Community Section -
Accounting
Ron Baker - 03/02/2010
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.
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.
Ron Baker - 02/01/2010
I haven’t been blogging very much lately, so big thanks to Ed for keeping up!
I’ve been working on my new book since December.
My publisher (John Wiley & Sons, Inc.) and I are struggling with the title of the book, so I thought I’d solicit the “wisdom of the crowds,” because there is so much of it in this community.
Structure of the Book
The book deals with much more than just implementing Value Pricing. When professional firms eliminate billable hours and timesheets, it changes the DNA of the firm, not just its pricing, but everything: its marketing, it value proposition, how it communicates with clients and manages their expectations, what it measures for customers and team members, and so forth.
The book is actually proposing a new Business Model, from “We sell time” to “We sell intellectual capital.”
It will have a toolkit, along with a 7 step process for pricing an engagement. Moreover, an Appendix for each professional sector—advertising agencies, CPA, Law and IT firms— and will include customized checklists, sample forms, examples, issues, etc., from that particular profession.
So, it’s a Toolkit + Reference Book + an explanation of a revolutionary business model. It’s a one-stop read that is not dependent on reading any of my other books.
Some Titles So Far
The Timeless Practice: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Transitioning to Timeless: VeraSage Institute’s Guide to Selling Intellectual Capital, Not Time
From Time to Timeless: VeraSage Institute’s Guide to Selling Intellectual Capital, Not Time
The Timeless Firm: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Professional Firm 3.0: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Timeless: The Professional’s Guide to Profitability, Effectiveness, Intellectual Capital, and Value Pricing. Thanks to Ed for the subtitle on this one!
Any suggestions folks? There’s a bottle of Dan Morris’ finest wine in it for the best suggestion.
Ron Baker - 01/18/2010
On January 9, 2010, I received an email from Kim Foard, CPA from Billings, Montana that created an HSD for me—High Satisfaction Day—as we like to say here at VeraSage:
Your book, Professional’s Guide to Value Pricing, improved my client’s happiness and my success. While the financial rewards have been fun, the improved relationships are priceless!
Pricing on Purpose is next.
Kim Foard
Kim was kind enough to provide us with a case study for our Trailblazers section, reprinted below.
January 16, 2010
What We Want
As a door-to-door Cutco© knife salesman in my freshman year of college, I learned that people buy what they want; not what they need.
When asked for several knives to sharpen, one couple would present broken blades so dull soft butter was a challenge. While giving me hearty nods of approval that they were in need of knives and enjoying the presentation of tricks performed with the sharp knives from my sales kit, they would politely say, “No. No, thanks; we don’t want what you’re selling.”
The couple in the next house would struggle to find any dull knives in the sets of fine cutlery displayed in their kitchen. As they apologized for not being able to play along, I would make a little conversation, reluctantly begin the show, and then quickly navigate my way through the script. Without even asking for the order, my focus was on an exit strategy. They would reach over, touch my arm and exclaim, “Yes! We want to buy the biggest set!”
Only years later, when studying one of the greatest salesmen, Zig Ziglar, did I learn, “You can get everything you want in life, if you will just help enough other people get what they want.”
This is my story.
The days of my childhood were spent horseback in a sea of cowhides with a Dad who knew the way to confidence was by doing what others said was impossible. The evenings were spent in epic tales of adventure with a Mom who knew the portal to opportunity was by learning from the stories of others.
After high school, I turned down scholarships to pursue my dream of being a cowboy. Fifteen months later, I knew I didn’t have the same love of horses and cows as my dad! Yet, all of those years living the notion, “Where there’s a will, there’s a way” came in handy for a poor kid with a “new dream” of going to college. In the course of managing my fledgling business as a twenty-something entrepreneur, the counsel of an older client friend cut short my whining as he said, “Kim, your problem is not that you were born poor. Your problem is that you were born with ambition. Many are born poor and stay that way. You want something else.”
The “something else” was finally discovered twenty years later in a book written by Ronald J. Baker, Professional’s Guide to Value Pricing (with CD), Edition 3, published by Aspen Law & Business, 2001 [now out of print].
By starting with one client in a little Montana town of 2,500 population, appropriately named Roundup, the cowboy in me was enjoying the gathering of a small herd of loyal clients. They understood from the very beginning: I was in the business of selling dollars. I didn’t understand Value Pricing; I did understand the importance of finding 5 to 10 times my fee in benefit for them. In the early years, there was an Exit Conference with every single client to explain what had been done. That made quite an impression and they would say, “No one has ever cared enough to spend time with me, like this!” Spend time? Heck, no! I was investing time with them; I wanted a long-term relationship!
Then, one day, time had taken its toll on a ranch family and they were in the process of transitioning the next generation into the accounting function. I remember the excitement of working with the new twenty-something CFO, as we set up QuickBooks© and enjoyed a day’s worth of coaching and visiting.
In the course of adding families, processes, and infrastructure to the ranch operation, right in the middle of a seven year drought, there was a Net Operating Loss to be carried-back: Many thousands of dollars of benefit for a thousand dollar fee. To my surprise, I received a call from the new CFO, who had questions about the bill.
Remember, this was before Value Pricing, Fixed Price Agreements, Retainers and crystal clear Communication at the beginning of every project.
Sure enough, he was right. There was a line on his bill, and every other client’s bill, that read: Photocopies and Assembly—$75.00.
Made perfect sense to a bean-counter; we have overhead. After a few years in business, we have a history of expense; we can project that cost into the next year and we can reasonably estimate number of clients and projects for a given year. So, we do the math. $75.00 was a good number, all clients paid the same on any project and it, definitely, was a Fixed Cost to me. Not to the client. He wanted to negotiate that amount, downward.
In fact, he had counted the number of pages, and fasteners, applied the going Office Supply Store rate for those commodities and arrived at his number of $7.50. In his mind, he had been overcharged by a factor of 10. Ah, that “Perfect 10”; yet, this time it was viewed as being in my favor, not the client’s, and it was causing harm to our relationship!
He thought I was cheating him; I thought he was behaving stupidly. We were, both, on to “something”!
The value provided to the family for the last twenty years didn’t matter at that moment. In essence, he was a “new client” and deserved my respect. So, we began at the beginning.
Having read enough of Professionals Guide to Value Pricing to think differently and having found the CD in the back of the book with templates, I approached this “new beginning” with fervor. I had nothing to lose and everything to gain; a relationship hung in the balance!
There must be a better way to build relationships than: work hard; send bill. For twenty years, I had done what I had been trained to do by my accounting mentors. It worked, most of the time: 95% of the clients understood the value and were willing to be surprised by the bill. For a competitive perfectionist, that other 5% was the challenge, and at that moment I had one very irate customer on my hands, and my mind!
Change nothing; Nothing changes.
Insanity is doing the same thing over and over, expecting a different result.
Easy is hard; Hard is easy.
We get what we allow.
It was time for a change.
The insanity was tiring.
A new path was needed.
I had created this mess.
A single line on a bill was the proverbial straw that broke the camel’s back.
One more witticism became the mantra of the day, “Fake it until you make it!” At the time, all I had was a page of script titled, “Questions You Should Ask The Customer During The Fixed Price Agreement Meeting” and a burning desire to find a better way.
Today, those questions have been customized and internalized until they are at the center of every new beginning, and potential client relationship.
They look like this:
- What do you expect from me?
- What are your biggest worries?
- How do you see me helping with these challenges?
- What growth plans do you have?
- What role do you want your CPA to play in your business?
- How would you define quality service?
- Is a 100% Money Back Service Guarantee important to you?
- What would you consider as timely response to your accounting and tax questions?
- Why are you changing professionals?
- Are you concerned about any, one, issue that I should give special attention?
- Were you referred to me by someone?
- Are you Able To Pay for guaranteed exceptional value?
- Are you Willing To Pay a retainer in advance and the balance upon completion of services?
Forget about Perfect 10s; these are the Lucky 13!
As accountants, we will eventually need, and want, to answer this question:
- Are we Relationship Builders, or Paper Shufflers?
Paper, as a commodity, is cheaper by the case.
Relationships are priceless.
For those who want to debate whether the glass is half-full, or half-empty, handling commodities might be an excellent career choice. For those of us who wonder why so much attention is given to “half” of anything, “Creating and Capturing Value” is quite a noble profession!
Wholeness comes from tapping into the Universal Principle of abundance; our real potential is unlimited. Yet, this isn’t about us.
Communication is what the listener does. Are we listening to our clients? Do we really hear, and understand, what our customers want?
Oh, sure, they will grudgingly accept bills for the compliance work they “need” to have done. When they understand how much we care about them, demonstrated by how we actively listen to their dreams, they are open to new ideas. As they consider all of the many menu choices available to them, with a clear pricing structure designed to express the value of each one, and ultimately commit to partnering with us, the “want” is palpable!
Yes, that new CFO in charge of the family ranching heritage understood the Value in the Price (when I covered up the detail of the bill) and wanted me to understand that he wanted more of that simplicity. Why did it take me so long to get the horse in front of the carriage? Answer: Good judgment comes from experience; Experience comes from bad judgment!
Disciples of Value Pricing never hear “The check’s in the mail.” In fact, because “the checks are in the drawer”, we manage risk, schedule our days, attract quality clients, stumble into opportunities, enjoy open communication, reap financial rewards, and tie “Ribbons and Bows” around each and every project on our way to building relationships.
I have learned a deep respect for one of Goethe’s couplets:
Whatever you can do, or dream you can, begin it.
Boldness has genius, power, and magic in it.
In our world of technological advances, “www” has become the gateway to infinite possibilities. If we will decide “What We Want” and, then, offer that with passion to others, the result is guaranteed to be a “Win Win Win”: for Customers; for Us; and, for the Whole Wide World!
Best regards,
Mr. Kim Foard, CPA
It’s rare to get cowboy poetry from a CPA, so thanks again Kim for making our day.
More importantly, congratulations to you for having an open mind, looking for a better way, and contributing to the dignity of our profession by doing the right thing for your customers.
Reading Kim’s story was another HSD!
Ed Kless - 12/09/2009
Congratulations to Mark Bailey and the whole team at Mark Bailey & Co. for being named the Best Accounting Firms to Work For by Accounting Today for a second straight year. The article specifically identifies the trashing of the timesheet as the reason for their tremendous success.
"We threw out timesheets," explained Mark Bailey, the firm’s managing partner. "But the motivation to throw them out is that they didn’t really reflect the value of the service that was being given. What we came to realize very quickly was that a timesheet is a control tool."
The 16-person firm decided that controlling professionals didn’t drive productivity; instead, it hampered innovation and creativity.
The entire article is available on-line and will be printed in December 14, 2009 issue of Accounting Today.
Ron Baker - 11/05/2009
There are many political and economic freedom indexes you can follow, such as the Heritage Foundation’s Index of Economic Freedom or The Fraser Institute’s Economic Freedom of the World report, among others.
The Legatum Institute was founded by Christopher Chandler, a New Zealand billionaire. In the institute’s view, man does not live on bread along, or merely political freedom and economic growth. Thus, there are two halves to prosperity, economic competitiveness and comparative liveability, which includes freedom of choice, ethical values, good health, equality of opportunity, civil liberties, spiritual faith, low unemployment, strong family life, and a temperate climate.
As its Web site reports:
The 2009 Legatum Prosperity Index is the world’s only global assessment of wealth and wellbeing. The Index finds that the most prosperous nations in the world are not necessarily those that have only a high GDP, but are those that also have happy, healthy, and free citizens. Now in its third year, the Index builds on the previous versions with expanded data and refined analysis and assesses 104 nations covering 90 percent of the world’s population.
The top 10 countries are:
- Finland
- Switzerland
- Sweden
- Denmark
- Norway
- Australia
- Canada
- Netherlands
- United States
- New Zealand
Sure, it’s a bit subjective, and is unsure about how to weigh religion in the Index, but it’s interesting and worth pondering.
It adds another dimension to assessing political and economic freedom without degenerating into meaningless platitudes that you find in some “happiness” and “environmental quality” indexes.
You can access the report here.
Ron Baker - 09/28/2009
Those who know me know I listen religiously to Rabbi Daniel Lapin on KSFO 560AM every Sunday from 1-4 pm.
He’s one of the most astute observers of human behavior, and even though I’m not Jewish, as he says, no matter what your faith “Everyone needs a rabbi, and for those who have no faith, you definitely need a rabbi.”
He’s written a fantastic book, Thou Shall Prosper, which I reviewed here.
Every Thursday, Rabbi Lapin sends out his Thought Tools, a short story that deals with various issues we face in our life, to which I highly recommend you subscribe.
I just finished reading his September 23rd Thought Tool, ”Retreat to Advance.”
As you’ve probably read, I’m involved in an intensive debate with Pat Lamb on the issue of efficiency vs. effectiveness.
I argue that knowledge workers work with their minds, which is an iterative process not subject to the rhythms and cadences of an assembly line.
For this reason, the “efficiency” metrics that are used in most PKFs—such as output per hour, realization, utilization, etc.—are a complete joke.
Knowledge workers aren’t machines.
Rabbi Lapin, I believe, would agree, given what he wrote in this thought-provoking Thought Tool:
Like all of us, I spend my day tackling challenges. Sometimes there’s a problem baffling me. Then I put it out of mind and retire for the night. Often in the early pre-dawn hours I will awaken and am instantly aware that I have had a creative thought breakthrough. Grabbing the pen and pad I always keep alongside my bed, and which I recommend as a vital business tool, I can hurriedly scrawl down the answer to the daunting problem from the day before.
Every time this happens I am amazed, yet it shouldn’t astound me. After all, this is one of those timeless truths of ancient Jewish wisdom. Human creativity thrives in an environment of thrust, retreat, and then thrust again. Work the problem, back off, and then return to the problem. It will yield more rapidly than it would in one long protracted push.
This is a physical parallel to a spiritual reality. Just as our bodies require sleep, so do our minds and souls. Creativity and productivity are enhanced by regular periods of withdrawal.
But where do I log this withdrawal on my timesheet? If I’m measured by output per hour I’ll feel like crap if I do this (and used to when I billed by the hour).
Isn’t it obvious that knowledge workers are different? They simply can’t run at 100% efficiency, day in and day out.
I’m completely baffled why this is so hard for some innovative leaders to understand.
I’d be grateful for your thoughts and input.
Ron Baker - 09/27/2009
Pat Lamb commented on my recent post on Lean Client Service.
Since I don’t want to repeat the entire post along with his comments, I will just respond to his comments, as shown below in all capital letters.
On the distinction between “value billing” and “value pricing” Pat writes:
[I APPRECIATE THE DISTINCTION AND APOLOGIZE FOR THE ERROR. BUT TO ME, THE CRITICAL ELEMENT IS THE PRICING AND SUBSEQUENT BILLING SHIFT TO THE LAWYER OR OTHER KNOWLEDGE WORKER THE NEED TO PRODUCE THE OUTPUT AT THE LOWEST COST IN ORDER TO MAXIMIZE PROFIT MARGINS].
This comment explains most of the differences between Pat and me.
Pat, you seem to have a “penetration” pricing strategy, which means any costs you drive out of the system are passed along to your customers, like Wal-Mart.
I think this is a strategic error for Valorem, especially if you offer “alternative” pricing and great customer service.
At worst, you should have a “neutral” pricing strategy, or better yet, a “skim” strategy. Little wonder you are still arguing for cost savings everywhere. You should re-read the story from Ben & Jerry’s from my book Pricing on Purpose (which you reviewed on Amazon and gave 5 stars), where they discuss their pricing epiphany. [In fact, I’ve reproduced it at the end of this post].
Your penetration strategy dictates your views, while most of the firms we work with are implementing a skim price strategy.
On the issue of “professional service” vs. “professional knowledge” firm, Pat writes:
[TO ME, A DISTINCTION WITHOUT A DIFFERENCE].
Really? Then Peter Drucker was wrong about knowledge workers, and the enormous differences between them and industrial/service workers? You can apply the same metrics to a KW as an industrial or service worker?
The difference is enormous, and I’m not just talking about the name. Knowledge workers own the means of production, and they are the system when it comes to many functions. I side with Drucker on this one.
If we can’t agree on this, then nothing else I say will matter to you.
Pat writes:
[IS YOUR POINT THAT WE WANT TO DO THE RIGHT THINGS INEFFICIENTLY? IF SO, I BEG TO DISAGREE].
No, not my point at all. My point is that in many cases, as I cite in my post, at the margin trading less efficiency for more effectiveness is a wise strategy.
Doing the right things efficiently, or to the best of our abilities, is just plain common sense. I don’t mow my lawn with my BB gun. I’m saying that your ruthless attention to efficiency is not a competitive advantage, because despite your penetration price strategy, most law firm clients are not price sensitive.
Pat writes:
[I THINK THIS IS WHERE THE PARSING OF WORDS GETS EXTREME, RON. FRED AND I LIVE I A WORLD WHERE PEOPLE KEEP SCORE AND NEITHER OF US IS MAKING CEMENT LIFE JACKETS. WE ADVOCATE, AND LIKE IT OR NOT, IT IS AN EVERYDAY PART OF THE BUSINESS WORLD].
Keeping score is one thing, but keeping score doesn’t make you more efficient. That’s like arguing measuring yourself more accurately will change your weight.
I’m not against keeping score (hell, I’m a CPA), I’m against keeping score of the wrong things.
Pat writes:
[FRED AND I, AMONG OTHERS, HAVE USED THE BUGGY WHIP MAKER ANALOGY TO DISCUSS BIGLAW. BUT THE PRODUCT BEING SOLD BY LAWYERS IS RESULTS—SOLVING CLIENTS PROBLEMS. I DON’T KNOW OF A CLIENT WITH A PROBLEM WHO WOULD ARGUE THAT HER LAWYER’S ABILITY TO ACHIEVE A RESULT AND MAKE THE PROBLEM GO AWAY IS AN ANTIQUATED BUSINESS].
I’m not arguing that lawyers will go the way of buggy whip makers, though other thoughtful people are. I’m saying a focus on efficiency at the expense of innovation and creativity will make you irrelevant, or less able to create services that customers value.
Pat writes:
[EFFICIENCY DOES NOT ALWAYS NEED TO BE MEASURED, BUT ARE YOU REALLY ARGUING AGAINST DOING QUALITY WORK FASTER AND CHEAPER?]
Please give me an example of an efficiency metric that is not measured?
When you attempt to do this you will make my point about the difference between a measurement and a judgment.
Even your definition contained in your comment further below is a measurement, where you write:
[EFFICIENCY, AT LEAST IN THE LAW, IS GREATER OUTPUT—RESULTS—PER UNIT OF TIME].
Looks like a measurement to me. You can measure the output, but the results must be judged.
Further, it’s greatly flawed, especially from a value/pricing standpoint.
Are you saying the Jonas Salk’s polio vaccine is worth the amount of time it took him to develop? Are you saying that if it took him decades to develop it would be less valuable?
Sure, we would have loved it if he came up with it sooner, but we are dealing with human beings, not machines. You seem to think lawyers can run at 100% efficiency all the time, or at least your measurements argue for that logic. I reject this as industrial thinking.
Pat writes:
[BUT A DOCTOR DOESN’T WASTE TIME NEEDLESSLY. IT IS BAD FOR THE PATIENT’S HEALTH].
Again, Pat, this depends. I want my doctor to spend as long with me as necessary for a complete exam, diagnosis, etc. Ever been to a Dr. who stands by the door ready to rush out to the next patient, probably because some Lean consultant imposed a patient per hour quota on them? Not very effective. The Mayo Clinic does not do this, for this very reason.
Now if you’re saying that a doctor shouldn’t waste time in surgery, I have no argument. But even if he does, that’s his judgment, and if I trust him and it leads to a more effective result, why do I care? Maybe he needed a consult, or to think about a procedure more carefully. Are you really arguing that there’s no room for inefficiency? Then we really need to stop this debate.
Pat writes:
[THIS IS A GREAT EXAMPLE THOUGH. TOY STORY AND OTHER COMPUTER GENERATED CARTOONS ARE JUST AS GOOD BUT PRODUCED AT A FRACTION OF THE COST, ALLOWING THE PRODUCERS TO INVEST MORE AT THE IDEA DEVELOPMENT STAGE AND STILL MAKE MORE MONEY].
I doubt Pixar movies are cheaper to make than Disney’s, given the price of human capital. Pixar wasn’t about lowering the cost, it is all about making a more awesome (effective?) animated movie.
Even if I accept your argument that they did it at a lower cost, did they pass that cost savings onto the moviegoer?
Ha! They skimmed it for themselves. This difference in pricing strategy, again, explains most of the differences in our worldviews.
Pat writes:
[LEAN IS ABOUT LOOKING AT PROCESSES TO SEE WHAT VALUE THEY PRODUCE FOR CLIENTS. ARE YOU SAYING THAT WE SHOULD BE INDIFFERENT TO THE USE OF TECHNOLOGY IN DOCUMENT REVIEW FOR EXAMPLE, EVEN THOUGH STUDY AFTER STUDY HAS SHOWN IT PRODUCES EQUIVALENT RESULTS AS HUMAN REVIEW FOR A FRACTION OF THE COST?]
No, I’m not saying that. I’m saying that you using technology for document review does not convey a competitive advantage, since your competitors are using it too. It’s like having restrooms.
I rather have you focus on how to create more value for your clients than worrying about how you can increase efficiency by 1%.
Pat writes:
[SO WE’D RATHER HAVE LARGE NUMBERS OF EXTRA COMPUTERS FOR EXAMPLE, RATHER THAN TRYING TO PURCHASE ONLY THAT WHICH IS NEEDED? WE LIKE TO HAVE EXTRA BODIES AROUND FOR THE RARE TIME THEY ARE NEEDED RATHER THAN LOOKING FOR ALTERNATIVE APPROACHES?]
This is not really addressing the point of the hammer example. That was made to prove that the efficiency measurement did not convey the underlying realities of the situation.
But to address your point, I do believe your firm should have spare capacity. Too many firms run at full tilt, they burn out their team members, don’t have time to effectively market for better customers, and are always playing catch up on hiring at the last minute.
Spare capacity is a good thing for knowledge workers, giving them time to invest in marketing, social media, education, thinking, creating, innovating, and just recharging their batteries.
Pat writes:
[NO, BUT YOU WOULD LOOK AT THE COST OF TRANSPORTING THE MUSICIANS FROM ONE ENGAGEMENT TO THE NEXT, OR THE COST OF PROCURING THE NECESSARY INSTRUMENTS FOR THESE PEOPLE TO PLAY THEIR EXCEPTIONAL LEVEL. YOU ARE LOOKING AT THINGS FAR TOO NARROWLY.]
Oh come now, Pat. Are you really going to transport these folks on Southwest because it’s cheap? Again, this is a mechanical view of knowledge workers. Most airplanes’ business and first-class are filled with business passengers. I wonder why?
Pat writes:
[RON, YOU WRITE AS IF PROCESS AND JUDGMENT ARE MUTUALLY EXCLUSIVE. THAT MAY TRUE IN THEORY OR IN YOUR WORLD. I CAN ASSURE YOU, HOWEVER, THAT IN THE WORLD MY CLIENTS OPERATE IN, THEY ARE INTEGRATED. YOU HAVE TO PROVIDE GREAT JUDGMENT AT A LOW PRICE.]
I work in the real world, Pat. I’ve transformed thousands of practices around the world. I’m able to do that because the theories I use are sound and predictive. Accusing me of not being in the real world lends zero credence to your arguments.
You also seem to think that customers only care about lowest cost. Do you buy the cheapest toilet paper? Customers aren’t price sensitive, they are value sensitive. But given your penetration pricing strategy, maybe you are dealing with the most price sensitive segment of the market.
In any case, it does not alter the fact that a judgment is far different than a measurement. Enron was not theoretical, it was a perfect illustration of the difference between a measure and a judgment.
Pat writes:
[RON, I JUST THINK THE MAJORITY OF PEOPLE ARE GOING TO REJECT YOUR ARGUMENT THAT WE SHOULD BE INDIFFERENT TO COST. NO ONE CAN AFFORD THAT THESE DAYS].
I’m not arguing to be indifferent to cost. Your costs should be driven by your price (not the other way around!), and your price should be driven by the value you create.
Again, if we can’t get past this basic economic fact, this debate is futile.
In the price-led costing world, your costs are determined up-front. You can only recover the costs you incur if you can command a price that covers those costs, plus profit. The only way to do that is to create value above the price, so your customer makes a profit on the transaction as well.
That, by the way, is how the real world works. It doesn’t work on a cost-plus basis, otherwise GM wouldn’t be in bankruptcy.
Pat writes:
["TOTALLY FOCUSED” MY POINT EXACTLY, IF YOU FOCUS ON ONE OR THE OTHER TO THE EXCLUSION OF THE OTHER, YOU LOSE. BOTH NEED TO BE PURSUED].
It depends on your pricing strategy. BMW of course cares about costs, but not to the point that it reduces the value of its cars. If customers value your product enough, they will pay for high costs, and even inefficiency (again, see the Ben & Jerry’s pricing epiphany below).
Pat writes:
[BUT EVEN THE BEST AIRLINES PAY ATTENTION TO COST, BUYING OIL WHEN IT IS CHEAPER, FOR EXAMPLE, OR HEDGING INCREASED OIL PRICES].
Sure, so what? Look at how they price. They change their airfares 11 million times in one day in the USA. They don’t do this because costs are changing that often, but because the value of the flight is changing the closer you move to take off.
Pat writes:
["IN AND OF ITSELF.” AGAIN, YOUR OWN WORDS SHOW YOU ARE CASTING THIS AS EITHER/OR WHEN I CERTAINLY DID NOT AND NO BUSINESS PERSON I KNOW OR HAVE HEARD OF DOES EITHER].
I stand by the statement, and you haven’t successfully refuted it. Efficiency, in and of itself, will not convey a competitive advantage.
Pat writes:
[BUT THEY DO HAVE PIANISTS ONLY DURING PEAK HOURS, NOT EVERY HOUR THE STORE IS OPENED].
It’s not that the dog dances poorly, it’s that he dances at all. No Lean/Sig-Sigma consultant would dream of putting pianos in a Nordstrom, even during peak hours. It’s not efficient.
Pat writes:
On doing the Right Thing, not Doing Things Right [IT SEEMS WISER TO ME TO DO THE RIGHT THINGS THE BEST WAY, OR AT LEAST A BETTER WAY].
Forget about efficiency. Worry about effectiveness. [IN MY WORLD, RON, I HAVE TO WORRY ABOUT BOTH. IF I DIDN’T, I WOULDN’T HAVE CLIENTS].
But which drives success? Effectiveness does. You have to worry about both to a point, but when your efficiency interferes with your effectiveness, which has to go?
Pat writes:
[BUT SOUTHWEST MORE THAN MOST ANY OTHER BUSINESS I KNOW LOOKS TO STRIP OUT “STUFF” THAT DOES NOT IMPROVE THE CUSTOMER EXPERIENCE, WHICH IS THE VERY DEFINITION OF LEAN].
Yes it does, but they don’t use Lean, or any other management fad. They’ve rejected those since they were founded. My point is that Lean isn’t the only way to eliminate waste.
Pat writes, in response to our replacements for Lean/Six-Sigma:
[I AGREE WITH ALL THESE CONCEPTS, NONE OF WHICH ARE FUNDAMENTALLY AT ODDS WITH THE CORE CONCEPTS OF LEAN. AGAIN, THEY ARE NOT MUTUALLY EXCLUSIVE].
Well, in the real world, I can tell you that companies I’ve seen use Lean/Six-Sigma have focused on the one while driving out the other.
Leadership attention is a fixed resource, and you can only have so many iniatitives. Lean and Six-Sigma is a low-value undertaking, compared to focusing on creating and capturing value.
Every study undertaken proves that a 1% increase in price adds far more to the bottom line that a 1% improvement in reducing costs, or even rainmaking.
Pricers have an axiom: Innovate for growth, price for profit. This is why Google gives 20% Google Time, which I notice you didn’t comment on? That’s not very efficient, so why do they do it?
To give a real world example: I know a PKF that uses Lean/Six-Sigma, it even has Black Belts in Six-Sigma on their team (yes, it’s a real designation). After one year of implementing Lean/Six-Sigma here are the results:
- Historical Metrics:
- Increase in Realization: 6.0%
- Decrease in Write-offs: 51.6%
- Increase in Revenue: 1.9%
- Increase in Cash Receipts: 10.0%
- Decrease in Charge Hours*: 7.50%
- Increase in Hourly Rate: $17/Hour
Now, I’ve been working with a similar sized firm on implementing Value Pricing, and over the same past year they report a 25% increase in revenue, and an even greater increase in profit.
Which result would you rather have? You may answer both. Ok, but I think you will find that low-value ideas crowd out high-value ideas, since they are easier to implement.
Your own comments tell me that you find value pricing very hard. It is, damn hard. It’s also a high-leverage activity, so is creating more value.
It’s much easier to sit around and gaze at our navels and discuss how to increase output per hour by 1%. It’s just nowhere near as profitable.
Pat writes:
[RON, WHEN WE FIRST MET, I ASKED YOU HOW YOU WOULD APPLY YOUR VALUE PRICING MODEL IN THE CONTEXT OF A CLIENT WHO HAD JUST RECEIVED A COMPLAINT AND WAS LOOKING AT 3 LAW FIRMS WHO WOULD HANDLE IT, TWO OF WHICH WERE PROPOSING SPECIFIC BUDGETS. IN MY WORLD, THAT PROPOSED PRICE WOULD BE WHAT THE CLIENT LOOKED TO AS THE BOGEY YOU WOULD HAVE TO MEET OR BEAT. INSTEAD OF RECOGNIZING THAT REALITY, YOU SHIFTED THE DISCUSSION TO THE THEORETICAL BENEFITS OF VALUE PRICING, MUCH AS YOU HAVE DONE IN THIS DISCUSSION BY FOCUSING ON ONLY CERTAIN ASPECTS OF WHAT LAWYERS DO. REALITY IS TOUGH THING TO DEAL WITH, BUT IN POSTING ABOUT THE POSSIBLE VALUE OF LEAN TO CLIENT SERVICE, I WAS SUGGESTING THAT LAWYERS WOULD BENEFIT FROM A CRITICAL ANALYSIS OF THE MANNER AND PROCESS BY WHICH THEY HANDLE ALL ASPECTS OF MATTERS FOR CLIENTS. THIS DISCUSSION HAS ONLY REINFORCED MY VIEW OF THE VALUE TO THAT CRITICAL ANALYSIS].
Again, Pat, if you don’t understand the value that you create then how will your customers? Taking a budget as a price is a serious mistake, unless of course you really do have a penetration pricing strategy.
You seem to think that all customers care about is low price. This is nonsense on stilts. I’ve talked to hundreds of General Counsel who confirm this view, and elasticity studies by economists back it up.
They want to understand value, and if firms can’t do this, then the only thing left to discuss is price and/or hours.
Even Fred Bartlit doesn’t have a “penetration” pricing strategy, as I’ve read he’s turned away a case at $5,000 per hour. What customer in their right mind would be willing to pay that?
A customer looking for value. That’s not theoretical, that’s the real world.
Focus on your value and your customer service, and stop thinking you can price for 100% efficiency in a knowledge firm (and don’t make them fly on Southwest for crying out loud).
Your people aren’t machines, and I’ll let Ben & Jerry make my point:
The history of business is the history of epiphanies. Sometimes the fog clears up, and the right path is seen. This certainly happened—with respect to pricing—for Ben Cohen and Jerry Greenfield, founders of Ben & Jerry’s ice cream. Before they sold the business in 2000, to Unilever, the British-Dutch food company, they wrote an essay in 1997, titled “Bagels, Ice Cream, or...Pizza?” in which they explain their “famous pricing epiphany”:
Each year we would break even and say we needed only to do a little more business to make a profit. Then the next year we’d do a lot more business and still only break even. One day we were talking to Ben’s dad, who was an accountant. He said, “Since you’re gonna make such a high-quality product instead of pumping it full of air, why don’t you raise your prices?”
At the time we were charging 52 cents a cone. Coming out of the ‘60s, our reason for going into business was that ours was going to be “ice cream for the people.”
Ben said, “But Dad, the reason we’re not making money is because we’re not doing the job right. We’re overscooping. We’re wasting ice cream. Our labor costs are too high—we’re not doing a good job of scheduling our employees. We’re not running our business efficiently. Why should the customer have to pay for our mistakes? That’s why everything costs twice as much as it should.”
And Mr. Cohen said, “You guys have to understand—that’s human. That’s as good as people do. You can’t price for doing everything exactly right. Raise your prices.”
Eventually we said, either we’re going to raise our prices or we’re going to go out of business. And then where will the people’s ice cream be? They’ll have to get their ice cream from somebody else. So we raised the prices.
(Quoted in The Book of Entrepreneurs’ Wisdom, edited by Peter Krass, John Wiley & Sons Inc., 1999, pp. 462-463.)
I don’t expect to alter your view on any of this Pat, and that’s not why I’m debating you.
I’m actually using this debate to illustrate how obsolete the industrial/service model thinking is in a knowledge economy.
Our metrics come from Frederick Winslow Taylor in the late 19th century, and they are obsolete with respect to knowledge workers.
That said, I truly appreciate your debating skills. I, of course, believe the empirical evidence supports my view.
The market, ultimately, will decide, and I have faith it will make the right decision.
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.
Ed Kless - 09/14/2009
A little over three years ago, a dialogue began in one of my consulting classes that I teach for Sage. The conversation focused around the levels (I am not convinced levels is the right word) of consulting. In the end, the group proposed the following four levels: Findings, Options, Recommendations, and Decision. Serendipitously, this yielded the acronym FORD. (I personally own a Honda Pilot.)
This model has served me quite well over the last few years, so I thought it worthy of a post wherein I will briefly define each level and provide some overall thoughts about the model.
- Findings - these are the issues (problems, opportunities, and desired results) that the consultant uncovers through a question and answer process, referred to by most as discovery.
- Options - these are the different possibilities that the consultant proposes for solving the uncovered problems, seeking the opportunities, or achieving the desired results. A great consultant always includes, “Do nothing,” as an option.
- Recommendations - this is the option (or options) that the consultant believes would be the best course of action for the customer. Making recommendations would usually include a list of advantages and disadvantages (pros/cons, positives/negatives, strengths/weaknesses, whatever you want to call them) of each options and a rationale for why the option(s) was(were) selected.
- Decision - one of the various options or a variation of the options is selected for implementation.
A few observations about the model:
- Each incremental level increases the level of risk on the consultant and requires an higher degree of knowledge. Since risk and knowledge required are factors in setting price, an engagement to just collect findings will be less expensive than an engagement to present options and an engagement to present options will be less expensive than an engagement to provide recommendation.
- If you are making the decisions you are not a consultant, but what Peter Block would call a surrogate manager. He defines this as “a person who acts on behalf of or in place of a manager.” Surrogate manager-hood is not bad in and of itself, but it is way more risky and deserving of a premium price.
- Being a consultant or a surrogate manager is a strategic decision. Some people may choose to never enter the fray as a surrogate manager and only remain in the role of consultant. This leads to what could be another blog post - the paradox of consulting - which is that consultants are paid to not make decisions.
- It is critical to have a conversation early on with every customer or prospective customer as to the level of consulting in which they would like to engage you. Failure to do so causes not only pricing problems, but myriad of other problems that are out the scope of this post.
- I believe that all professionals are consultants of some kind. Doctors are consultants on the anatomy and physiology of the human body; lawyers, on the law and legal system; accountants, on accounting practices, etc.
I welcome any comments and any suggestions on a better term than my proposed levels.
Ron Baker - 09/08/2009
Thank you to the Minnesota Society of CPAs for publishing my book review on the Mayo Clinic, and the difference between efficiency and effectiveness.
Ron Baker - 09/06/2009
From August 13th to the 29th, I had the great good fortune of touring Australia with my colleague, VeraSage supporter, lawyer, and legal consultant John Chisholm.
It was an amazing journey. I met several incredibly interesting and gracious people, went to an Aussie Rules football game, drank way too much OZ wine (all excellent!); got my butt kicked on the golf course by John; flew several non-United airlines (a reminder how valuable 1K status truly is); did sixteen speaking engagements over 11 days and 5 cities—Gold Coast, Sydney, Brisbane, Melbourne, and Geelong—including the ALPMA Summit, 11 law firms, a Young Lawyers group, ACLA members (General Counsel association), and a meeting with government officials.
As you can imagine, it’s hard to summarize such a tour, but here are some of the interesting insights I came away with:
- The Young Lawyers I spoke with were blown away with the concept of a “knowledge worker.” Essentially I told them that all the talk about Baby Boomers, Gen X, Gen Y, etc., was nonsense on stilts. The real change in the economy is the transition from industrial/service to intellectual capital, and the knowledge worker theory is far more robust and predictive of what the workforce is undergoing. Gen X, Y, etc., is as useful as reading your Horoscope—it’s absurd to stereotype people based on the year they were born.
- I believe law firms in Australia are further behind the accounting firms in implementing and experimenting with Value Pricing. I think both sectors are far behind the USA in pricing generally. That said, there is the same level of interest among both countries, as firm leaders sense that the billable hour’s days are numbered.
- The general counsel group and individuals I spoke with are very interested in the Value Pricing message. All expressed a desire to have a “value dialogue” with their law firms, to help them understand value. All would willingly pay a premium for certainty in price. Law firms, are you listening to this?
Liz Harris, a consultant and friend of VeraSage whom I had the pleasure of meeting for the first time and spending time discussing our Quest, taught me that the GCs in Australia are far more concentrated than in the States, and thus could definitely exert more influence in getting law firms to change pricing strategies.
This runs counter to my strong opinion that sellers change pricing strategies and business models, not buyers. However, I concede she makes a compelling point, and I would be all for buyers helping force law firms to change. I remain totally unconvinced, however, that buyers have the economic power—or incentive—to accomplish this.
To support my contention, I issued the GCs the following challenge: Stop issuing tenders (RFPs) asking for hourly rates. Simply insist on your law firms quoting fixed prices for a fixed scope of work. Period. If they continue to give firms the option, out of pure inertia firms will default to hourly rates.
Of course, some GCs are as mired in the billable hour mentality as are law firms, so this is not as easy as it sounds. I hope proponents such as Liz and John can get in front of more GCs to explain the benefits of Value Pricing for both sides.
- The Global Financial Crisis (GFC) was milder in Australia than America, and the leading indicators point to them already coming out of a shallower downturn. This lessens the pressure on firms to change pricing strategies. The news of Pfizer forcing its outside counsel into fixed prices—and less profit—did send ripples of fear over law firms, as well as procurement beginning to get involved in negotiating law firm pricing. Whether or not this forces widespread change remains to be seen.
- John and I met with government attorneys who understand the need for change. Like the general counsel we met, they, too, left the practice of law firms because of the timesheet and billable hour treadmill. How do their employers know if they are producing without timesheets? The question seems sort of silly, doesn’t it? After all, the private sector doesn’t use timesheets.
- Several law firms have sprung up that offer alternative pricing, such as Optim Legal, Advent Lawyers, and Marque Lawyers. I had the pleasure of meeting the directors of the first two, and I applaud their efforts to offer innovative pricing alternatives to hourly billing. However, I do not understand why they are using a “penetration” pricing strategy. I believe they should be using a “neutral” or better yet, a “skim” pricing strategy.
- Michael Stewart from Integrity Financial Solutions, a VeraSage Trailblazer firm, hosted a seminar I gave to a mixed audience of professionals. I also met the CEO of APS, a large software firm that is working on a project management and pricing module for accounting firms. If more software firms begin to offer alternatives to their time and billing programs—literally the buggy whip of the knowledge economy—that would certainly validate the concept of Value Pricing, the uselessness of timesheets, and would help diffuse the ideas faster.
- I had the pleasure of finally meeting Matthew Tol and some of his team in Geelong. Matthew is a VeraSage Trailblazer firm that thoroughly understands that valuing knowledge by tracking time is the equivalent of plunging a ruler into your oven to determine its temperature—it’s simply the wrong measuring device.
- I also met some folks who truly don’t understand the concept of Value Pricing and are mired in the Old Practice Equation, with its obsessive focus on efficiency, realization and hourly rates. Some of these are employed in very large firms. I came away thinking large firm equals small brain; larger firm equals even smaller brain.
I asked this one question every time I encountered one of these proponents of The Firm of the Past: Do you really believe that the value of Jonas Salk’s polio vaccine is determined based on how long it took him to develop? To ask the question is to answer it—unless you lack intellectual curiosity, not to mention honesty.
- The billable hour has had an deleterious effect on the “trusted advisor” role of lawyers. It has created a zero-sum mentality between client and lawyer, with both focusing on how much the one gains at the other’s expense. It has allowed both sides to disregard the creation of value—the very reason law firms exist. Even Pfizer does not understand this, which is why I find the video of the GC so repugnant—specifically the idea that law firms will have to live with less profit (I totally agree with them, however, for forcing their law firms to change pricing strategies). Why can’t both sides create and capture more value?
- For two great articles on what’s happening in Australia, check out John’s ”It’s time to get rid of those silly, unnecessary timesheets” and ”Seeking a price model that will fit the bill” (which quotes Liz Harris). You will be hearing more from John in the future.
- I’m beginning to develop a “pincer claw” theory of change: there are several pincers squeezing the old “we sell time” business model—general counsel, government regulators, young attorneys who don’t want to be a prisoner to the timesheet, the competition for talent, the GFC, competition from upstarts such as Optim, Advent, Marque, among others, and partners themselves who intellectually understand that time does not equate to value but who are too risk-adverse to do anything about it. The confluence of these pincers, it seems to me, will bring about change one way or another. It’s just a matter of time. And, of course, progress will happen funeral by funeral. Sorry, but it’s true.
- I met and had dinner with the father of Hamish, of the famed OZ national radio program Hamish and Andy. The significance of this is that Hamish and Andy are responsible for the “Street Accountants” video clip that we’ve played for audiences around the world (first shown to me by Tom Hood of the Maryland Association of CPAs). One of the best clips ever made!
- John and his welcoming wife Karen showed me hospitality over and above the call of duty, allowing me to invade their home for a week and get to know some of their family. John also shared several fantastic bottles of wine, as did many of the firms I presented to. For more on Australian wines, subscribe to John’s newsletter where his lovely daughter Kate will introduce you to many boutique wineries that you will love.
- I’d like to know how Ozzie’s compute golf handicaps? John told me the entire trip he was a 20, then when we played 9 holes and he shot a 40, while I spent my time duffing around in every sand trap on the course. 20 my (Aussie) foot!
- OK, I’d be remiss not mentioning by far the highlight of the trip: I learned I would have been a great goat racer. Attorney John de Groot gave me a signed copy of his book, Memoirs of a Goat Racer and more, which I will always remember. You can learn more here.
All in all, this was a great trip and an incredible learning experience. John plans to visit the United States, and if you are interested in meeting him, please contact him or me directly.
The billable hour is on the defensive around the world. I’m still waiting for someone to defend it with an argument that VeraSage hasn’t nuked. Some are still trying, but I’ve yet to read or hear anything new in its favor in the 15 years I’ve been on this Quest.
It’s simply the wrong theory of value. And just like your high school algebra class, if you begin a long problem with the wrong first answer, it doesn’t matter how efficient you are in the rest of your work, it’s will still going to turn out wrong.
Let us hope law firm leaders in both the USA and Australia have the vision, fortitude and guts to put the billable hour where it belongs—its grave. R.I.P.
Ed Kless - 09/01/2009
The Journal of Accountancy recent posted excerpts of an interview they conducted with Ron Baker. In this seven minute clip, Ron does a great job at summarizing the concepts surrounding the firm of the future, also known as a professional knowledge firm.
This is my latest slide that illustrates this powerful idea. It differs from what Ron espouses in that I make a change in the mathematical operator used in the equation to signify that the transformations enhance each other.
Enjoy!
Ron Baker - 08/02/2009
As a follow-up to our blog post on Was Drucker Wrong About Knowledge Workers, senior fellow Paul Kennedy sent me his “brain dump” on the topic.
As usual, Paul contributes a more holistic view of this topic by introducing the concept of positioning.
In this short essay, Paul explains why you can only be more effective in the context of an objective.
Michael Gerber distinguishes efficiency and effectiveness with “what” and “how” questions so:
Efficiency—How do we do this faster? How do I do this with less waste?
Effectiveness—What should we be doing?
But other than that I think definitions as you present them work.
If the challenge is to “how to create and capture value through knowledge workers” then there may be another step in the chain (can you have a step in a chain?)—positioning.
Calling things by their proper name is a big part of the problem. To confuse terminology, Michael Porter in his famous HBR article “What is Strategy?” distinguishes between Operational Effectiveness (OE) and strategic positioning. He defines OE as “performing similar activities better than rivals"—nearer our definition of efficiency.
He goes to explain “OE includes but is not limited to efficiency. It refers to any number of practices that allow a company to better utilize its inputs, by for example, reducing defects in products or developing better products faster” (still sounds like our definition of efficiency!). He goes on to write “In contrast strategic positioning means performing different activities from rivals’, or performing similar activities in different ways.” This sounds more like our definition of effectiveness!
Porter goes on to explain that improvements in OE do not create sustainable advantage as such improvements are quickly copied. Porter points to rapid diffusion of best practice, the outsourcing of some activities often to the same organisations competitors use and role of consultants in ensuring that advantage is at best temporary. OE effectively shifts the bar for everyone but relatively for no one. Becoming more efficient is just a hygiene factor.
Has tax software made the accounting profession more profitable? No, because it has merely raised the bar. It has become a table stake.
Porter argues that to create and capture value in any organisation (including organisations of KWs) in the long term strategic positioning is the only way. My understanding of his theory of strategic positioning is that it is about alignment (he uses the term fit). I think that for a KW to be effective a KW’s capabilities need to be aligned to the needs of the organisation’s customers and the customers need to be chosen to optimise this chance. I think this optimisation of alignment goes beyond effectiveness.
Jim Collins talks about putting people in the right seat of the bus and Kaplan and Norton seek to align intangible assets to financial objectives through the use of strategy maps. These maps articulate an organisation’s theory of value creation and capture through a series of cause and effect links. They make explicit how it is hoped intangible assets are developed, orchestrated and aligned to target customer needs and how this value creation is then captured to meet overall (often financial) objectives.
It seems to me that you can only be more effective in the context of an objective and these cause and effect diagrams we call Strategy maps, go some way to articulate an organisation’s plan for being more effective in the context of an overriding objective. In my experience this is a good way of getting KW alignment to organisational objective and thereby enhancing effectiveness.
But understanding a theory of value creation does not give you a better way of measuring KWs nor, in my opinion, does it matter. Even Kaplan and Norton for all their preoccupation with scorecards don’t try to measure this stuff!
Thanks, Paul, as always your comments are extremely cogent and logical. I missed the topic of positioning, taking it as a given.
Yet as you and Paul O’Bryne teach everyone so well, you can’t value price the wrong customer—hence, positioning and strategy is crucial to this topic.
Ron Baker - 07/24/2009
The recent book review of Reinvent Your Enterprise has sparked a fantastic discussion on the difference between efficiency and effectiveness, especially in a Professional Knowledge Firm (PKF).
Senior Fellow Paul Kennedy, of OBK fame in Great Britain, joined the discussion in an email to me explaining the obk simple management system™.
As OBK is a true Firm of the Future, I was excited to share Paul’s methodology. I only wish more PKF leaders understood the difference between knowledge and manual/service workers, efficiency and effectiveness, and a measure vs. a judgment.
Obviously Paul Kennedy does. Study the following. If you’re smart, implement it, or something similar to it.
Thanks for [the book review] Ron.
I have been giving this some thought about efficiency vs. effectiveness and I will send you some notes. However, the underlying issue if I have read the article correctly is how to manage a knowledge worker (KW) or can KW’s be managed?
I had thought that this debate had ended. That is—KWs are more led than managed. At obk we have developed the obk simple management system™ which is laughingly simple but seems to work. It is about aligning the skills of a KW to business objectives and then coaching them. It goes like this:
Step 1. Everybody has a job and every job has a body. This involves designing a functional organisation chart with a “position contract” in each box ([Michael] Gerber style). This is business object orientated.
Step 2. Each position contract describes desirable outcomes, qualitative performance expectations and cross refers to an assessment form (see step 3 below).
Step 3. We design an assessment form for each KW. This is a short list of judgement criteria that assesses how well the function is being discharged. Against each criteria (usually between 5 and 10 headings) is 2 columns. One for self assessment and one for manager assessment. The KW and their manager score how well the criteria point is being done / performed / achieved, using 1 = low and 5 = high. The criteria headings can be anything you like but in our case includes:
- Development of relevant Human Capital
- Contribution to firm’s structural Intellectual Capital (IC)
- Consistency with firm’s core values
...Among others
Step 4. The KW and their manager have a 15 to 20 minute chat about their scores on a regular basis (sometimes weekly, sometimes monthly)
We have been experimenting with this system in the obk lab for some time and we have a number of clients using this system. What we have learned is:
- When you present a position contract describing desirable outcomes and with qualitative performance expectations some KW don’t want the position! (This may explain why management has been so frustrated with this KW for so long)
- Others say “to get to that standard I need help” (also good because its management’s job to provide help in terms of inspiration, tools and training).
- When assessment forms are completed we have observed a number of things:
- When a KW scores themselves low but their manager scores them high—the KW is pleased and their work is recognised (A good thing according to Blanchard’s One Minute Manager and Baker see Page 64 of The Firm of the Future—the 4 reasons why people go to work).
- When a KW scores themselves high but their manager low—also good because it means we are now at stage 1 on the progress ladder. Most managers never get to this stage with their KWs and can therefore never make progress.
- Whenever a score is less than 5 the conversation is about how can we get you to a 5? In other words this becomes a coaching process.
- The coaching chat plans and monitors the KW’s personal development.
At obk we have badges (Boy Scout style). We use these badges to define and test competence in skills required to create value for our customers. These badges may be technical or may relate to personal skills such as listening or speaking. Our KWs target and acquire these badges as part of their development. Their personal development is therefore aligned to our business needs.
This system works for us and for others where it has been introduced. In getting clients to use this system we have to educate them to make judgements. To get them to tell their KW’s how they feel without the need for justifying why they feel the way they do. We do not use measurements unless they can be directly related to KW performance, e.g., a salesman picking up new customers.
I think the key to making this system work is the environment in which this management system sits. This environment of course is the function of leadership and this is the key to getting more from KWs.
In my opinion, this is a far easier framework than the one laid out in the Reinvent Your Enterprise book. I can always count on Paul to shave with Occam’s Razor.
We’d love to hear what others think of the obk simple management system™.
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