expected to work the night before daylight savings time. We all work until 3:30 a.m. at which point we have a party. The party consists of waffles and a cheese tray. How we can afford to treat our people that good, you ask? Well, it’s all thanks to Ben Franklin and a little thing that we like to call the TIMESHEET because at precisely 2 a.m. we set our clocks ahead to 3 a.m. With a staff of 52 and an average billable rate of $120, our firm pockets an extra $6,240 just for staying up late and “springing ahead”.
Talk about leveraging people power! The lever is the timesheet and the hands pulling it are the hands of our clock. Hey, relax; we know this doesn’t work for our affiliates in Arizona or Hawaii. And we are very careful in that we forbid our people from working late when we “fall back”. (Imagine that: we’ve thought it through even though we don’t have the luxury of a think tank.)
Boom! Did you hear that? That was the sound of another hole blown in the hull of the Good Ship VeraSage. Sorry, Cap’n Ron.
VeraSage prides itself on dissenting ideas, which is why we have a “Skeptic/Dissenter” category under membership.
Greg Kyte is the self-proclaimed “Champion of the Dissenters.”
I’m proud to post his first contribution and let our readers decide for themselves the merits of his arguments. I’m sure this won’t be the last we hear from Greg.
Enjoy!
Ron Baker is Wrong
Ron Baker and his stooges at VeraSage have long tried to discredit the well established modus operandi of professional firms: Time Accounting. To do so, they use the following simplistic equation:
Revenue = People Power x Efficiency x Hourly Rate
Unfortunately for the VeraSage minions, they have been attacking a straw man. The manifestation of the formula as conjured by Mr. Baker does not accurately represent the robust nature of the hourly billing convention. Professional firms naturally augment the formula with the processes by which they calculate Hourly Rates for their personnel. Best practices for calculating the Hourly Rate element include the use of the following formula:
Hourly Rate = RABR x Experience Factor x Stupidity Factor x Biorhythm Factor x Opportunity Cost Adjustment.
Allow me to enlighten the brainwashed value pricing hoard on the components of the augmented hourly rate element.
Reputation Adjusted Base Rate (RABR). Every firm has a reputation within the context of the business community that it serves, and this reputation determines the base rate to be used as the starting point for calculating billing rates for personnel within the firm. Also, it is universally accepted that the reputation of a firm equals the quality of its service. Arthur Anderson was unquestionably the most reputable accounting firm in the world in 2000, and to this day nobody questions the quality of their work.
Experience Factor. To begin to hone the firm-wide RABR to the individual practitioner’s hourly rate, it is obvious to everyone but Ron Baker and his goons that experience is the most important factor. Without a doubt, a college graduate with a piercing analytical mind and a penchant for big picture value creation cannot deliver the same quality of service that a middle-age alcoholic in the middle of a years-long divorce and a crippling debt burden with 20 years of experience can.
Stupidity Factor. Stupid individuals should have a lower billable rate than smart people. A Stupidity Factor of 1.00 means that the individual has committed the average number of errors during the prior period. A Stupidity factor above 1.00 indicates more errors, more stupidity, and a lower billing rate. No, no wait. A lower stupidity factor means lower intelligence and more errors. No, that doesn’t seem right. A higher stupidity factor means stupider people with higher rates. Yeah, there we go.
Biorhythm Factor. I am a morning person. I work best in the morning, and I am virtually useless in the mid-afternoon. Therefore, since my efficiency and the quality of my work are higher in the morning, I bill clients 15 percent higher before lunch. I also charge a fifteen percent premium for the 20 minutes right after drinking a Diet Coke. To be fair, I also give my clients a 15 percent discount for the 20 minutes immediately following calls from my ex-wife or for any time that I happen to be hung over. For price sensitive clients, we have a partner with clinical depression and irritable bowel syndrome.
Opportunity Cost Adjustment. One of Ron Baker’s harebrained arguments against time accounting is that it does not reflect the realities of economic laws. Is there a more irrefutable economic concept than opportunity cost? Opportunity cost comes into play constantly during busy season when personnel are working odd hours. I charge an opportunity cost premium on Tuesday and Wednesday evenings because I hate missing Idol, and I give a discount on Sunday mornings just so I can have a good excuse for skipping church.
So, sorry, Ron, your simplistic revenue formula has been turned on its head. It looks like I’ve single-handedly brought VeraSage to its knees, and I sincerely hope that you can get out of the lease on the office space for your (virtual) headquarters.
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.
My wife, Christine, and I have recently become devotees of the AMC Original Series, Mad Men. For those of you not familiar the shows follows the personal and business life of a Madison Avenue creative who goes by the name of Don Draper in the early 1960s.
Small spoiler alert if you are planning to watch the show!
In Season 3, Don happens upon an elderly gentleman in the back unused bar of a country club named Connie. It turns out, he is Conrad Hilton. In this later scene, Hilton asks Don for his opinion on a new ad campaign. What follows is a terrific lesson on providing a free sample without giving away too much.
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