On a beautiful day here in North Texas, my family and I decided to take a short trip from Allen to McKinney to attend the Oktoberfest running this weekend. On the way from the parking lot to the quaint city square we encountered this.
Oh, help! Talk about not getting it! Here is the thing, upon visiting their Web site I found that it is not as bad as it could be. They do, in fact, offer “packages” that are menu priced. Maybe the name is just the problem.
Paul Miller and Paul Bahnson did it again in their regular article series “The Spirit of Accounting,” in Accounting Today. I wrote previously about their Sept 8-21, 2008 article, “The perils of clinging to the status quo—Part 1.”
In the September 22-October 5 issue, they are back with Part II of their response to the status-quo CPA, “Tom,” who is defending the increasingly irrelevant historical GAAP financial statements.
They slaughter more sacred cows in this article, such as comparability—the argument that GAAP produces consistent and comparable financial statements. This, of course, is nonsense. What it actually produces is a mindless adherence to principles that produce results valuable to no one.
As they say, GAAP never asks the auditor to question if the financial statements are useful for making decisions; they only ask if they comply with GAAP.
This point especially resonates to those of who understand GAAP is increasingly outdated for a knowledge economy:
Tom and the many who agree with him miss the point that the whole purpose for accounting is to provide useful information that facilitates rational and productive economic and other kinds of analyses. Rather, they seem to think that accounting’s purpose is to help accountants do the same riskless things over and over again.
As Ed Kless taught me this last week, project management can sometimes suffer from the same problem. It becomes the ends, rather than a means to an end.
CPAs seem to be doing GAAP because they can, with a historical legacy to justify their decisions. But they are ignoring the fact that these principles are virtually worthless to users of financial information for making future economic decisions.
If all the profession wants to do is to be scribes with respect to the past, then perhaps they should be relegated to that role, while letting others enter the market of providing financial statement attestation to interested users, willing and able to pay for knowledge they value.
This path would be far more challenging and full of opportunity rather than to continue playing historians with lousy memories. Miller and Bahnson seem to agree:
Our suggestion to [Tom] and others like him is to channel their energy and talent into achieving progress, instead of trying to protect and preserve the deeply flawed status quo. They deserve a better purpose for their professional lives, specifically leading the way into the new paradigm. We have nothing but best wishes for them and high hopes that they can see the world in the same new light that we encountered ourselves only a short decade or so ago.
It is so rare to read such candor in the accounting mainstream media. Miller and Bahnson are fearless pioneers, willing to challenge the status quo. I only wish there were more like them.
To be fair, there is one other voice in the same issue of Accounting Today, Wanda Wallace. At least in this article, “Take back the professions!” she is arguing against the check-list mentality and outside regulation of the profession.
One of the hallmarks of being a profession is autonomy—Greek for “self governance.” The CPA profession is no longer self-governed, what with the alphabet soup of regulators looking over the profession’s shoulders.
Due to rent-seeking and what economists call “regulatory capture,” the profession for the most part doesn’t have a problem with this. Witness Grant Thornton CEO Ed Nusbaum comment with respect to PCAOB being found constitutional in a recent court ruling:
Personally I think it [would be] a mistake to do away with the PCAOB, he said. The PCAOB is painful at times. We don’t always agree with their comments. They’re tough. Sometimes they even bring firms up on charges. I think they’ll continue to be aggressive, so it’s not like we love them. But, on the other hand, you need some oversight. They seem to be doing a pretty good job at that, and I think it would be a mistake to get rid of them, because then there’s no regulator.
I don’t doubt he thinks that, since his firm has benefited mightily from regulatory revenue. Even absent that, there’s enormous proof that PCAOB and SOX has hurt the very investors it was designed to help.
What happened to our profession’s belief in free markets, competition and capitalism?
We seem to be willing to run to the nanny state, hat in hand, lobbying for regulations that increasingly decrease our liberty and freedom. All under the guise of protecting the investor class. How far we’ve drifted from the signers of the Declaration of Independence.
Want to protect investors? Open up markets to competition, including the auditing profession and establishment of GAAP. Let the market sort out what are the best processes.
We do this with everything else in our lives, why not the accounting profession?
There’s nothing sacred about a profession. They can and do die, especially when they no longer add value to those they are pledged to serve.
If “Tom” is representative of the thinking among the leadership of our profession, then we may very well be at the beginning of the end.
As Henry Ford said: “The man who is too set to change is dead already. The funeral is a mere detail.”
I’ve been remiss in not posting about the Professional Pricing Society’s Blog.
PPS is an excellent organization. I’ve had the privilege at presenting at many of their seminars and have tremendous respect for the vision and leadership of Eric Mitchell, its president and Founder.
As a result of organizations such as PPS, pricing has become a distinct discipline in corporations around the world. PPS explains its purpose on its Web site:
Founded in 1984, it now serves thousands of members, representing all leading industries and over 50 countries.
The Professional Pricing Society’s mission is to nurture a growing community of pricing professionals committed to disseminating pricing expertise throughout the business world. We do this by providing a multi-platform forum through which exceptionally talented and creative experts can exchange cutting edge pricing strategies, tactics and technology. In short, we connect great ideas with great people.
Be sure to add PPS’s Blog to your list of regular reads. It’s full of excellent information and ideas from dedicated pricing professionals.
(Darn it Ed, 167 words, you’re right, I can’t Twitter!).
So last week, I took the plunge and have begun to “twit” in earnest.
For those of you who have not heard, Twitter is a microblog/social networking/time waster. Here is a BusinessWeek article about the pros and cons of Twitter which, curiously, someone twitted to me. Microblog means you can only post 140 characters at once, which will pretty much rule out Ron Baker from ever twittering.
If you are interested my Twitter user name is edkless, so feel free to follow me if you like. I will follow you too so you don’t feel so lonely.
In the meantime, what are your thoughts on Twitter?
Consulting requires rational thought. Is everyone ok with that premise? Often times I think that half of consulting is pointing out contradictions in the attempted logical thinking of our customers.
One of the tools I have found that works best when one comes across these contradictions is the Help-me-understand question. Here’s the basic structure:
“Help me understand how A reconciles with B?”, where A and B are contradictory thoughts.
When asked in the right tone, this question, while it appears to be seeking understanding, is really pointing out the contradiction. I find that it often leads the customer to the realization of the contradiction and therefore the ability to correct the irrational thinking.
Ok, because I cannot help myself, I must ask one of these questions myself — Help me understand why the talking heads on TV are talking about the market failure of Fannie Mae and Freddie Mac when the F in both stands for Federal?
If you receive the FOX Business Channel in your cable line up, you are in for a real treat. In two weeks, they are featuring The Call of the Entrepreneur at the following times:
Saturday, September 27 5:00 - 6:00 PM EST / 2:00 - 3:00 PM PST
Sunday, September 28 12:00 - 1:00 AM EST / 9:00 - 10:00 PM PST
This is an outstanding documentary on the ethics and moral justification for the free market. We at VeraSage have been very proud to be a part of several screenings of this film. It completely destroys the “zero-sum game” beliefs about capitalism.
Hat tip to John Chisholm in Australia for sending along the following article from the Australian edition of The Economist, a magazine I read regularly and have tremendous respect for.
The article is from the August 28th print edition. It’s titled “Killable Hour.” Here are the highlights:
Is time almost up for clockwatching lawyers?
OF ALL the tedious tasks that lawyers have to do, time-recording is perhaps the most deadly. Private-practice lawyers account for their time in increments of 15 minutes, or even five or six minutes at some firms, and then send the bill to clients. This structure has been in place for decades. But cost-cutting has put a squeeze on companies’ legal budgets, and there is growing interest in doing away with the “billable hour” approach in favour of other pricing schemes.
So far so good. But then it goes on to conclude:
If the billable hour does perish, it will be at the hands of the clients, rather than the private-practice lawyers themselves. Some companies are starting to switch to fixed fees, with a performance bonus related to results. Tyco, an American conglomerate, took this approach with Eversheds, a British firm, in a deal signed earlier this year. The firm has taken on Tyco’s commercial legal work for a fixed fee, and will receive a bonus if it improves its client’s satisfaction by 35% and reduces litigation against Tyco by 15%.
I’ve written about the fallacy of this logic so much my head hurts. I used to believe exactly the same thing—that the clients would be the impetus for change. After all, those with the gold rule.
But it’s historically not true, nor does recent evidence support this conclusion. Sure, some firms will enter into a fixed price agreement with customers who demand them in order to get the work.
But do they then spread this pricing to the rest of their customers? No. If so, the profession would have adopted fixed prices and thrown out the billable hour in the early 1990s when the ABA began to publish books on the deleterious effects of the billable hour.
It’s not the buyer’s job to change a pricing strategy. It’s the sellers.
Even one lawyer, D. Michael Grodhaus, who initially disagreed with me has come around to this way of thinking, given the evidence, in this post.
The article goes on to offer this nonsensical statement:
Litigation is less suited to fixed fees, however, because of its unpredictability.
Replace “litigation” with “earthquake insurance” and see if the logic holds up.
Then this:
Finding a new model to price legal services is no easy task. A lawyer’s skill, knowledge and experience are hard to quantify, as is the importance of a legal matter to a company. The fixed fee at least gives in-house lawyers certainty when budgeting and confidence when explaining that budget to the board.
Exactly. There’s the new model—fixed prices, just like every other business on the planet. Notice how “time” isn’t mentioned in this sentence. It’s used because it’s quantifiable.
At least their conclusion is correct:
But the legal industry is not known for welcoming change. Whatever it turns out to be, the billable hour’s replacement must be easy to use—and must strike a compromise between clarity for the client and profits for the law firm.
Why is it so hard to understand that fixed prices, along with change orders, do exactly that? What are we missing here?
But wait, it gets worse. In the American print edition of The Economist, August 23, there’s this gem:
Few managing partners know their firm’s profit per billable hour, even though that is the main product law firms sell.
The Economist, of all magazines, should know better, especially since Karl Marx is buried in their backyard. This is the labor theory of value, and they’ve debunked it in their pages often.
But, somehow, when it comes to professionals, it becomes what they sell. This is nonsense. By this logic, all everyone sells is time, from doctors to automakers. But why doesn’t anyone say this about them?
Well, for one, they’ve done a more effective job at understanding what, exactly, their customers are buying. Time can’t be bought. If it could, I’m sure we’d purchase it from someone cheaper than $1,000 per hour.
You know the labor theory of value is endemic when The Economist starts to promote its virtues.
We have a lot of work to do to change this thinking.
Paul Miller and Paul Bahnson are at it again in their regular article series “The Spirit of Accounting,” in Accounting Today. I wrote here about their recent article on GAAP deficiencies, and in the Sept 8-21, 2008 issue, they have another excellent article, “The perils of clinging to the status quo—Part 1.”
The May 2008 issue of The Journal of Accountancy included some commentary by Paul Miller. In response, a CPA emailed him and defended the status quo against “the ravages of value-based accounting practices,” stating that “When we increase subjectivity, we decrease value [of the financial statements].”
Miller and Bahnson spare no contempt, or logic, for this status-quo CPA. Here’s my favorite part of their reply:
An audit cannot make GAAP statements useful any more than an alchemist can turn lead into gold or a weaver can turn a sow’s ear into a silk purse.
What we see in his premise is a reflection of the profession’s blind spot that causes it to overlook the fact that, more often than not, compliance with GAAP doesn’t produce useful information.
Amen. How refreshing to hear criticism like this coming from inside the profession.
Too often, the accounting press is like reading Pravda in the old Soviet Union. If you don’t tow the party line, you’re exiled to Siberia.
Miller and Bahnson are fearless at pointing out the deficiencies in our decrepit, ossified reporting model known as GAAP.
But it seems that the rest of the profession is happy to continue to produce information that is of limited usefulness and value to users of financial statements, for fear any change will imperil their overblown “objectivity and independence.”
We are one of the least innovative professions on the planet, the current GAAP reporting model being Exhibit A. It’s 500 years old, and all we’ve managed to do with it in that time period is add more rules—oh, and to be fair, we did innovate the financial statement compilation and review services, in 1978.
This is why Thomas Stewart, editor of Harvard Business Review, refers to the GAAP financial statements as the three blind mice. And he’s not the only one.
It’s apparent that the profession is happy with its role of financial historian with a bad memory. We don’t look outside ourselves for new ideas, innovations, and we are constitutionally incapable of self-criticism, taking each one as a personal affront to our beloved integrity.
This is precisely why CPAs are destined to become less and less relevant in the economy of the future. They simply are not adapting quickly enough to their changing environment.
There’s absolutely nothing sacred about a profession. They can and do die. They do so because they are no longer relevant, adding little to no value to those who utilize them.
Is this where the profession is at this point in time? It may be. There’s very little on the horizon that demonstrates the profession is willing to change, innovate, or experiment with new services that offer users what they are most interested in—information that helps them peer into the future rather than simply confirming the past.
The profession’s leaders, collectively, don’t seem to be up to the challenges. Perhaps the younger generation of CPAs offers more hope? But I’ve scant evidence for that wish, given that they are trained to b greyhounds in bookkeeping while paying little attention to what is happening in the world around them.
Few CPAs we’ve met around the world even know there is a debate about the usefulness of GAAP, or what the criticisms are.
A good proxy is to look at what they read, if they read at all—since most firms don’t give their knowledge workers the time to read because it impairs billable hours. And we wonder why we’re in the mess were in.
At least their is a light at the end of our tunnel vision. For now, it’s Miller and Bahnson—and others like them—who have the courage to say the emperor doesn’t have any clothes.
Be sure to tune into the next issue of Accounting Today for Part 2 of their response to the status-quo CPA.
Have a quick look at this video and then ask yourself, “How long before we see this kind of a video about accountants in India doing US tax returns?”
Of course the last line of the voice will be, “This is exactly the kind of firm we would like to have in the US, but the AICPA (or insert your organization or consultant to the profession of choice) insisted we bill by the hour.”
There’s a classic joke that illustrates an important point with regards to the over-used term “productivity”:
A CPA from the city is walking down a country road past a farm when he sees a farmer feeding pigs in a highly unusual manner. The farmer is standing under an apple tree, holding up an enormous pig so that the pig can eat as many apples as it wants. The farmer moves the pig from one apple to another until the pig is satisfied, then the farmer starts again with another pig.
The CPA watches the farmer feed his pigs in this way for some time. Finally, he can’t resist asking the farmer, “Excuse me. I can’t help notice how hard it is for you to lift and carry and feed these pigs one by one at the apple tree. Wouldn’t it save time if you just shook the tree and let the pigs eat what falls on the ground?”
The farmer looks at the CPA with a puzzled expression and asks, “But what’s time to a pig?”
We read and hear it repeated everywhere: productivity needs to be improved in Professional Knowledge Firms (PKF). But nowhere is this term defined. What, exactly, does it mean to say that efficiency needs to be increased in a PKF?
[I will use the two words—productivity and efficiency—interchangeably throughout this post].
What, Exactly, Is Productivity?
Productivity 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 productivity, 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? Would counting the number of paintings produced over a given time period help?
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 benefits, 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, making the resulting ratio look better. Efficient, yes; effective, hardly.
The fact of the matter is, we do not know how to measure the productivity of a knowledge worker. And this is true for a very fundamental reason.
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 idles 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 (I am indebted to Thomas Sowell, and his masterful book, Basic Economics, for these two examples).
A Thought Experiment
Princeton economist William J. Baumol asks this thought-provoking question: How would you go about increasing the productivity 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 generic “productivity,” at least given the way PKFs currently measure that statistic.
So, Why All the Fuss About Productivity?
Most likely, because it can be easily measured. But that in no way means we can manage it, let alone change it, especially when you’re talking about knowledge workers. One does not change one’s weight by having a more accurate scale, or by weighing yourself more frequently.
Your automobile is not 100% efficient, since it’s idle a majority of the time. So what? When you want to go somewhere, it is incredibly efficient, since it meets your purposes.
What would you conclude regarding the efficiency—that is, output divided by input—of a particular laser beam that wasted 60 to 90 percent of the electric power received at its back end before projecting an intense, blinding beam out the front?
It doesn’t sound very efficient does it? Yet that is exactly the productivity of the laser beam used for cataract surgery to restore eyesight. It is not at all efficient. So what? It is, however, highly effective. In this case, the waste of energy is clearly a virtue, not a vice. You would never draw this conclusion studying the ratio of output to input, as the math misses the miracle of restoring the joy of human sight. If you were the patient, inefficiency is clearly superior to ineffectiveness.
None of this is meant to suggest that firms ignore productivity tools, such as document management, faster computers, software, printers, dual monitors, PDA devices, etc. We are not Luddites. No one is suggesting we return to typewriters and carbon paper, though the logic of the billable hour would reward that very behavior.
I am making a very different argument. That efficiency in a PKF, 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, 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.
What is the Purpose of a PKF?
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.
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 productive 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.
Purpose and strategy are not driven by operational efficiency. You could run the most efficient buggy whip manufacturer in the world. Again, so what? Being efficient at doing the wrong thing is a colossal waste of resources.
Walt Disney didn’t build his empire based on efficiency. Your kids are not watching The Two Little Pigs, even though this would have been one-third more efficient to produce.
This ruthless quest for increased productivity 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.
Doing the Right Thing, not Doing Things Right
Forget about productivity. 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 PKFs for customers.
In an intellectual capital economy, and within PKFs, 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 that are used were developed in the late 19th century 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 output-input 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.
You’re only going to be able to achieve that by hoisting up some pigs and stop worrying about efficiency.
It continues to amaze me that professionals can sometimes be so daft when it comes to new ideas. With pricing on purpose, it is not even a new or radical idea. Pricing the intended results before the sale is standard practice everywhere but the professions. The obsession with cost has cost more than we will ever know.
Recently I came across a series of videos from The Idea Group. Here is one on the invention of the wheel.
The scary part is I have been in this meeting with many professionals when talking about pricing on purpose. “It could roll away,” becomes “I won’t know my costs.” “I could smash your foot,” becomes “I might lose money.” “Does it come in square?” becomes, “Can you give me any assurances that this will work?”
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