Community Section -
Ron Baker - 12/31/2006
The following E-mail was sent to Ron Baker on December 28, 2006 from Mark Bailey, one of our Trailblazer whose firm has shifted to Fixed Pricing and no timesheets. It’s a multi-faceted question, so this is a long post.
Happy New Year Ron,
I’m wrestling with some issues that I hope you can help me with by sending me to some reading material.
I am trying to get an administrative protocol in place that will help us with evaluating pricing, and help us capture the services not covered under the fixed fee agreements. There is a fairly significant amount of leakage there.
We’re adapting a software program “Tracker” which is essentially due date monitoring. Part of the inputs come from our engagement budgeting, which by necessity is based on hours. The engagement budgeting isn’t used as a staff management tool. It is important for engagement management on large engagements. On an annual basis it could provide a good denominator for a KPI. It necessitates each staff person to input the time they’ve spent in the respective areas of the engagement on a weekly basis, and a memo explaining variances. The purpose of the variance explanations is to generate any necessary change orders. The whole process smacks of time sheets, which we don’t want to get back to, but that leaves me with a couple of additional measurement problems.
Pricing—if I don’t know what my costs per engagement were,(1) how can I effectively evaluate the desirability of that specific client, and (2) on the largest engagements, how can I be sure I’m invoicing for everything we provide (some of our engagement teams are 5 or 6 people providing service over a 12 month period)?
Another issue I’m wrestling with is perceived productivity by the staff. I’m really laissez faire about workdays. Total flex time. If you have work be here and do it. If you don’t, don’t. When we are really busy, the work momentum ensures high productivity out of everyone, but when it’s slower, there’s no individual motivational conscience (in the absence of a benchmark, all good people are convinced they are working hard. For all the bad things it is, the clock is a benchmark)—that’s just human nature, even from your best employees. Administrative responsibilities particularly seem to fall through the cracks. The individuals however, remember all the hours they put in from Feb to June, as a good faith rationalization for not putting in solid work weeks now. In other words, it’s easy to remember those nights at work until 10 or on Saturday, but not as easy to remember that you come in every day at 9:30 after dropping your kid off at daycare, and leave at 4 to get in a game of racquetball before you pick her up.
How do you measure the differences in effectiveness of two people doing the same job? Productivity has traditionally been measured by hours x rate x % billed. I an get around it easily enough on small engagements where Joe does all the work and the fixed fee is $XX, but how do I do that when 4 people worked on that engagement?
Ok. Give me some direction to research. (You are not allowed to say “Mark, you’re a trail blazer, figure it out.")
Mark Bailey
Ps—just writing this has given me some ideas.
Pps—the discussion in the blog regarding your Brit counterpart who wants to tell his client that his pricing was based on hours was interesting, but easily addressed. Try sending a $150,000 change order, after the work was performed, to an audit committee, and then explaining how you came up with the amount, without using the additional hours as a basis for your pricing. I did it and they are still a happy client.
Here is my response to Mark:
Happy New Year Mark,
Thank you for your questions. It inspired us to create an “Ask VeraSage?” section on our Blog. Hopefully, this will help future Trailblazers learn from the experience of others, since no one has enough time to make all the mistakes on his or her own.
Your question is multi-faceted, and will require the same type of response. I’ve also distributed it to all of the VeraSage Fellows, and I’m sure some of them will also provide answers, which will probably differ from mine on some points.
Let’s deal with your first question, contained in your first two paragraphs, regarding leakage and Change Orders. Nothing will derail a fixed priced environment quicker than not issuing Change Orders on all “scope creep"—that is, work outside of the scope of your FPA (Fixed Price Agreement). This is the main reason why firms that have tried FPAs have reverted to the billable hour. It’s an enormous issue, and demands—more than any administrative protocol—a culture change. The firm has to provide education to all team members on the importance of only performing work that is within the scope of an FPA or a Change Order. Since team members are usually the first to spot scope creep—since they are at the “coal face,” to borrow an Australian phrase—it’s vital they understand the Change Order process.
You can put administrative processes in place, but only after adequate education and leadership. Some firms even allow team members to negotiate Change Orders that are below a certain dollar amount; although I’m more partial to having a Pricing Cartel perform this function. I think it’s time your firm appointed a Pricing Cartel and possibly a Chief Value Officer in order to deal with the procedures, processes and education that are essential to deal with this leakage issue.
The “Tracker” software program you mention is not the answer, because it will only show a variance after the work has been performed. And as you know, you MUST PRICE EVERYTHING BEFORE DOING THE WORK. Period. What possible good is it to learn after the fact of a variance? When do we want to learn that a customer doesn’t like our price? I’d rather find out before I begin the work, not during or after. Since your team members are knowledge workers, they will be able to spot scope creep before it happens, thereby prompting communication with the customer and a Change Order to be drafted by a member of the pricing cartel. If contractors and auto mechanics can be taught how to do this, I remain hopeful CPAs can be as well.
Your comment that the hours from “Tracker” could be part of a denominator and used for a KPI is certainly true. We can divide many things into many other things, but the question remains: what is important to measure? Any KPI that would result from Tracker would be lagging, and what you want are leading indicators. Also, they must define the success of your firm the same way the customer does. No customer cares about how many hours it takes you to complete a project.
To your pricing questions: “Pricing—if I don’t know what my costs per engagement were,(1) how can I effectively evaluate the desirability of that specific client, and (2) on the largest engagements, how can I be sure I’m invoicing for everything we provide (some of our engagement teams are 5 or 6 people providing service over a 12 month period)?”
Mark, let me suggest you do know the costs of your engagements, since your firm is a fixed cost environment. If I were to take your total overhead and divide by the number of customers you have, I’d get cost per customer. I could then adjust this number for simple, medium and complex customers. Would I be close enough for government work and cost accounting? You bet.
We are not going to become better pricers by becoming more accurate cost accountants. We will only become better at pricing by understanding the value we create. Does that mean you don’t need cost accounting? No. But what’s important is when you perform your cost accounting. I want you to perform it before you do the work, not after. This way, the value of your work will drive the price; then the firm can decide if it wants to invest in the costs it will take to provide that service at that price. Will it leave an acceptable profit? If not, you don’t do the work. This is known as price-led costing.
This is exactly how Toyota builds all of its cars. It doesn’t have a standard cost accounting system (and never has!), because it knows value drives price, not costs. So before it sinks a penny into making a car, it already knows its sales price (determined by value), then it can decide to invest in the costs required to produce the car. The problem with cost accounting is manyfold, but probably the worst thing about it is its emphasis on historical costs and lagging information. Sure, we can count every cost, but no one knows what a cost should be. What if one of your team members finds a better way to do something? Costs would actually go down. What if they find a better way, but then have to develop some tools to be used on future engagements? Costs would go up in the short run, but down in the long run. Cost accounting doesn’t distinguish between these scenarios. It’s myopic; it only sees the costs right in front of it.
As to the desirability of a specific customer, let me suggest you know this without looking at any financial information. What’s your gut say about the customer? What does your team think about working for these people? Why must everything be quantified? Most things in life require judgment, discernment, and intuition, and for the life of me I don’t know why CPAs (and MBAs) aren’t comfortable with this. They rather be precisely wrong rather than approximately right. I suppose quantifying gives us a sense of objectivity, but whether or not to continue to service a particular customer is a judgment, and should not be driven by the economics alone (especially in a Professional Knowledge Firm—PKF—where customers add so much to its social capital).
As for #2 in your question, you should be invoicing for everything you provide because your Pricing Cartel is doing Change Orders and FPAs before any work is started.
There are two other tools to be used, which I’ll introduce at this point, even though they are the answers to your other question of determining the “productivity” of your team. The first is project management. If you can convert “Tracker” to a true project management tool, you should. I cannot believe how bad our profession is at project management. No matter how a firm prices (even by the hour), it should be good at project management. Yet, because of the billable hour and timesheets, we can be pretty crappy at this essential skill. We call this one of the deadly sins of the billable hour. It allows us to be crappy at determining our value, at project management, at customer communication, etc.
Good project management allows you to project, and allocate, your capacity perspectively, rather than historically as with timesheets. It plans project milestones, due dates, resources, risk, etc., and allows for excellent customer communication (certainty in delivery). Someone in the firm should be responsible for PM on each job. It needs to become a core competency, just like tax and auditing (and pricing!).
But it’s important to remember this: project management is not pricing. The two are different functions, and while they need to communicate with each other, PM should be decoupled from pricing. Think how closely related they are under billable hours and timesheets. As the file gets loaded with hours, we invoice (in arrears of course). But Toyota already knows the price of the car before they run it through the factory! The pricers are not down in the factories tracking the car’s progress, anymore than your price should be determined by watching the file wind its way through your firm.
The second tool is the After Action Review (AAR), developed by the US Army. We are huge advocates of this procedure for all large engagements. Everyone who works on it essentially asks four questions:
- What did we expect to happen?
- What actually happened?
- Why was there a difference?
- How could we do it better next time?
It’s the AAR where you can perform historical cost accounting, by simply asking: “Mark, about how long did you spend on that engagement?” Again, close enough for horseshoes and cost accounting. This will also help identify team members who are making substantial contributions to serving customers better, innovating for the firm, developing reusable intellectual capital, etc. The AAR is a critical tool for all PKFs since it’s a learning tool. Too many firms just bounce from one job to the next without reflecting on what they’ve done, how it could be done better, what they learned, etc. Yet doing without reflection is mindless activity.
As for your last question, productivity of the team. Let me posit there is no definitive, let alone accurate, method to calculate the “productivity” of your team. These are knowledge workers, not factory workers. They think. Thinking is invisible, how do you measure it? Sure, we can count the hours they log at work, but what if they are doing auctions on e-Bay or stressed over a sick child? What if they have a flash of brilliance and save a customer $10,000 in ten minutes?
Productivity is nothing more than a ratio, usually: outputs divided by inputs. This is fairly simple if you work in a factory making widgets, it’s much harder if your a knowledge worker using your brain. What are the outputs? Number of tax returns completed? Number of audits? What about the quality of the work? What about the attitude and passion of the team member? What about their customer service ethic and interpersonal skills? These are vital outputs of a successful professional, but there’s not a statistic in the world that will be able to capture them. Too many firms think they should price based on 100% efficiency, but this is totally unrealistic in a human, knowledge environment.
And what about the inputs? What should we use? Hours? But then what about the ten minute, $10,000 idea? Or what about someone spending a week developing a tool that the firm will be able to use on future engagements for several years?
In other words, forget productivity. What matters is effectiveness (hence effectiveness replaced efficiency in our equation for The Firm of the Future). Would you rather have an efficient surgeon or an effective one?
There’s nothing more useless than doing efficiently something which should not be done at all.
Effectiveness can’t be measured; it has to be judged. Yes, that is subjective, but so what? I rather judge the right things than precisely measure the wrong ones.
To your question of two people doing the same job, and how do you measure the differences. Again, you can’t measure the differences, you have to judge them. One person could take ten times as much time to do the same task, but so what? What if they are new and learning? What if they had to hold the customer’s hand over a rough situation? Are we going to charge more for the less effective person? Or charge less for the more effective one? The price has already been set, so assign the team member who has the right skills to do the job, and keep the customer happy.
If you’re asking how you allocate revenue per person, I would again ask: Why? Aren’t we one firm? Who cares what each person’s revenue is? My brother works for Procter & Gamble, and he doesn’t have revenue assigned to him. But if you insist: put the 4 people in a room and have them divide up the fixed price amongst themselves. They will figure it out, trust me.
Now Mark, I’ve thrown a lot at you in this response, and I know it’s hard to digest. But read it a couple of times, and let your team read it. You are bright people, you will figure out how to overcome these challenges if you are committed to staying a Trailblazer.
For future reading, though, I want you to read Measure What Matters to Customers. It discusses a lot of the issues in this response, especially the “productivity” vs. effectiveness of a knowledge worker, After Action Reviews, and leading KPIs for knowledge workers. It’s also a short book (less than 200 pages). Yes, I know, incredibly self-serving of me to suggest my own book, but I feel better about it after giving you this response. Besides, you know I’d buy it back from you if you don’t get any value from it.
Also, my Pricing on Purpose discusses pricing in great detail, Toyota’s success with no cost accounting (using price-led costing), and the function of a Pricing Cartel and a Chief Value Officer. It also has a sample After Action Review form.
Better yet, assign specific chapters of these books to your team and let each one lead a “Lunch and Learn” on one topic at a time. You will be amazed how much someone can learn from a book when they know they have to present it to their colleagues.
I’m going to stop, since this response is much longer than I hoped (I didn’t have time to write a shorter one). I’m sure my colleagues will weigh in as well, and I’m looking forward to their responses to you.
Mark, the challenges you cite are not insurmountable. Every firm has overcome them that has blazed this trail. You have to keep the faith and commitment. I would also suggest involving your team more in the answers. I’m constantly amazed at the innovative ideas and creativity that team members come up with when confronted with issues similar to yours. They have an enormous collective IQ—tap into it. None of us has all the answers.
Also, just to clear something up in your Pps: Did you price the $150,000 Change Order after the work had been done, or before?
I hope this helps. Keep up the great work.
Ron
Mark responded to my last question before I posted this, so I thought I’d include it as well. Regarding the $150,000 Change Order he received from the audit committee, I had asked if he issued the change order before or after the work is performed, and here’s Mark’s response:
The $150,000 invoice was after the work had been done.
We’ve also had similar situations with other clients for large invoices. Our FPA has the ‘don’t pay if you don’t feel you got the value’ clause, as well as the ‘you don’t have to pay, if you don’t get a change order before the work is done’ clause.
We do a lot of auditing, of which a fair amount is for publicly traded companies. Typically, post Sarbanes-Oxley, the small and medium sized clients find themselves up against the filing deadline, which frequently (virtually always) results in pressure on the auditor. With the additional regulation and the constant change in complex accounting standards, most clients don’t have the expertise to prepare the financials as they should. Unfortunately because of the deadline, the audit team ends up going above and beyond in the last month, and in our case there was not a benchmark, which would trigger a change order. Consequently we didn’t realize how badly under water we were until after the engagement was signed off. When we did we went back to the audit committee with our ‘good faith’ argument. Fortunately they are a quality company, and the recognized the commitment we had made and honored our invoice for an additional $150,000. We’ve incorporated some changes that we hope will prevent this from happening again.
This year we have set more specific parameters in our fixed price agreements, regarding the obligations, responsibilities and timing required of the client. As an example we now incorporate wording that results in a change order if we have to review more than two drafts of the filing; a change order if documents are not received when agreed on; a change order if we find management’s assessment of internal control to be deficient; a change order if the opinion is qualified, or if there are undisclosed transactions, e.g. discontinued operations that they haven’t accounted for properly.
We also make sure the engagement supervisors are schooled on the fixed price agreement, and are very aware of what we have and have not committed to, so they can timely identify situations requiring a change order. We did not do a good job of that last year.
Mark
Excellent Mark, that’s a very well thought-out analysis of the mistakes you made this past year (very similar to the AAR process). You simply must price all work before you do it. From a pricing standpoint, this is also when you have the maximum amount of leverage, and the customer perceives the highest value. I think the company paid the $150,000 because you showed good faith, and your service guarantee is certainly a big plus. But what if you could have received $175,000 agreed to up-front?
I think you are already know the benefits of pricing up-front, so I will not beat a dead horse. I like your concept of laying out a tighter scope with the customer, listing their responsibilities and deadlines, and triggers for Change Orders. Many firms do this, and the more you do, the better you get. Your team, no doubt, which catch on regarding scope creep. Then you’ll be able to change your woding on the Change Orders, from not having to pay if you don’t authorize a Change Order before the work is done, to before the work is begun!
Many firms insist their team members don’t pick up pencil, boot up a computer, or crack a book on behalf of a customer that doesn’t have an authorized FPA or Change Order, no different than a contractor or mechanic. It works. I’m looking forward to other VeraSage Fellows input on this.
Ron
Michelle Golden - 12/28/2006
To have a VeraSage fellow answer your Q, submit an e-mail with “Ask VeraSage” in the subject line. We’ll post your Q along with your first name and city/country and allow the dialogue* to begin!
*submissions will be posted at the discretion of VeraSage
Ron Baker - 12/27/2006
We at VeraSage do not think of ourselves as “trainers.” Dogs are trained, humans are educated. As Senior Fellow Paul O’Byrne wryly points out, “When my daughters were 12 years old, I was very happy that they had sex education...but training would have been a different thing!”
Education is not simply a matter of someone pouring knowledge into another’s head. The root of educate, educere, means “to draw out,” not to stuff in, and the ultimate responsibility rests with the willing student, not the educator. We try to always follow the Law of the Lesson: The truth to be taught must be learned through truth already known.
Value Pricing education is a challenge. Sure, we can teach the economic theory, and provide literally hundreds of examples from people’s everyday lives to illustrate how ubiquitously this practice is utilized in the great majority of businesses, from airlines to Starbucks.
We can even show them case studies from other successful Professional Knowledge Firms that have successfully implemented the concepts, along with the forms, checklists and processes they utilize. Sometimes, we have practitioners who tell “war stories” about their implementation, the struggles they encountered, and how they overcame them.
But I’ve learned, after approximately one decade of providing education on this topic, that none of the above makes a fraction of the impact on someone as when they successfully implement their first Value Pricing engagement.
It’s similar to the little boy having expressed surprise at the shape of the earth when he was shown a globe. The boy was asked, “Did you not learn that in school?” To which the boy replied, “Yes, I learned it, but I never knew it.”
How can you tell when someone really understands—at a deep and meaningful level—something as complex and multifaceted as Value Pricing? I struggled with this question for years, since professionals follow radically different learning curves, with some “getting it” almost immediately, others take years, while others never understand it at all.
Is there one telltale sign? What’s the common BFO—that Blinding Flash of the Obvious nearly everyone experiences once they finally see the light?
I finally have an answer to this question. Until we hear our colleagues utter these immortal words, we know they truly don’t understand Value Pricing. It’s best illustrated by an E-mail I received yesterday from an accountant who attended the Sole Proprietor Retreat taught by Dan Morris, Daryl Golemb, and myself this past November for the California CPA Education Foundation. See if you can spot the telltale sign that proves he truly internalized his education:
I had my first FPA (Fixed Price Agreement) closing meeting today. Went well. I was really in my head in advance of the meeting worrying about all of the possible objections the client may have. When I gave it to him with the engagement letter, he said “Oh yeah, I was expecting this” and asked if the amount listed (about $6,000 for tax returns, tax planning, and a couple of strategic planning/budgeting meetings) was for the whole year (versus per month). Then he signed it. He looked at the agreement for 5 seconds. Looking back, maybe I should have asked for more, but I am very happy with the price and since it was my first one, I let myself off the hook. Thanks again for all of your support.
[name withheld by request]
“Looking back, maybe I should have asked for more...” That’s it! The dreadful feeling you left money on the table. All pricers should feel this, all the time. It never goes away. It can’t. If it did, you’ll never truly understand the value you create for your customers. That’s precisely the BFO we look for, and it’s music to our ears.
There’s also another important lesson from his E-mail, and that’s the “Looking back” comment. We are strong advocates of the U.S. Army’s practice of conducting After Action Reviews (AARs), so we can learn from our experiences.
In today’s frenetic firms, demanding more and more output with less and less inputs, this type of activity is too little rewarded. The average professional is so busy doing they do not have the time to reflect on what they have done, let alone discover major breakthroughs. But action without reflection is meaningless, as the T.S. Eliot poem expresses well: “We had the experience but missed the meaning.” In Latin, reflect means to refold, implying the action of turning things inward in order to see them in a different way.
Is there any doubt he learned by reflecting on what he did right, and wrong, in this pricing encounter with his customer? Does anyone doubt that his second Fixed Price Agreement will be better, and his third better still, and so on? Pricing isn’t a science, it’s an art. But it’s also a skill—the more you do it, the better you get.
How often do you ask yourself: “How much money are we leaving on the table?” Until you’re asking yourself that question—and trying to answer it—every single day, you are not Value Pricing. You are simply using hourly billing—the Sisyphus of morons. We congratulate our colleague for his personal BFO and for now beginning his journey of getting better at pricing, not just costing.
Ron Baker - 12/21/2006
VeraSage Fellow Chris Marston has an excellent post on his Blog, ”Pricing Psychology Part 1: Why Many Attorneys Lose Money with Fixed Pricing.”
It speaks for itself, so please be sure to read it along with the comments, which are also quite interesting. My favorite lines are when Chris writes, “Again, the profitability problem is not in the model, IT’S IN YOUR HEAD!,” and “Formula-based pricing (which really is the same as the billable hour) is VALUE IGNORANT.” Excellent post, Chris!
Michelle Golden - 12/20/2006
Check out this article at Workforce.com about ROWE: Best Buy’s conversion to a flexible workplace. From the article:
Welcome to Best Buy’s Results-Only Work Environment, or ROWE, a radical experiment whose aim is to reshape the corporate workplace, achieve an unparalleled degree of work/life balance and redefine the very nature of work itself. In ROWE, most of the rules, restrictions and expectations within which corporate workers traditionally labor—such as keeping regular hours and showing up at the office each morning—are discarded.
Instead, employees are allowed to decide how, when and where they get the job done. Whether they choose to work in the office or somewhere else, such as a spare bedroom, salaried employees are required to put in only as much time as it actually takes to do their work. (Hourly employees in the program have to work a set number of hours to comply with federal labor regulations, but they still get to choose when they do it.)
Physical attendance at meetings usually is optional. As for supervisors, they no longer give the hairy eyeball to anybody who lingers too long at the water cooler or occasionally dares to leave in the middle of the afternoon to watch a child perform in the school play. The only yardstick for evaluating employees is whether they meet goals for productivity.
I guess the greatest barrier will be related to the last sentence of the excerpt, above. There would actually have to be GOALS established, in advance, as to what needs to be accomplished.
So, in what year do you forecast law and CPA firms will be adopting such an approach? Any bets professional services will be the LAST industry to adopt?
Michelle Golden - 12/19/2006
No doubt about it. We’re in crisis mode.
Recently, the Anonymous Accountant blog featured an eye catching post: ”Holy Crap, This Really Sucks”
Two months in as an auditor in the Big 4 and s/he writes:
Some may have been wondering where I have been. Lately, I have been somewhat too disillusioned by the accounting profession to bring myself to right about it. Two months in, and I really HATE public accounting. I started off with a positive, “gotta pay your dues” attitude. Everyone does. But it wears thin not long after your training.
First, you begin to realize that all of the other associates and senior associates also dislike their jobs, yet they keep doing them irregardless of this fact. You especially begin to notice that the senior associates have arguably the hardest, most time consuming job which they must do for very little pay. I must say, they are troopers and so far my seniors have been very supportive, but it gives you little to look forward to with that “paying your dues” attitude. After all, if what I have to look forward to is 60-70 hr weeks planning and supervising audits for what DEFINITELY is the LOWEST salary for someone putting in those kind of hrs, then hope feeds quite quickly.
One senior told me everyone starts off thinking that they will do their 5-6 yrs, get to the Manager level and then leave. This too fades, and you begin to understand why so many leave after getting their designation.
Straight from the horse’s mouth. This is pretty much what I hear in firms, too. In firms of all sizes; not just the giants. Same thing in law firms.
I was reading INSIDE Public Accounting’s most recent survey this week and came upon staggering stats that parallel what I read in the legal profession. That the average tenure for accountants at the various levels is only 5-6 years—peaking about a year or two after accountants become qualified&mdash&and dropping down toward 5 years average length of stay for more experienced accountants.
Similarly, but perhaps a little worse, the legal profession reports that 85% of lawyers areleaving the profession within 5 years.
That’s it. Five to six years. And how much you wanna bet that a good portion of those who stay longer aren’t the ones whom you most wanted to stay?
Law and accounting both face the “who will be left after all these smart, bored, and spent kids leave the firms and go into industry or leave the profession altogether” syndrome. Firms are discouraged and so are we.
VeraSage has some exciting plans to inspire team members to stick around and give these professions a chance. But firm management might not like what we plan to teach their team members. We’re even thinking of advertising these programs as “The CPE your partners don’t want you to have.” What do you think?
As such, we realize firms may not want to foot the cost of the program or allow people the time off to attend. We recognize this so Ron Baker and I plan to offer some inspiring and eye-opening seminars on Saturdays, all around the US, at barebones prices (under $50 just to cover materials) so that even the youngest, most modestly paid professionals can attend.
Stay tuned for dates, locations, and early-bird sign-ups later this week!
Ed Kless - 12/13/2006
“She felt the excitement of solving problems, the insolent delight of taking up a challenge and disposing of it.” - Ayn Rand, Atlas Shrugged
One of deleterious effects of the billable hour, as we at VeraSage call them, is the propensity to entice professionals into practicing solutionism. This is a term I have coined to describe the condition wherein a professional provides a solution for a customer, not for the benefit (i.e., value) of the customer, but, rather, solely for the purpose of solving the problem.
Solutions, in and of themselves have no inherent value. It is only when the solution is applied to a current problem or potential needed result that the solution derives value. The trouble with the billable hour is that it often leads professionals astray at the expense of the customer.
Let me explain by providing an example.
A customer comes to a professional with a current problem or requirement, for example, a seemingly needed new report that they, the customer, could not develop on their own. The customer will ask, “So, how much will that be?” The solutionist professional will take the customer’s view of the problem as sacrosanct with no additional inquiry and respond as follows, “About 8 hours.”
Strangely, the professional did not even answer the question. Rather, he responded with a nonsensical time estimate leaving the customer to remember the professional’s billing rate and do the calculation in her head. “Oh, so $1,400. Your rate is $175 an hour right?”
“Yes, $175 an hour, so about $1,400,” he echoes. Notice his restatement of the estimate by repeating the word about.
“Ok, do it,” the customer replies.
Now, it begins to get interesting. The professional in his zeal attacks the report like a hungry shark. What motivates him is the challenge to solve the problem, not the value to the customer, but his own desire to be the hero. For some professionals, myself included on some occasions, the feeling of solving the problem is as addictive as crack cocaine. It is truly an adrenaline rush and we need our fix. This is the essence of solutionism.
In this example, let’s say that the report takes twice as long as the estimate to create. The professional sees no problem in this and gives the solution to the customer. The customer accepts the solution and is happy with the results, until, two weeks later, when the bill arrives.
“Hey, what’s this bill for $2,800 for?” she questions.
“For the report you asked for, remember?”
“You said it would be $1,400.”
“I said it would be about $1,400.”
“Ok, fine, explain to me how $2,800 is even close to $1,400.” And, so it goes.
The sad part is that the professional asking a few more questions upfront probably could have prevented this whole thing. The professional should have “moved off the solution” as Mahan Khalsa says, by saying, “We do those kinds of reports all the time, but I was wondering what is driving the need for this report?”
One of two possible outcomes would follow this question. The customer and professional would examine this presenting problem and find what the value of the solution really is. If the solution has, at least some value, then they could come to an agreement on price or, if value could not be found, the customer and the professional would agree that the solution is not worth pursuing. The solutionist professional fears this latter scenario, not necessarily because it means no work, but because it means no solution. No solution, no fix!
Beware the solutionist professional!
Webmaster - 12/13/2006
Southland, New Zealand—December 4, 2006—VeraSage Institute is proud to announce that senior fellow Brendon Harrex was named New Zealand’s Young Chartered Accountant of the Year. Each year, the Institute presents this award to celebrate the profession’s rising stars and recognize exceptional individual achievement.
At 33 years of age, Harrex is the youngest chairman of a major accounting firm in New Zealand, Ward Wilson Ltd. With only nine years in the profession, he has been instrumental in the firm by leading the charge toward eliminating timesheets and offering customers agreed prices before beginning work. This innovative approach has contributed significantly to the firm’s recent revenue growth.
Read full release in pdf.
Check out newspaper articles regarding Brendon’s win.
Brendon Harrex - 12/11/2006
The extract below is from the E Myth Revisited—Why Most Small Businesses Don’t Work And What To Do About It—by Michael Gerber.
The best of the best I have known are extraordinarily grounded people; they are compulsive about detail, pragmatic, down to earth, in touch with the reality of ordinary life. They know that a business doesn’t miss the mark by failing to achieve greatness in some lofty, principled way, but in the stuff that goes on in every nook and cranny of the business—on the telephone, between the customer and the sales person, on the shipping dock, at the cash register. And so the great ones I have known seem to possess an intuitive understanding that the only way to reach something higher is to focus their attention on the multitude of seemingly insignificant, unimportant, and boring things that make up every business. (And that make up every life for that matter!)
The simple truth about the greatest business people I have known is that they have a genuine fascination for the truly astonishing impact little things done exactly right can have on the world.
Have an awesome week and remember, the difference between good service and exceptional service is in the simple details.
Ron Baker - 12/08/2006
Professional Knowledge Firms lament the fact they can’t find good people. But that’s often a function of not being able to retain, and develop, the people they already have.
It seems competitive pressures, lack of a coherent pricing strategy, and the worship of the Almighty Billable Hour are all colliding, making Australian law firms relatively crappy places to begin one’s career.
In an article in the November 23, 2006 issue of Australia’s Lawyers Weekly, ”Reality versus expectations sees lawyers leave the law,” Justice George Palmer recounted in a speech to practical legal education teachers:
Just in the last month, I have heard of two young lawyers who became completely disillusioned after working for a year or so in a large firm, and have left the law for good.
Palmer then cited the experience of one of his team member’s recent job interviews at a large city firm who was told by a senior lawyer:
I’m a busy man, I don’t have time to be nice, so if you’re looking for some sort of mentor you’ve come to the wrong place. I have high standards and I’ll hold you to them. If you don’t meet them you’ll soon know about it. If I suspect you’re not giving me 100 per cent of your best you’ll soon know about it. Don’t expect this to be a nice place; it isn’t.”
Makes you want to sign right up, doesn’t it? The article goes on to cite consultant Sue-Ella Prodonovich, who advises firms not to create a gap between the expectations of recent graduates and the reality of practicing law. Good advice, to a point. Until she offers her method to do this:
Say to them ‘this is hard work, you will work long hours, you will be working with great clients, a high-powered team.’
No doubt this is better than not informing the interviewee that the firms intends to make them a galley slave on the SS Billable Hour, but is it really enough to attract top talent? More importantly, is it enough to retain that talent once the firm is lucky enough to hire them? She claims US firms are doing a better job of managing team member expectations, but count me as a skeptic.
Do these firms really believe that this generation of knowledge workers is going to work long hours simply because the past generations have? Do they really believe that this generation confuses being busy with being valuable? Do they really believe this generation subscribes to the labor theory of value? Or are these firms engaged in one big hazing ritual ("I lived through it, and now you will too").
Until these firms develop a core competency in pricing for value, not treating their knowledge workers as union employees, invest in life-long earning, and other progressive policies that will help develop and retain talent, no amount expectations management will suffice. They have to be able to deliver on the purpose and promise of their firms. Otherwise, why would a law firm student, who has invested an inordinate amount of money developing their intellectual capital, want to work for that type of firm?
In fact, I have come to believe there is a one-dimensional acid test for any organization, when it comes to retaining and attracting talent.
Would you want your son or daughter to work there?
For law firms, it seems, to ask this question is to answer it. That’s sad.
Ron Baker - 12/05/2006
Hugh Williams, a Chartered Accountant from Great Britain, has graciously agreed to make a preview of his new book available. Life without Timesheets: The freedom to charge what you are worth is the story of how Hugh’s firm, HM Williams, threw its timesheets onto the ash heap of history.
In the Acknowledgements Hugh gives credit to Paul Dunn and Ric Payne, “who showed me that it must be done.” Knowing both of these fine gentlemen as I do, I can guarantee that it was Paul Dunn, and not Ric Payne, who encouraged Hugh to get rid of his timesheets. I’m still working on Ric, and haven’t lost hope.
In any event, Hugh attended the RAS Bootcamp in 1998, an obviously it had a major impact on his thinking, and then ultimately, his behavior. Another testament to the genius of Paul Dunn and Ric Payne.
After reading Hugh’s book late last month, I began a correspondence with Hugh over a major disagreement I had with his approach to pricing. The point of contention was over his firm’s continuining to communicate hours to customers as a way to justify a price. In all honesty, I cringed when I read that, and I knew I had to bring it to Hugh’s attention. As a result, Hugh and I began an exchange of e-mails, each defending our position.
Thanks to Hugh for allowing us to post an excerpt from his book, and for being one of the pioneers in the profession creating a better future for posterity.
Ron Baker - 12/04/2006
In honor of Milton Friedman, Idea Channel TV is streaming the 1980 and 1990 PBS Series, Free to Choose. This series was a complement to his book—co-authored with his economist wife, Rose—of the same name.
This is a great series on the lessons of liberty and the ideas of Dr. Friedman. Towards the ending of each series, Friedman has a debate with at least one economist who disagrees with him. It’s a fantastic lesson in forensics, and very instructive.
For residents of California, you may find the introduction to Volume I (1990) by Arnold Schwarzenegger quite ironic. Given his track record as Governor of the Golden State, he seems to have forgotten most of Friedman’s lessons on limited government, spending and taxation.
On Januray 29, 2007, PBS will air a biography on Dr. Friedman, “The Power of Choice: The Life and Ideas of Milton Friedman.”
Thank you goes to the Idea Channel for making these fantastic series available.
Brendon Harrex - 12/04/2006
Once upon a time, there were two lumberjacks who challenged each other to see which one could cut down more trees in a day. At daybreak, the first one began furiously chopping down trees. He worked up a sweat and by noon he had cut down 16 trees. Meanwhile, the other lumberjack was way behind because he took the first two hours to sharpen his axe.
As he sharpened it, his challenger laughed at him thinking he was doomed to lose the race because of all that wasted time. That’s when things got interesting. By early afternoon, the first lumberjack was slowing down. It took him almost an hour to cut down one tree, while the other lumberjack was catching up fast.
This didn’t make sense—he was as strong as his friend. Unfortunately, strength had little to do with it. It was all about whose axe was sharper.
By late afternoon, the second lumberjack who had sharpened his axe had passed his friend by many trees and won easily.
Sometimes we are that keen to get into our work or a new project, that we dive right in thinking that the sooner we start, the more we will accomplish. Taking the time to plan and scope a job before actually beginning it ensures we have a clear understanding of what we are trying to achieve, have identified the issues before we start, and therefore can plan how we are going to overcome them. An hour spent at the front end preparing is far more valuable than an hour spent later on, catching up.
If lumberjacks had timesheets, who would have had the most productive hours? While the first lumberjack may have recorded the most activity, it is clear he accomplished significantly less.
Remember—our customers reward us for accomplishment, not activity. Everyone wins when you take the time to ensure you clearly understand what you are to accomplish and how, before the activity begins.
Have an accomplishing week.
Ron Baker - 12/04/2006
While I was in Kansas City, Missouri, this past November along with VeraSage senior fellows Paul Kennedy and Michelle Golden, teaching two courses for the Missouri Society of CPAs, Paul gave me a copy of a new book, Life Without Timesheets: The freedom to charge what you are worth, by Hugh Williams, a Chartered Accountant from Britain.
On my flight back home I read the entire book (it’s a quick read, at 72 pages). I was impressed with Hugh’s story, and I e-mailed him when I returned home.
That started a dialogue (and a friendship) that continues to this day. We both felt it would be worthwhile to publish this exchange because Hugh and I disagree on a critical issue. Certainly not on the validity of timesheets (since he got rid of them!), but rather on still communicating hours to customers in order to justify a price.
VeraSage profoundly believes that truth (and science) progresses based on dissent, not consensus. I don’t learn much from people I agree with. It is in that spirit we are posting this exchange. It is a long exchange (over 5,400 words, which is why we have placed it in a pdf file you can download and read at your convenience), but we think it’s an important contribution to the Value Pricing debate.
Please feel free to weigh-in with your opinions, and experiences. Hugh and I look forward to continuing this important dialogue.
Ron
Ron Baker - 12/01/2006
CLIENTS ARE almost entirely united in seeing an end to the billable hour, with a majority of lawyers willing to agree, an anonymous survey has revealed.
So writes the Lawyers Weekly from Australia in a November 30, 2006 article entitled ”Clients slam billable hour, again.”
The article cites a survey from a recent conference showing 95 percent of clients believe a majority of law firm clients want a change from the billable hour system, while 71 percent of lawyers concurred. Only 3 percent believed the billable hour was extremely effective, but 40 percent said it was some-what effective.
As if more empirical evidence was needed that the billable hour is universally disliked. We already knew that; what’s more interesting is what are these Australian law firms going to do about it? It’s like Mark Twain said about the weather, everybody talks about it, but nobody does anything about it.
On November 23, 2006, Lawyers Weekly ran an article entitled ”Please choose your payment method,” which began by stating:
If they can’t get a quote from a service provider, most consumers will move on to someone else. But law firms have so far largely managed to avoid this accepted fact of commercial life.
The reasons are complex. There are now isolated examples of law firms offering alternative ways of pricing their services, and more are likely to follow driven by a combination of market dynamics, client demands, and competition, not to mention national profession laws requiring upfront costs agreements.
No, the reasons are not complex. The fallacies are complex. The subjective theory of value teaches us that value is in the hearts, minds, and souls of customers. It’s an elegant theory, it’s also quite simple. Yet there is an enormous difference in being simple and simplistic. Being simple often is the outward sign of depth of thought.
Ronald Reagan had a simple idea about the Cold War: America wins, the Russians lose. Most economic theories are relatively simple; it is the fallacies that get complicated. It is an unnecessary complication to believe that complex effects must have complex causes.
The fact that the earth tilts on its axis is fairly straightforward, but this certainly causes complex reactions in plants, animals, people, ocean currents, and so forth. To say that value is subjective is also fairly straightforward; it’s when we deny this basic theory that we run into vast complications.
The billable hour contradicts the subjective theory of value, so if you start with the wrong theory, it doesn’t really matter how accurate everything else is, you end up with precisely the wrong result. How many instances of this do we have to hear from customers—not to mention lawyers themselves—before we understand this basic point? Einstein once said, “Perfection of means and confusion of ends seems to characterize our age.” Nowhere is this more true than in how professional knowledge firms price.
If the billable hour correlated with value, why is everyone so frustrated with its continued use? The article quotes general counsel:
One general counsel we spoke to said ‘the first firm that gets fixed fees right is going to clean up,’ he says. There are other general counsel saying: ‘I’m comfortable with hourly rates, because I can compare the rates [easily] from different firms, from one to another’. There are different views on the specifics.
In the final analysis, the customers are not the ones who change pricing strategies. I have intensely studied the history of industry pricing changes, and nearly every one was driven by the sellers, not the buyers. Why?
Because it’s the sellers that have the most incentive to capitalize on the gains from pricing commensurate with value. Sellers sell thousands (or millions) of times, whereas buyers only purchase relatively infrequently. It’s simply not worth their time to try to change how the businesses they patronize price their products and services. But when a competitor comes along with a superior pricing/value model, they switch.
The article also quotes Colin Jasper of Beaton Consulting:
According to Jasper, “contemporary pricing theory” says a combination of three different methods of setting prices should be used: the value the client places on the deal (known as the marketing emphasis), competition (the sales emphasis), and the cost of providing that service (accounting emphasis).
With advice like this, we don’t need consultants. I know of no “contemporary pricing theory” that states these three methods, not to mention the utter lunacy of trying to use a combination of all three (I’ll give him the benefit of the doubt and assume he didn’t mean at the same time). In realty, the only pricing strategies are Skim, Neutral and Penetration. Once again, consultants love to obfuscate the obvious with dubious language.
What possible good is it to price based on cost if that cost exceeds value? And why would any business want to let it’s dumbest competitors set its price? And which competitors? Is Porsche concerned with what Chevy charges? Is Ritz-Carlton concerned with Hampton Inn’s rates?
Strategy determines price, not the other way around. It may come as a shock to some consultants, but firms pick their competitors through the strategy they adopt. To say that the competition sets price is utterly meaningless until you define the competition. And even then, you have room to charge a premium if you offer a superior alternative. See iPod and Disney for just two examples.
There is one bright spot from this article:
The chief executive partner of Minters’ Adelaide office, Nigel McBride, told Lawyers Weekly the service they offer is not just commodity-based, but includes sophisticated legal services in medical and workers’ compensation claims management.
“The whole system before we came along was based on inputs,” he says. “How much time did you put in, how many pages did you write, how many pages did you read, how many files did you open. We just scrubbed that completely; our lawyers don’t even put down their time.”
McBride says essentially their system has removed the “ridiculous” amount of time some lawyers spend on “shuffling paper, filling in time recording and counting pages to bill”.
“That all goes and that makes [the lawyers] incredibly efficient because they can focus on being lawyers on that part of the case management that requires their strategic input.”
But then McBride slips right back into the fallacies, with this unbelievable contention:
However, he says there will always be certain areas that cannot be offered on a fixed-price basis. “I don’t think we’ll see hourly billing replaced in a number of areas. If you are doing high-level tax advice, [for example], you can’t commoditise that.” But he maintains “so much of the legal market” could be offered on a fixed-fee basis.
Why do these lawyers assume that only “commoditized” work can be fixed price? Because they know how long it takes to do it, on average. We are right back into labor inputs equal value, a fallacy dating back to Mr. Karl Marx (and long before).
What they don’t know is the value they have created, because they’ve never given it much thought. As Oscar Wilde said about cynics, they know the cost of everything and the value of nothing.
If lawyers had any pricing acumen at all, they would realize it’s exactly the work higher up on the value curve that should be value priced, since that is where they would be able to capture more of the value they are creating. With hourly billing, they are overcharging on some jobs, while undercharging on many others.
VeraSage Senior Fellow Paul O’Byrne has been doing a lot of work in Australia lately with law firms, and obviously has been stoking the flames of reform. The billable hour is on the defensive. There exists an incredible window of opportunity for the first firms who move to a real Value Price model.
Do these lawyers have the courage? Do they have the vision? The leadership? The faith in their firms and the value they provide? A faith in the future?
Or will they remain tone deaf to the cries of their customers, who are anxiously waiting for the opportunity to defect to a firm offering a superior value proposition?
Stay tuned…
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