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Archive for June, 2007

Missed Moments

June 21st, 2007

Andy Grove of Intel once said “There is at least one point in the history of any company when you have to dramatically change to rise to the next performance level. Miss that moment and you start to decline.”

I wonder how many opportunities to achieve great things are lost because of the “missed moment”. I suspect it explains why so many practices grow rapidly to a point and then seem to stagnate and/or decline.

It also explains why some new kids on the block seem to be able to put firms together that have a refreshing feel about them and represent a viable alternative to the established organizations. These firms experience rapid growth and often race past the established firms with respect to profitability, the ability to hire and retain talent and the quality of new business they attract. These firms represent the new order.

But once the new order has become established, complacency sneaks in, a fear of losing market share emerges, innovative energy subsides and “the moment” is missed. The firm settles comfortably into the role of being an accounting business like all the others and gets more or less the same results as all of the others.

And those results are not always great. In fact they are scary.

The Australian Bureau of Statistics Accounting Practices Survey (2001-02) notes on page 4 “Despite a growth in the activity of accounting practices, profitability declined since 1995-96, decreasing 0.6 percentage points from 19.4%. Profitability continued to decline since 1992-93 when the operating profit (before dividends and drawings) was recorded at 20.5%”

Taken over the longer term it looks even worse than that. For smaller practices with less than 10 partners, here are some disturbing trends.

Blog_Productivity

This graph shows accounting firms have been able to generate more fees (in CPI adjusted value) over the past 30 years. Technology has obviously played a role in that. Interestingly smaller practices have seen the highest productivity gains as shown below.

Blog_Prody_Growth

And as you’d expect this has enabled less people to do more work so the number of team members per partner has fallen.

Blog_TeamPerPtner

So far so good. With labor costs rising all the time we might reasonably expect the productivity gains from technology to be reflected in a bigger bottom line. WRONG!

When Net Profit per Partner for 1971 is expressed in 2002 dollars we discover that it has actually fallen. What’s gone wrong?

Blog_NPPerPtner

Obviously this does not apply to all firms. I know lot’s of firms that are doing fantastically well. But I think the profession as a whole is suffering from a malaise.

Why is this happening?

My thoughts on this are as follows:

Technology has flattened firm structure so that higher level people are able to do lower level work, not because they should but because they can. Because clients are vocal in their concern with fees, some firms have been experiencing horrendous write-offs (in the range of 30-40% in some cases and typically in the 10-18% range).

Clients have become less loyal, more mobile and much more vocal about fees especially in the face of increased compliance requirements mandated by the government. Additional compliance costs are the necessary evils of business and the work is not viewed as being valuable. This has served to keep charge rates down and/or write-offs up.

The use of timesheets as the exclusive basis for billing is likely result in downward fee pressure for several reasons:

· To the extent that technology-driven productivity improvements leads to improved faster throughput because of better workflow management or higher first pass yield, the savings are passed on to the client in the form of lower real costs when timesheets are used for billing.

· Work that is considered low value by clients is assigned the same hourly rate (when done by the same person) as work that would otherwise be seen as being higher value but it is always the lower value work that sets the perception of overall value received.

· A reward structure that gives a strong emphasis on time causes higher value people to hoard lower value work which has a huge opportunity cost because although they are “busy”, they are neither seeking nor doing higher value work. Once again this negatively impacts clients’ perception of value and keeps charge rates down.

I believe inter-firm comparison and best practice benchmarking studies contribute to industry complacency and a migration towards mediocrity. Simply put, human-kind has a heard mentality. We tend to feel comfortable going with the flow and as long as we’re performing more or less at the same level as others around us we’re content with life.

At the risk of appearing to contradict myself, I do not believe that these studies are useless. In fact I find them very useful to identify potential and in particular to remind under-performing firms that there is room for improvement. But I also believe they can stifle innovation by encouraging under-performing firms to mimic the strategies and operations of the best performers and while this might help the under-performers lift their game it manifests a me-too industry that has very little product or process innovation.

Finally, the barriers to entry for this profession are low while the barriers to exit are high. This is one of the main reasons for the industry being so highly fragmented and explains why prices are below what they would be with a higher degree of consolidation. A discussion of this is best held over for another day because it addresses the whole issue of industry economics and structure. Suffice it to say that the price floor in highly fragmented industries such as the accounting services sector tend to hover at a level just high enough to keep the marginal service provider in the industry and this serves to pull all prices down.

The consequence of this is that the consumer of the services of accounting firms has been the consistent beneficiary. However, those firms that choose not to play by the “industry rules” and instead offer innovative (true value added) services, innovative pricing systems, innovative delivery models and innovative organizational structures can and are doing extremely well. These are the firms that are ready and willing to move when the “moment” arrives.