Who’s in Charge of Value in Your Firm?
VeraSage - 03/30/2006
Who’s in Charge of Value in Your Firm?
by Ron Baker, Founder VeraSage Institute
The final question needed in order to come to grips with business purpose and business mission is: “What is value to the customer?” It may be the most important question. Yet it is the one least often asked. One reason is that managers are quite sure that they know the answer. Value is what they, in their business, define as quality. But this is almost always the wrong definition. The customer never buys a product. By definition the customer buys the satisfaction of a want. He buys value.
––Peter Drucker, Management: Tasks, Responsibilities, Practices, 1993
My VeraSage Institute colleagues and I have had the privilege of posing this question–– Who’s in charge of value in your firm?––to thousands of accountants around the world.
We are usually met with a momentary staring ovation, and then someone will inevitably shout out, “Everyone!”
Really? I live in California, where I’m told everyone “owns” the Golden Gate Bridge. I would like to sell my portion; unfortunately I encounter what economists call the tragedy of the commons. If everyone owns something, no one does. No one has an incentive to protect and maintain the value of the asset in question. Think public toilet. Species become extinct because no one owns them, such as the American Buffalo; species thrive—such as dogs, cats, and cattle—because they are privately owned. You can bet your retirement fund KFC is not about to let chickens become extinct.
In a professional service firm, someone needs to own the value function, someone who can be held accountable for creating and capturing value. One throat to choke.
The Marketing Concept
The sole purpose of a business is to create wealth outside of itself. Unlike a biological organism, the true test of a firm’s success lies outside of its four walls. All results are external, there is no such thing as a “profit center,” there are only cost, activity and effort centers. The only profit center in your firm is a customer’s check that doesn’t bounce.
The Four Ps of Marketing—Product, Promotion, Place and Price—all must look outside of the firm and ask, “What do our customers value, and how can we increase that value?” Marketing executives must focus on the outside of the firm where the results are created, whereas cost accountants focus on the inside of a firm. Becoming better cost accountants is not going to help us create value for our customers, nor will it be much assistance in capturing that value through strategic pricing.
In order for firms to price better, they must understand the Five Cs of Value:
1) Comprehend value to customers
2) Create value for customers
3) Communicate the value you create
4) Convince customers they must pay for value
5) Capture value with strategic pricing based on value, not costs and efforts
These five components determine the wealth-producing capacity of any firm, and will drive internal profits in the long run.
Grading Your Pricers
Engage in this thought experiment: Rank the individuals in your firm on their pricing skill:
Acceptable
Mediocre
Wimps
Given that pricing is the number one driver of profitability in a professional service firm, why are people who are mediocre—and wimpy—allowed to price? Just because they are partners? Your airline pilot is a great aviator, but he doesn’t set your airfare. Pricing is a core competency, a separate body of knowledge, and not everyone is adept at it. If I am a lousy auditor, you wouldn’t let me near an audit engagement. Why let your sub-optimal pricers continue to handicap the profitability of your firm with bad pricing? This is ballistic podiatry.
Cost is a fact, but pricing is a policy, and in order for it to be effective someone must be accountable for results. Who is in charge of this function in your firm?
The World’s First CVO
If you worked at Ward Wilson, a four-office, ten-partner, one-hundred team member firm in Invercargill, New Zealand, your answer would be Brendon Harrex, who was recently appointed Chief Value Officer, responsible for creating and capturing value across the entire firm. Brendon, at age 31, is the youngest partner in the firm, and is an amazing visionary, bringing leadership not only to his firm, but our entire profession. He understands the historical significance of his appointment, and realizes it will change the way accountants think of value and pricing for posterity. A recent McKinsey study demonstrated a 1% improvement in pricing results in a nearly 12% increase in net income, dwarfing what can be achieved with a similar 1% improvement in reducing fixed or variable costs, or increasing volume (you can excel at rainmaking, but if you bring in that additional work at the wrong price you are simply adding layers of mediocrity to your firm). Other studies put this 12% at between 20% to 50% increase in the bottom line, depending on the industry. In other words, value and pricing deserve a promotion, as this is a strategic function.
The Fortune 500 companies already understand this, as nearly all of them have a director of pricing who overseas a pricing department. UPS has approximately 200 pricers, while Honeywell has 150. Why are these organizations investing such an enormous amount of human capital into the pricing function? Because they realize they can only cut costs, re-engineer, implement TQM and Six-Sigma programs to a certain point, and diminishing returns have already arrived. By focusing on creating value, and then capturing it through pricing more intelligently, they are realizing large returns for their investment.
More Value, No Timesheets
Meet Jayme Schneider, an accountant with Easdown & Partners in Wagga Wagga, New South Wales, Australia. This five-partner, twenty-four team member firm recently appointed Jayme CVO, making her the first CVO in an accounting firm in Australia, and the first female, non-partner CVO in the world. Jayme is 27 years old, and will now have the same responsibilities, and accountability, her counterpart Brendon has across the Tasman Sea.
Both Jayme and Brendon will now be responsible for implementing a value pricing culture in their respective firms. Hourly billing is dead, and no longer will either of these firms establish, quote or use hourly pricing with their customers. Furthermore, Easdown & Partners will eliminate timesheets as of July 1, 2005, while Ward Wilson will eliminate them November 1, 2005, joining some 300 other pioneering firms around the world that have trashed this antiquated measurement device, and blazing the trail for the rest of the profession.
Hourly rates and timesheets are internal looking metrics that have absolutely nothing to do with the external value created for the customer. They don’t measure things that are important to the customer (do you care how long it took for General Motors to build your car?), nor do they judge knowledge workers on the most important characteristics of being a true professional.
We must stop thinking in terms of management and operational efficiency metrics that are irrelevant in a knowledge environment. The most important traits in a knowledge worker cannot be measured, they must be judged and discerned. Characteristics like interpersonal skills, passion, desire, motivation, innovation, creativity, risk-taking, knowledge, and pride may not show up anywhere on a firm’s financial statements or timesheets, but they are the traits that will ultimately determine the fate of the firm. Knowledge work is non-linear and not subject to the cadences and rhythms of an assembly line; rather it moves by iteration and reiteration, a process of the mind. The traditional metrics of productivity need to be replaced by judgment, and there is an enormous difference between a measurement and a judgment: a measurement requires only a stick; a judgment requires knowledge and discernment.
Another major responsibility of the CVO is to develop, test and track Key Performance Indicators (KPIs) in order to monitor and track the results the firm is producing outside of itself. KPIs such as turnaround time, customer loyalty, number of customer contacts per week, share of customer wallet, among others, have been selected to monitor firm-wide performance. For team members, judgments on interpersonal skills, customer feedback, continuous learning, and personal development have been selected by these firms to monitor progress on these necessary characteristics of a true professional.
While the consultants to the profession keep it mired in the mentality it must measure every hour (witness their incessant benchmarking studies and advice on how to increase ralization rates by raising hourly rates), no doubt these pioneering firms are going to take the arrows of incredulity, ridicule and scorn. So be it, since not having timesheets will allow these firms to attract top talent much easier than firms who intrinsically don’t trust their people and hence make them account for every six minutes of their working lives (as if inputs had anything to do with value created). As finding and retaining human capital is the number one issue firms around the world are confronting, imagine the competitive advantage firms without timesheets will have in attracting talent. This advantage, alone, is worth getting rid of your firm’s timesheets. But it’s obviously not the only one.
Value, Not Cost, Determines Price
No customer buy hours, and hence accountants don’t sell time. Yet two generations of accountants have been taught they do, and by forcing them to account for every six minutes of their day, they begin to internalize this attitude to the detriment of focusing on wealth creation for their customers. Both Brendon’s and Jayme’s mission is to change the culture in their firms from focusing on activity, efforts, and inputs—which is what timesheets measure—to one of results, output and value, the same things customers care about. In order to achieve this, the following diagram will now be embedded into the DNA of their firms. First, consider how accountants have traditionally been taught to think of the pricing function:
Cost-Plus Pricing
Product > Cost > Price > Value > Customers
Notice you start with the product (or service), determine its cost, mark-up that cost with a desired profit to set the price, and then pray the customer values the output at a level higher than the price they are being asked to pay. Notice where the customer is in this chain of events—at the end! This is the paradigm of pricing held by cost accountants, and it is wrong both in theory and practice, which may explain why most professional pricers are not cost accountants. Value Pricing inverts this chain to correspond with the economic realities of the marketplace.
Value Pricing
Customers > Value > Price > Cost > Product
This value chain recognizes value is like beauty, it is in the eye of the beholder—in this case, the subjective value of the customer. Customers don’t care about your internal costs, nor your profit desires. They demand value higher than the price they are paying, and they want to make that comparison before they buy, not after (as is typical with hourly billing).
This inversion reveals a further fact of economic life: Your costs do not determine your price; rather, your price determines your costs. This is anathema to a cost accountant, but self-evident to a professional pricer. You should ask yourself before taking on any job if the price charged will allow you to invest in the costs required to complete the engagement at a profit the firm can tolerate—known as price-led costing. If not, you should not undertake the project. The important point about this process is when you are making that determination—before you provide the service, not during, and certainly not after.
CVOs understand the hardest part of this new value chain is determining value. After all, cost is relatively easy to determine, since accounting firms are comprised mostly of fixed costs, at least in the short- to medium-term (in the long run, all costs are avoidable, as you can close the firm’s doors, or sell it). Setting price above cost is also not difficult, as even the most inept businessperson can accomplish this.
In determining value, cost accounting, timesheets, realization rates, and all the other metrics firms have historically analyzed provide absolutely no help. Your customers don’t have much of an incentive to contemplate your value, since they purchase your services infrequently. But your firm sells thousands of times, and gaining a deeper understanding of the value you create, how you can increase it, and better capture it, is well worth your time and investment to study.
We Get What We Measure
If this is true, isn’t it time we measure what we want to become? No accountant entered the profession to bill the most hours. Who in your firm is measuring value? An old Proverb instructs “Trees die from the top,” and unless someone in your firm owns the value function, it will not get the proper executive attention, respect and resources it deserves.
For too long, the accounting profession has relegated the pricing function to an administrative task of completing a timesheet and letting the time and billing program spit out an invoice, which is then usually written down. It’s time to stop this practice, and to invest in the value and pricing functions, which will enable firms to create value for their customers and capture that value for its partners, team members, and future growth of the firm.
Brendon and Jayme––as the world’s first accounting firm CVOs––provide light at the end of our tunnel vision. The CVO position is not just a fad––something people merely talk about––it is actually being done, and it will no doubt change the competitive landscape of accounting firms worldwide, and simultaneously make the profession more attractive to young people.
If you are competing against a firm with a CVO––either for customers or talent––you will be at a severe competitive disadvantage. The Roman God Janus had two sets of eyes, one to see what lay behind and the other to see what lay ahead. A CVO is a outward-looking position, with duties carried out in a world of risk, uncertainty, innovation, and faith in the future, where value is solely determined by the customers your firm is privileged to serve. If the only set of eyes you possess look behind you––at historical costs, efforts and hours billed––you are destined for a perilous future.
So, who’s in charge of value in your firm?
Copyright © 2005 Ron Baker. All Rights Reserved.