Armed with a new PhD in Organizational Behavior at the age of 30 Goldsmith was making very good money doing 360-degree feedback consulting when one of his mentors said “Marshall, your problem is you’re making too much money. You’re very successful running around selling days and getting paid.  But you’re becoming addicted to this success. At your current pace, all you’ll do is run around and sell your days. You’ll have a good life, but you’ll never be what you could be.”

His mentor suggested to him that his idea of “success” was limiting his vision of what he’s capable of.  Goldsmith went to to say “I’m convinced that if Paul hadn’t pointed this out, I’d still be doing today what I was doing 30 at thirty.”  It’s amazing how some brief, almost trivial, conversations can be life changing!

This is precisely the same message conveyed by Jim Collins in Good to Great – good is the enemy of great because it causes us to be reluctant to challenge the status quo.  By nature most humans do not generally like to take risks.  Making choices that could result in you moving out of our comfort zone of “good” immediately conger up thoughts of the trade-off between what you believe you must give up and what you stand to gain.

This is natural and yet in my personal experience, and in every situation I’ve been told about by other people, accomplishments I and they have been most proud of have resulted from a career change. If you are interested in this issue I strongly recommend Susan Jeffers’ book Feel the Fear and Do It Anyway.  If you’ve got children or grandchildren it’s worth reading too!

During the last 20 years I have dedicated my professional life to helping accountants experience a more fulfilling life by creating a firm that focuses on creating exceptional value for its clients, team members and owners.  But I did not start my career with that purpose in mind.  It evolved as I’m sure everyone’s has.  After all, when a 5 year old is confronted by a career choice of becoming a CPA or a Fireman the latter will win every time so when does one’s career path become evident and is it a path we really want to be on or is it the result of circumstance?

I’ve had 4 careers. First, as an economist with a government department – in many ways this was a dream job, it was interesting, challenging, for the most part I worked with exceptionally talented people, I got to travel and I enjoyed rapid promotion.  I could look forward to the security (it was tenured position) and perks (e.g. fully funded retirement benefits) that then attached to a government position.  My mojo was intact, I liked to go to work.  But during that time I started a business on the side which turned out to be a financial success but the real payoff was that I got the “business bug.”  This resulted in me feeling a shift in what gave me a positive spirit about what I was doing which led me to walk away from a secure future to pursue my next career.

I enrolled in Graduate School and discovered a mentor who piqued my interest in the role accountants could play in helping small business managers achieve their full potential.  He encouraged me to pursue a research and teaching career.  I loved it.  I’d found my mojo: for a time anyway.  With tenure and the security that offers, it would have been easy to settle into teaching.  I still believe few careers are more noble or rewarding than teaching but as was the case with Goldsmith, a friend said “you’ve got a lot more upside potential in public practice” so off I went on another career change.

Everything I had done before going into practice was a preparation for that excursion into the unknown. When I look back on that now I see what a big risk I was taking financially–a view shared by my first wife I suspect. But once again I’d found my (new) mojo.  I loved what I was doing.  I loved the challenge, I loved my colleagues and I loved our clients.  I felt I was making a difference on many levels so my life had meaning.

Then along comes another opportunity.  This time it’s a small business conference conducted by Paul Dunn in the Blue Mountains bordering Sydney, Australia. Paul said from the stage “… our goal is to change the face of small business on the planet.”  I looked around the room and saw about 130 business owners and I thought “… at this rate that will take a thousand lifetimes but what if we married his incredible energy and insights with my experience and protocols and tap into the accounting channel. That would give us the leverage needed to get somewhere near accomplishing that lofty goal and in the process it will give my colleagues in the profession an opportunity to play off our experience and most importantly, give them their mojo back.”

This is now what I do and each of those career experiences was a building block for the next one.  I have my days like everyone but my mojo is well and truly intact.  It has given me a greater sense of satisfaction than you could possibly imagine.  I’ve been privileged to work with with literally thousands of accountants around the world and many of our team members are now also consulting to the profession in some form or other.  I’m proud of this because I know Paul and I inspired them to take this path and they’re helping the profession rise to greater heights.  But my work is far from done.

When I started on this journey I thought the answer to building a successful firm was to give people a roadmap that provided them with direction together with a suite of tools and methodologies including marketing resources and sales training.  These things are incredibly important but I now consider them to be a table stake in the sense that without them the challenge of building a great firm is daunting and will be harder, take longer and cost much more than you expect.  However, they alone are not the answer for the majority of people.

I’m now certain that personal development must come before practice development.  By this I mean it’s crucial that you have a very clear understanding of WHY you are in practice.  Only then can you have that “positive spirit towards what you are now doing that starts from the inside and radiates outside.” This is a personal thing for sure but when you get to clearly understand WHY you are in practice the other things fall into place and you’ll be amazed at what can result.

Recently we conducted two webinars that were presented by Tim Fitzgerald, one of our members from St Louis, Missouri.  The webinars were about the importance of understanding why we are in practice and are based on Simon Sinek’s bestselling book Start with Why: How Great Leaders Inspire Everyone to Take Action.  Essentially Sinek’s message is that people do not buy what you do, they buy why you do it—Sinek has done a great presentation on TED that’s worth viewing.  If you would like to view Tim’s webinars click in this link.

In the November, 2011 issue of The Harvard Business Review there’s a short article written by Peter Fuda and Richard Badham called Fire, Snowball, Mask Movie: How Leaders Spark and Sustain Change that also points to the importance of having a very clear “why” in any transformational effort.  Click on this link to view a really cool animated movie showing Fuda’s three metaphors that “explain, inspire and accelerate leadership transformation.”

With that in mind I’d like to recount a conversation I had with one of our clients that I recently shared with our members and friends in an end-of-year note. I talked about how easy it is to miss the incredibly important contribution we can all make to our clients and our community when we allow ourselves to be drawn into the “vortex of compliance.”

I was privileged to talk with one of our members from Seattle, Washington, and he mentioned in passing how tough the past few years had been for many of their business clients. But he went on to say that after using GamePlan he had saved one from bankruptcy and had helped another experience a $300,000 increase in profitability (more than double the previous year!) as a result of showing them the folly of dropping prices and the critical importance of focusing on transaction planning and monitoring.

I mention this not to sing the praises of GamePlan (hopefully it speaks for itself!) but because the conversation moved to what I consider to be the really important issue and that is accountants have the power and the position to make a difference in the lives of people.

Randy mentioned that had he not had these conversations with those two clients who knows what might have happened to them—one may have succumbed to bankruptcy and the other may have left $300,000 of profit and possibly $1million of business value on the table.

The conversations that took place were not based on rocket science.  All they took was for the CPA to shift his mindset from that of service agent to change agent.  Change agents literally change lives.  I passionately believe that this profession has people with the skills together with the opportunity and, dare I say in these tough times, also the responsibility to proactively help business clients not only survive but set themselves for long term prosperity.

I don’t know if we’re at the bottom of the business cycle, still on the way down or on the way up but I do know that we are not at the top.  If I were starting a business I would not want to be doing so at the top of the cycle so the way I see it now would be a great time.  That being the case, it’s also a great time to implement a business growth strategy.  The results that Randy helped his clients achieve that I mentioned earlier came from a conversation which, coming from a professional properly equipped with analytical tools, give business owners confidence to take action that will dramatically change their lives.  The most valuable thing we can do for our clients at this time is give them confidence and convey the sense that we care enough about them to have these conversations!

As Marshall Goldsmith notes people have a default response in life to experience inertia—in other words, change is hard for most people.  He mentions that an analysis of his database of 250,000 people “Very few people achieve positive, lasting change without ongoing follow-up.”  This is why I encourage you to engage your clients in a process on regular “accountability” meetings.  Help them create a Management Control Plan that’s built on a profit and cash flow plan and a range of non-financial KPIs.

So my challenge to everyone in our wonderful profession is let’s make 2012 a truly great year during which we do good and have a great life.  Speaking of which, I came across this quote from a book I read some time ago.  It is most appropriate for this time of year and for this point on the business cycle …

A great life would naturally bring more meaning, purpose, love, laughter, wonder and adventure to your days, and, at the end of your journey you would look back on a life of significance, rather than regret, knowing in your heart that you left the world better than you found it, knowing that you made a difference in the lives of others, knowing that you got something wonderful out of it and you gave something wonderful back.  A great life of course is not something we experience; it’s something we create.

Sure, other accounting firms may be interested in winning your clients but that’s only one source of competition and, quite frankly, the least important in my view.  I say it’s the least important simply because there is such a low level of client movement between accounting firms that either your “competitors” must be very poor at the competitive game or, probably more to the point, they do not offer any good reason for people to incur the cost of switching which is significant in both time and money.

The main reason clients switch is not due to the “pull” of the strategic marketing genius of other firms, nor is it because they are phenomenal salespeople; it’s because of the “push” of service failure from their current firm.

If you want to grow your practice you need to master four things: (1) improve the service experience you give to your clients, (2) develop an intimate relationship with clients who meet your stringent selection criteria i.e. clients in respect of whom you are able to add significant value, (3) empower all of your people to embrace a client-centric service philosophy and, (4) implement a marketing process centered on a structured referral system.  Oh, and by the way, when you take special care of the first three things the fourth one takes care of itself.   A great reference to follow up on this is Jeanne Bliss’ 2009 book I love You More than My Dog.

The traditional work output of accounting firms is well known –I’m talking about compliance-based services of the A&A type and tax planning and return preparation mixed in with a smattering of business advice usually financial in nature.  These work outputs are very difficult to differentiate because the buyer is not expert enough to make a judgment of quality.

But the buyer is very good at making a judgment of the service experience.  If you can’t differentiate what you do you must differentiate how you create and deliver those work outputs.  Differentiation in accounting firms is essentially about the experience you offer to your clients. I’m not just talking about the WOW factor –how ever that may be created—I’m talking about getting the job done, I’m taking about being fast and on budget; I’m talking about rapid response to inquiries, and I’m talking about proactive initiatives that are in the interest of the client rather than being blatantly driven by the interest of the firm e.g. constant marketing emails about your financial planning or other services!

Somerset Maugham wrote a short story called “The Verger”. It was about a middle-aged a man named Albert Foreman who had been a verger for most of his adult life at St. Peter’s Church, Neville Square in London.  The church council discovered that he could not read or write so he was fired.  On his way home, disenchanted with life and uncertain of what he was going to do, he craved a cigarette but to his dismay he couldn’t find a shop to buy a pack.  Thinking that he was probably not the only person in London looking for a shop to buy a packet of cigarettes he decided to establish a newsagency and tobacconist store.  It was an immediate success so he opened and other, then another until ten years later he had 10 stores and was very wealthy.

One day his banker needed him to sign some papers and when he told the bank manager he could not read or write the manager was shocked. The banker said “do you mean to tell me that you have made your fortune without being able to read or write; what would you be now if you had been able to?”  ”I’d be the verger at St. Peter’s, Neville Square” he replied.

There’s a lesson here.

Several years ago one of our members in Sydney lost 30 percent of his fees when the firm’s largest client was acquired by another company.  This experience reminds us of the danger of having an unbalanced portfolio of clients but that is not the reason I’m relating this story. When this happened our client’s initial response was one of disbelief.  He told me his felt totally depressed and even contemplated leaving the profession because, in his words  he’d “worked so hard to develop the relationship with the client that [I] could not face having to do this again.”

However, in keeping with Thoreau’s advice that “all misfortune is but a stepping stone to fortune”, he re-grouped and within 18 months not only had the lost business been replaced but the firm’s bottom line had increased by 25 percent because the previous client had so much leverage over the firm, the margin earned on the work (which included a significant audit component) had been cut to the bone.  Not only that, the client didn’t treat the firm’s team members very well so there was a big improvement in morale.

Let’s take a closer look at this.

What he accomplished in 18 months was a 43% growth in fee revenue which is equivalent to 27% per year!  This was for a firm that for the past 10 years had averaged about 10% per year.  Of the 43% revenue growth, about half came from additional services and pricing adjustments for existing clients and the remainder came from new clients.

No less important was the fact that the team members were happy to see the last of the client despite being concerned for their jobs in the first instance.  Further, because the fee loss had been replaced with a number of new clients the firm’s risk exposure from client loss was dramatically reduced (although having had this experience, the loss of the big client turned out to be the best thing that could have happened—remember, good is the enemy of great) and its pool of potential referrals significantly deepened.

But what is truly amazing is what can be achieved when adversity looks you in the eye. Annual revenue growth of 30% is extraordinary but, as proven by this firm, it’s possible any time you’re willing to give it a shot.

And that brings me to the title of this post, what might you be able to do if you decided to rid yourself of all of your low level tax work?  Perhaps you’d be able to achieve 30% revenue growth and 25% profit growth.

Why haven’t you talked to me about this before?

We’ve been doing this sort of work for some of our clients for a long time but just recently we decided to put more focus on it. To do that we have implemented new systems and have invested in new resources to improve our advisory services protocols.

We have taken a very hard and long look at our business model as well as the clients who we believe have the potential to take their business to the next level. You are one of those clients.  In fact as I mentioned earlier we have run some numbers on your business and we’ve discovered that there’s at least $100,000 <you refer to the profit improvement you have estimated> of additional profit that we think you could tap into and to the extent that is sustainable over the long haul the impact on the value of your business is staggering.

Instead of waiting for you to come to us with a request for help with your business development process we decided that it would be appropriate for us to take the initiative hence the reason for this meeting.

How would you know anything about my business, you’re an accountant not a business person?

This practice is a business and we experience precisely the same challenges that you face. The product we offer is different to yours but in all other respects we confront the same issues on a daily basis.  For example, we need a strategic and operations plan, we need to market ourselves, we need to design and implement a customer service strategy, we need to hire, develop and retain team members, we have to monitor our profitability and cash flow … in fact all of the things every business needs to address we must also attend to.

But uniquely and perhaps more importantly, we work with hundreds of entrepreneurs and business managers just like you. We see some extremely successful ones and we see some abysmal failures. From this vantage point we are able to take an objective look at our clients’ businesses. We see systems that work and we see those that don’t. To the extent that much of the unexploited potential in any business will come from focus and process systematization it’s logical that we can help you because we are ‘systems’ people.

It’s also important to note that we are not suggesting we will run your business. That’s your role. Our role will be to act as your external non-executive Chief Financial Officer. Every business, large or small, needs a CFO but small businesses don’t need that person 5 days a week, 52 weeks a year.

When we took the decision to allocate time and resources to this area of our practice we realized the critical importance of having access to a network of other people who specialize in business advisory services. For this reason we are a member of the Principa Alliance. This is an international network of accounting firms that offer business advisory services to small and mid-sized businesses just like yours. We not only have access to the people in that network but to an enormous array of business enhancement tools and resources that we can draw on to support you.

I can’t afford this service

Probably the greatest cost incurred by most businesses is the cost of the lost opportunity. It’s an invisible, but real, cost. It is invisible because, unlike other business expenses, it is not reflected by a transaction but it is real and it shows up time and time again in under-performance. It is the sale that was never made because of a customer service failure, it’s the action plan that was not implemented because there was no-one holding you accountable.

From the Profit Improvement Analysis we have just done with you you’ve seen the potential benefit is a substantial increase in your disposable income and a corresponding increase in the value of your business – probably you’re most valuable asset. The cost, of course, is substantial but there are few “cheap” investment opportunities – in the final analysis you get what pay for.

In a sense, what we’re talking about here is no different to the decision process you must have gone through when you started the business. You invested in the belief that you would achieve a return that exceeded the time and money you invested in the business. You have achieved that. Now it’s time to take the business to the next level or to put that another way, to make another investment.

How can I be sure this will work?

The simple answer to this is you can’t and nor can we. But there is one thing that we can take as a certainty and that is the certainty of change. The competitive landscape faced by all businesses in this country is changing and in some cases rapidly. What worked for you in the past probably will not in the future. Customers are demanding more for less and employees are expecting better conditions and higher levels of compensation.

Most importantly though, at no stage in process will we be suggesting that you bet the business on an idea. In fact our approach is built on a simple philosophy of testing and giving attention to detail. The key, we believe, is not to take the negative position and contemplate whether this will work but to take the positive view and make it work. If you do not take that position we can’t work effectively with you. We all must believe in a positive outcome.

Why can’t I do this myself and save the fee you’ve talked about?

You may be able to re-engineer your business and I hope that our brief meeting has at least made you realize that it is both possible and necessary. However, the sad reality is that most people in business know that there is scope for improvement but they are so bogged down with day-to-day operating problems that they can’t see the forest for the trees.

Business owners are generally the worst self-disciplinarians. It is too easy to put off doing those tasks you set for yourself. When you are not accountable to anyone but yourself you forgive yourself easily. However, when you have made a commitment to another person you are much more likely to honor it.

This is precisely the reason elite athletes need a coach who is vitally interested in their performance and who can help them keep focused on the results they want to achieve and the work they need to get done to. This is the role we are proposing to play for you.

In that role we will help you map out the game plan and set specific objectives with time frames and benchmarks. We will assist in prioritizing the activities that need to be performed so that you can keep focused on the main goal. We will also contribute our specialist expertise in financial management, planning and control. In short our job will be to help you take care of the money side of your business so you can concentrate on all of the other important areas.

My research clearly shows that in many (I suspect ‘most’) firms close to 50% or more of their clients are unprofitable to service. I published a detailed discussion of this last year in a blog post called Are all your clients profitable to service? The “solution” to this issue is simple: deploy the right people, on the right tasks for the right clients at the right price and everything will take care of itself. I doubt that many people would disagree with what I’ve prescribed here but what is “right” in each case is the hard part in practice.

However, if I was allowed to keep just one thing I have learned about practice profitability it is this: CLIENT SELECTION is paramount.  When you get that right and stick to it, most other things will fall into place.  The clients you choose will determine what services you can provide, that will determine what prices you can charge and who your “competitors” are, that will determine where you sit on the industry value curve, that will determine what type of people you need and can attract, and that will determine what you strategic options are.

Unprofitable firms are all over the industry value curve, profitable firms know exactly how to add value to the customer franchise they have choose to work with (that’s the effectiveness aspect of their execution) and they deploy the right people and systems to deliver that value in a way that they are able to capture their fair share (that’s the efficiency aspect of their execution.)

My thoughts on the importance of customer selection are neither new nor original and it surprises me why so many people ignore it.  I think the main reason for this is the pursuit of “money” in the short term rather than being willing to have a clear strategic plan and sticking to it.  I have urged our clients to rid themselves of unprofitable and difficult customers and without exception, those who have followed my advice have been surprised by the positive outcomes they experienced.

This is further evidenced by a case study David Maister describes in his excellent book Practice What You Preach. Mortimer Ransford is a 200 person professional service firm that doubled its revenues and margins in 18 months.  Although it is not an accounting firm, what Colin Ransford, the CEO, says in relation to client selection is very relevant—I have added emphasis.

We really believe that chasing money is not what makes money. We believe that if you have the right client base, the right people with the right attitudes and the right systems, the money will follow.

We made a big decision two years ago, turning down (for the first time) a potentially lucrative opportunity, because it was really boring work.  We asked, “Is this what our life has come to, pitching for this kind of work?”  On the same grounds we resigned [fired!] one of our largest accounts, one we had worked with for four years, and one that had consistently earned us strong revenues.  When we first started on the account, it was exactly the type of work we wanted.  However, over time we became the ‘bottom of the food chain’ for this client.

We didn’t like working that way, we deserved a lot better.  The work was neither intellectually challenging nor strategically satisfying, and we knew that at some point the client would spot our boredom, because we could not cover it up for so long.

So we decided to walk away.  It’s easy firing a small client, but this was huge.  We stopped being nervous about two weeks after we dropped this client, because we realized that resigning the business was the best thing we’d ever done.  In fact it was so obvious we asked ourselves why we hadn’t done it earlier.

Ransford reports that the benefits from doing this were tangible and immediate:

1. A strong message was sent to the team to the effect that the top guys were willing to make tough decisions and put their money were their mouth is –  not just talk about “doing great work for great clients”, and we “care about our people and we give them interesting work to do” etc.
2. The action signaled to the team that management was in touch with the quality of the firms clients and it was okay to alert management if necessary to situations where particular work is not challenging and the best use of one’s time.
3. It gave a sense of renewal to the team.  The boring work that some of them were required to do prevented “our really good people from being able to develop much more interesting client opportunities, ones that they would get a much bigger kick from, and ones that would dramatically improve the firm’s performance.”
4. Whenever they turned down an opportunity (which happened 70% of the time) they “nearly always discover an upside.”  They found that turning down work results in you becoming “sought after.”  He continues, “Our reputation has grown and our revenues have gone through the roof.”

In my own experience, when you turn away work or fire clients in respect of whom you know you can’t add much value, you free up resources, and that gives you a reason to look for opportunities to deploy those resources more effectively and by effectively I mean in a way that really does create value either by getting out and bringing in the “right” clients or finding value creating opportunities within your existing client base.

Most firms that are failing to achieve their full potential have clients who are silently crying out for help.  When I do presentations to groups of accountants I ask the question: “how many of you routinely do end-of-year business performance reviews with your clients?  Rarely, do more than 30% of hands go up!  Interestingly, or perhaps I should say, frighteningly, I have also seen studies that report 70+% of business clients say “they would like their accountants to do more to help them run a better business.”  There is a clear supply-demand gap that is not being filled by our profession.

Now, given that a review meeting of that type — if done properly, as in forward looking, is an opportunity for you to:

1. Create a greater perception (and reality) of value by going beyond a review, compilation and tax return followed by a “see you next year” departure greeting.
2. Uncover opportunities for advising your clients on how to improve the profitability of their business.  What’s really important here is the fact that you can only do this by adopting a forward looking perspective rather than the backward-looking view that most accountants are associated with; i.e. the idea that we report on history rather than play a role in creating it.
3. Manifestly position yourself as more than a bean-counter.  This is a major differentiation key and a strong cause for quality referrals.  In fact, the review meeting is itself an opportunity for you to ask for a referral in a totally professional and inoffensive way.
4. Show the client that you actually care about his/her business and financial well being.  Remember, at a 40% marginal tax rate, helping a client improve the profitability of a business by $1 will add $0.60 to his/her bottom line, and increase the value for the business by $3 to $10.  On the other hand, reducing the client’s taxable income by $1 puts an additional 40 cents in the bank. I’m not suggesting you should not help the client reduce taxes; I’m suggesting that you can and should do both—at least give your client the opportunity to make that choice and if the client rejects your offer to help then maybe this is not the client you’ll be growing the firm with.  More importantly, you don’t what this client referring more people of his/her ilk.  Remember also the poignant saying “clients don’t care how much you know until they know how much you care.”  One of the best ways to exhibit this is to engage in a conversation about the client’s financial wellbeing.

So let me conclude with a thought … 1–2 hours spent on an annual business performance review with a business client who you believe has at least $100k of profit improvement potential that you’ve been able to identify with 1–click in GamePlan will be the most effective marketing initiative you could employ in the next 12 months and all it will cost is 2 hours of your time — my goodness did I really say two hours?  Ron Baker would tell me to wash my mouth out.

Here’s what one of of our members, Tom Vermeulen, thinks about the process:

Presenting the Annual Business Performance Review and Game Plan as part of the tax return exit interview is the best thing I have ever done.  Clients are open and receptive at this time of year like none other.  I have sold several long-term business plans and Management Control Plans to be implemented after tax season.

The first was: “If you were not already in this business (referring to each of GE’s business units) would you enter it today?”  The second question was: “If the answer to the first question is no, what would you do about it?From this discussion Jack Welch framed a strategy that would change the face of GE and arguably, the business world, forever.

Welch’s strategy was simple: we will either be number 1 or number 2 in every industry we’re in or we’ll fix, sell or close the business unit.  The year before Welch took over GE it had revenues of approximately $28 billion.  The year before his retirement revenue had grown to $130 billion and the market capitalization of the company had grown by nearly $400 billion.  You could say each of these questions was worth $200 billion!  I wonder if Drucker was into value pricing at that time.

The reason I mention this is not to signal Drucker’s or Welch’s genius – that’s self evident and needs no confirmation from me.  But what I do want to signal is the power questions have in changing the way we look at things and most importantly, the power of these two questions.  As a leader of your own organization and as an advisor to your business clients these questions should be asked right now.

Drucker’s advice to the owner of a small local business that is not already #1 or #2 is a difficult pill to swallow.  But let’s think about what being #1 could mean in a local community setting.  Seth Godin gives us some insights in his great little book called The Dip which is worth reading if you feel your business is not getting traction.  Godin supports Drucker in that he suggests you need to strive to be #1 or quit but he adds a qualifier that makes it a more palatable, and in my view, a more realistic strategy.

He qualifies his advice by the way he defines #1. He argues that one customer’s #1 best-in-the-world service provider is not necessarily another customer’s provider of choice.  In other words he suggests that many providers can be, and in fact are, #1.  He writes (page 10):

Anyone who is going to hire you, buy from you, recommend you, vote for you, or do what you want them to do is going to wonder if you’re the best choice.

Best as in: best for them right now, based on what they believe and what they know. And in their world as in: their world, the world they have access to.

He goes on the make the point that “best” is subjective.  It’s something your customers decide not what you decide.  If enough of them decide you are the best you will become #1.  If enough of them decide you are not their best choice you won’t.  This is an interesting way to look at it because it very clearly gives you the opportunity and permission to strive to be the best irrespective of your starting position. That is, being the best is a journey, not a destination.

Godin’s truly powerful idea is the reminder that mediocrity (those service providers who reside in the middle of the bell curve, those who are OK with average) are the ones who settle for less than they are capable of, or as he says, “For good enough instead of best in the world.”  This is precisely the advice Drucker gave to Welch back in 1981.

And that brings me to a powerful idea I expressed in my April 2010 blog titled Are all your clients profitable to service? My research has shown that many accounting firms (I suspect most) are just breaking-even or losing money on about 50% of their clients.  One way to look at that there is not a good fit between many of these clients and the firm e.g. they do not want higher value services, they are costly or difficult to service, they are highly price sensitive, they are not conducive to taking advice.  Another way is they do not consider the firm to be #1 or even striving to get there.  Yet another way to look at this is these clients form a business unit within the firm that is not a profit contributor.

Drucker’s advice to Jack Welch for a business unit of this type was to fix it, sell it or close it.  Godin nicely explains why this is the logical thing to do “…because it distracts management attention. It sucks resources and capital and focus and energy. And most of all, it teaches people in the organization that it’s okay not to be the best in the world.”

My two questions for you are: Do you have clients that need fixing, selling or firing? And, are you doing everything you can for your firm to be the best in your world?

We all worked in the Wool Marketing Section of the Bureau of Agricultural Economics in Canberra (the Capital of Australia for the information of my friends abroad.) Through this employment connection we had close contact with the sheep industry and in particular wool marketing.  One of my partners was a Kiwi (aka a New Zealander) and over a glass of beer he mentioned that sheepskin shops were popping up all over NZ to cater to the exploding Japanese tourism market — they loved sheepskin floor mats as gifts to take home. He suggested that we open a shop in Canberra. We thought that was a great idea (everything sounds great after a few beers – have you noticed that?) and with no real plan in mind we each contributed $300 to start the venture. By the way, we were economists not business graduates so we really had no idea about business at all.  I had taken one class in Accounting and that was the sum total of our collective business wisdom and that qualified me to ne the General Manager.

Now $900 was quite a lot of money in 1970 but we quickly discovered it’s not really enough to start a business.  By far our biggest challenge was the cost of  carrying inventory. Most of our initial funding was invested in setting up the shop – which we did on a shoestring by the way. But we sweet-talked one of Australia’s best sheepskin tanneries to supply us on a cash-for-product basis. That is, we gave him $200 up front and he delivered us about 50 skins overnight. We took out an advertisement in a cheap tourism brochure that simply said “The Perfect Gift: Authentic Australian Sheepskins from an Australian Shearing Shed”. We stretched the truth a small bit in that it was not an authentic Australian shearing shed but The Shearing Shed was the name of the business. That ad got some attention and we sold all our stock in the first week.

We parlayed $200 into $300, a GP of $100, in our first week which annualizes to revenue of about $21,000.  That was scarcely enough to make us rich but what the heck, we had another job and it was fun and at least we were in a position to buy some more stock with our next order which we did. The next week we also sold most of our stock again. This continued for several weeks and we kept buying more stock but then a chance meeting, again over a few beers, with a guy changed everything.  With beer in hand he said to me what do you do? I told him I was research officer with the BAE but my real passion was our business. I then asked him what he did and he said he was an accountant.  I said “really! we need a ‘good’ accountant [how many times have you heard that inane statement!], do you work with new businesses? Our sheepskin business is going great (truth stretching again).”  He said “of course we do!”  His name was Tim by the way.

Then Tim said, “tell me about the business.” So I did and he listened as he asked a few more probing questions that told me he was genuinely interested! Then he said “so you’re saying that you turn your stock every 5 days.” Correct I replied. He said “that’s a stock turn of 70 times a year–amazing!” I had no idea what stock turn meant let alone considered it to be amazing – would any of your clients be in the same boat?  All I knew was that every dollar we made went straight out the door to pay for inventory, wages, rent etc. But I digress.  He went on, “you’re telling me that when Japanese tourists come into your shop they never leave without buying something?”  “Correct.” I replied again. Then he said, “let’s sit down and take a look at this” as he led me to a vacant table and flipped over a drink coaster and took a pen out of his pocket.

On the coaster (it turned out to be several of them actually) he showed me that our GP was just $33 out of every $100 of revenue and that was all we had available to cover all of our expenses and finance additional stock. Then he pointed out that if we were able to sell virtually everything in the store each week we are not charging enough for our product. He then suggested that I do, or at least try by testing for a month, two things.  First he said to apply a 100% mark-up on cost to get our GP% up to 50% – this did happen and as we all now know it’s the first way to grow a business i.e. average transaction value (price effect) and secondly, he suggested we quadruple our order size and negotiate 7 day payment terms, or better if we can, with our sheepskin supplier on the strength of our past track record (even though it was short). He continued, “not only will this give you a gross margin of 50% but I suspect with the obvious demand for your product you will sell more because you have greater availability [which did happen] and you can increase that even more by adding other related product lines that fit with the sheepskin-Australian-shearing shed theme.  This as we all know is the second variation of the first way to grow a business – i.e. average transaction value (volume effect). And he continued, “your additional revenue will be generated with very little additional cost other than the cost of product so your net margin will increase as you utilize your facilites more productively” this, as we all know is the fourth way to grow a business i.e. resource expense productivity and it did happen.

That conversation lasted less than 1 hour because we had a serious amount of beer to consume.  But the impact on our business was amazing. In our first full year, the business did a few pennies under $1 million and threw off a gross margin of about 52%. We ended up manufacturing powder puffs for Elizabeth Arden, and in addition to selling thousands of skins we made sheepskin carpets, ugg boots, coats, mittens, underblankets for hospitals and the elderly, car seat and steering wheel covers.  All of this came from a conversation and a single but simple question: “tell me about your business.” 

Tim became our accountant and he continued to give us really valuable business advice, he visited us frequently and took obvious delight in our success.  On one of his visits we were talking about the fact that one tourist bus operator had been bringing visitors to the store on their way back from a local tour of Parliament House and Tim said “it would be interesting to contact all the tour operators and see if they would do likewise.” This as we all know is the second way to grow a business i.e. attract more customers of the type you want. Isn’t this a BFO – why didn’t we think of this?  Most of the people we approached were not interested but a couple were and what happened is simply amazing: after a couple of months at least one bus (sometimes 3-4) would park at the back of the shop 5 days a week. Between 20-30 people would get off each bus and by mid afternoon we were frequently close to being out of stock. 

Because of the high margin and tight cash control we were able to grow the business really quickly, we secured 30 day credit terms, rented a warehouse to carry our inventory and serve as a manufacturing facility and the rest as they say is history. This would not have happend had I not had a chance meeting and conversation with an accountant who was willing to listen and smart enough to ask a couple of dead simple questions.

Interestingly after Tim moved back to Adelaide we were passed on to another guy (I have forgotten his name – that’s how impactful he was) who took no interest in us or the business other than to tell us when we had to get our books to him for our taxes.  Needless to say, we left that firm in the fullness of time and he probably didn’t even notice and will never know what fees he walked away from as a result of his indifference.  But there’s more to this story. As a result of this experience I decided that I wanted to learn more about business and in particular the role that accountants can play and the profound impact they can have on their clients. I left my “secure” government job and enrolled in graduate school and took as many accounting classes as I could to qualify and do the sort of things Tim did for us. The business also made it financially possible for me to do that.  That one conversation that lasted less than 1 hour changed the direction of my life completely.

As I look back on this event in my life and the subsequent path it took me on I think about it quite differently than I did at the time. Here are the lessons I have learned that you might like to reflect on during the Christmas Holiday.

1. Everything good and bad starts with a conversation.
2. Listen and not only might you learn something but you will develop trust with the other person. Once you have that you can become an agent of change.
3. A pen and the back of a drink coaster or envelop is all the technology you really need to change people’s lives which is why we created concept models to help you engage in concept model grass-roots conversation.
4. Accountants have the ability and positioning to make a huge difference to the lives of people.
5. Visiting with your clients is what really shows how interested you are in them and their business.
6. People outside a business (i.e. you) are far more likely to come up with ideas on how to improve it than the people in the business especially the owners. And I would add to that, I found I came up with a lot more ideas when I was at a client’s business than I ever did at my desk.  The reason for this is what I call environmental immersion which is akin to experience we have had with our Mastermind Alliance – the collective wisdom of a group of people talking, thinking about and focusing on an issue is far more powerful than a person thinking alone.
7. Perhaps the biggest lesson of all …. this is not rocket science, conversing about the 4 ways to grow a business large, or small, is a no-brainer framework for a robust conversation.  So with that in mind go back to bullet point 1.

During the Holidays you might like to think about the conversations you’ve had with clients this past year.  How many of those conversations may have, or will, change lives?  How many conversations could you have had that might have change lives? How many conversations will you have this coming year that could change lives? And if someone asks you what you’d like for Christmas suggest they give you a pack of envelopes then spend some time practicing your conversation on the back of them.  Never leave home or your office without an envelop and a pen in your pocket. Finally, never forget that there are just 4 ways to grow a business, any business, and when you master a conversation around those 4 ways you’ll grow you own business.

When they get busy doing the technical things the business does i.e. the IN stuff, they take their eye off the ON things and the business stagnates.  Worse still it tends to drift towards mediocrity.  Growth comes from trying new things, getting out there, looking for and taking advantage of opportunities just like you did when you started your business.  If you are not the person who started the businesses you’ll have a special challenge to address and that is, you don’t really know what “growth hunger” is all about.

I have a simple (perhaps over simplistic) theory: the reason many, if not most, established practices hit a growth brick wall is that the people who inherit a leadership role have not been mentored and seasoned as “business growers”.  Their training, experience, performance expectation and financial reward has been as “business doers”.  So here’s a very simple thought: if you were able to grow your business at 40% a year from start-up and keep that up for 3-5 years, which is not at all unusual, then you should be able to do that from any starting base at any time BUT NOT IF YOUR TIME IS TOTALLY CONSUMED WITH DOING THE THINGS THE BUSINESS DOES.

And there’s a flip side to that theory.  The reason most most practices that were started by the present owner(s) hit a brick wall after a few years is that they start to make enough money to get by and are not willing to “risk” what they’ve built up in the pursuit of more growth.  This is rationalized by the statement “I’m too busy servicing my clients to get out and do the things I should be doing to grow the business.”  I would argue they face a much greater risk by standing still and the risk will become even greater in the future if only because:

(1) quality team members will not hang around in slow growth, no opportunity, environments and

(2) practice values in the future will increasingly be based on growth prospects (reflected by growth experience), client quality and loyalty, team member quality and loyalty, service design and margin.  These are not typically things that score very highly in slow (or no) growth firms.

Strategic planning is very important but it can also be very limiting. The key is to take the “limits” away and the most constraining limit is a mediocre growth target set in your plan. If you want to double the size of your business you need to start with that as your goal then ask yourself what will it take to do that?  Now, you might not do that overnight but at just 15% a year, you will do it in 5 years.  I’d add to that, if your practice revenue has not doubled in the past 5 years then it won’t double in the next 5 unless you start to do some different things.  And, I’d also add — 15% is nowhere near what I know you’re capable of doing!  To quote Herb Kelleher, when he was CEO of Southwest Airlines: “we have a strategic plan, it’s called doing things” which explains the amazing sustained success of that business despite it being in a horrible industry.

Here’s one more thought. Peter Drucker told us in 1973, there’s only one purpose of a business: to create a customer.  He goes onto say “the business has two–and only two–basic functions: marketing and innovation.  Marketing and innovation produce results; all the rest are ‘costs’.”

So here’s something for you to ponder: what marketing and innovating are you doing?  Those firms that are doing this, knowingly or otherwise, are stealing the march on the rest. Let me conclude with Michelangelo’s famous words.

The greater danger for most of us is not that our aim is too high and we miss it, but that it is too low and we hit it.

I made the point that …

(1)   Change is what provides both threats and opportunities and unless an organization is changing at least at the same rate as its environment it has a bleak future, and

(2)   The difference between great organizations and mediocre ones can be tracked back to the quality of leadership and management.

The leaders of today’s accounting firms should take particular note of this.  Leadership is essentially about vision and vision is about the future.  When we are talking about the firm of the future we must therefore be talking about leadership.  David Maister, I believe, said somewhere that “most firms are over-managed and under-led.”  I agree with him.

One of the reasons for this is a natural tendency for those leading a business to orientate their energy and attention towards improving efficiency as the means of improving short term profitability.  This is totally understandable but to the extent that it diverts attention away from thinking about, and preparing for, the future it results in a loss of perspective that usually results in lost opportunities and stagnant growth.

Stephen Covey describes this natural characteristic of most businesses with the analogy of a team hacking it’s way through a jungle when the team leader decides to climb a tree to take a look at the environment.  On reaching the top he yells out to the people below “stop hacking, we’re heading in the wrong direction” to which the team below yell back in response “shut up we’re making great progress.”

Leadership is about getting up into the canopy of the jungle you’re in and taking a look at the environment.  From that vantage point you need to make choices as to where you actually want to be heading.  The vantage point takes the form of asking yourself questions that relate to the future of your business.  The big question is: What is the vision I have for our firm 10 years from now?  In framing that vision you need to be thinking about the following issues.

• In what ways are our clients’ businesses changing and what does that mean for the services we should be offering now and in the future?
• What do our clients value i.e. what is “value” to them?
• What are our strengths? Are they the right strengths to create and deliver value to our clients? Are we adequately endowed with these strengths? Are they currently deployed where they produce results?
• Who are our future competitors from within and outside the industry going to be? What are we doing today that will help us really stand out from these competitors?
• What technologies should we be using now to better service our clients, in particular how well appraised are we of what firms in adjacent industries are doing?
• What process, product or business model innovations have we introduced in the past three years to better service clients and offer a more valuable business value proposition?  Do we lead or follow the pack when it comes to introducing new ideas?
• To what extent are we really adding value to our clients, by that I mean, is their business performing better as a direct result of our firm’s involvement or are we simply providing a service that any accounting firm could do for them?
• Do we know the profit contribution made to our firm by each of our clients? What % of our clients are at break-even or below?
• To what extent are we being held captive by some of our clients who, for their own reasons, do not see any need to change their service requirements but who we allow to consume our valuable resources for fear of losing some short term revenue that has little or no growth potential?
• In what ways are we attempting to change the culture of our organization to better accommodate the work preferences and environment needed to attract and retain talented people?
• What are we doing now to implement re-training of our people to equip them with the skills that are going to be needed in the future?
• What are our plans to align with a network that will be able to provide back office research and development support, global reach and a source of colleagues we can collaborate with to quickly and effectively offer affordable solutions to our clients without risking them being lured away from our firm?
• How adaptive is our firm to change?  Specifically, based on our past behavior, have we been willing to cast aside legacy mindsets and systems so that we are better equipped to accommodate new opportunities?
• And the final but critical question: what resources in the form of time and money are we willing to invest to ensure that our firm not only transitions successfully to a new service model but takes rank with the top performers in the industry?

As you think about the above questions it might be useful to reflect on what Charles Darwin concluded in relation to species generally: “It’s not the strongest nor most intelligent of the species that survive; it is the one most adaptable to change.”

Ideally, a costing system for a service firm should be able to provide management with information relating to the profitability of different customers and different products or services.  It should also be able to be tied back to the firm’s budgeting system and I would expect it to be able to be used in pricing decisions and for determining whether to accept or reject engagements etc.  I have yet to discover a time-based “practice management” system that does more than price jobs.  If you know of one please tell me and I’ll do what I can to promote it to the world.

No matter what pricing methodology you decide to adopt you would be wise to know your costs.  That statement almost sounds trivial and yet I have come across very few people in professional service firms (PFS) who actually know their costs or show any real interest in them for that matter.  They are taken as a given because, at least in the short term, most costs are fixed and the gross margin is generally so high that any revenue is assumed to contribute something to the bottom line.

Your firm’s P&L will obviously tell you whether the aggregate of your revenues exceeds the aggregate of your expenses but it tells you practically nothing else of any significance. It’s a little like using a thermometer as the sole indicator of your current state of health.

Now let’s take this further. Your so-called “time costing” system will tell you what time went into producing your revenue, it will even tell you whose time it was and you’ll get a crude idea of what work was done for each of your clients.  However, for the most part, the “cost” attached to the “hours” will be the cost from the client’s perspective.  That is, the targeted charge rate for the time allocated to the task.  This is quite different to the cost of resources used by the firm to service its customers and therefore you will not know how profitable that work was.  This is why the vast majority of PSFs are harboring unprofitable customers without even knowing it.

If the cost of resources utilized to service a client is greater than the revenue generated then, unless there is a reasonably clear expectation of a future profit stream i.e potentially high lifetime value, it makes sense to implement one or a combination of the following strategies: (1) increase the price of the service, (2) re-allocate lower cost resources to the work process, (3) reduce the cost of resources used through negotiation with suppliers, (4) seek to  improve productivity of the work process, and/or (5) cease to service that client and redeploy the resources that are released to more profitable work.

If the published research conducted by people such as Fred Reichheld (Loyalty Effect guy) and Bob Kaplan (Balanced Scorecard guy) is any guide, the cost of unprofitable customers is likely to be very high in PSFs.   For example, the following graph relating to an insurance business is from an article written by Bob Kaplan that was published in the Balanced Scorecard Report (August, 2005) called “Add a Customer Profitability Metric to Your Balanced Scorecard”.

Commenting on the graph, Kaplan notes:

The shape of the curve occurs in virtually every customer profitability study ever done, (emphasis added)  in which 15 percent to 20 percent of the customers generate 100 percent (or more) of the profits. In this case, the most profitable 40 percent of customers generate 130 percent of annual profits; the middle 55 percent of customers break even, and the least profitable 5 percent of customers incur losses equal to 30 percent of annual profits. With its most profitable customers, the company worked harder to ensure their continued loyalty and to generate more business from them. For customers in the middle break-even group, it would improve its processes to lower its cost of serving them. It focused most of its attention on the 5 percent-loss customers, taking actions to re-price services and asking them for more business in higher-margin product lines. If the company could not transform these customers into profitable ones by these actions, it was prepared to drop the accounts.

My research confirms that Kaplan’s findings seem to be replicated in accounting firms.  With the cooperation of several members of the Principa Alliance I have generated a client profitability graph for their firms.  The diagram shown below is for one of those firms (a sole practitioner) and reflects the pattern that is typical for all the firms I analyzed. For this particular firm, 141% of its final net profit is generated from 53% of its clients.  The next 30% are approximately at break-even and the last 20% of clients “cost” the firm about 41% of its potential profit while utilizing 45% of its capacity.  Applying the Pareto Principle, 80% of the firm’s maximum profit potential is generated from 14% of its clients!

Before turning our attention to the loss makers, let’s talk about the ones at break-even.  This is an interesting group and may represent 40-50% of your clients.  Some of these clients will be your stars of tomorrow so they’re not candidates for firing.  However, the fact that they are break-even suggests that you should at least look at the effectiveness of the process you are using to service them, the services they are buying and especially the pricing of those services.

Now to the loss-makers.  Other things being equal, if you fire the bottom 20% of your clients the costs that they are now absorbing would need to be absorbed by the remaining clients so you’ll end up with another group of loss-makers and so on. This is the rationale that most people use to justify keeping these loss-makers on their books.  However, I will strenuously argue that is NOT usually the smart thing to do.  Here’s why. …

The clients I’m referring to are, for the most part, the most difficult to serve, they are the 20% who contribute to 80% of your challenges, they are probably small, have high write-offs, they only require low level services, they are uncooperative or your service protocols are not well suited to them.  In short, they are not a good fit for your firm but may be a great fit for a different firm.  Of course, some of this group may be new clients with strong potential who you see as being solid in the medium to long term in which case you’ll want to hold on to them and develop the relationship.

What is important is that the clients in this group are certainly consuming resources that could be better deployed if you could find more “better” clients and as long as you’re allocating capacity to them you will not have time to look for and attract “better” clients.  With the exception of the high potential group I previously mentioned, the gutsy strategy is to refer them to a firm that is better suited to their needs  and then go out and replace them with better quality clients.  Based on my experience this is the fastest way to improve the quality of your client base and I never cease to be amazed at how easy it is to implement.  My colleague and friend Ron Baker tells me that’s been his observation as well.

The less courageous, but nonetheless very sensible, strategy is to replace lower level revenue with higher quality revenue as it comes in.  That is, suppose, you sign up a new client with a revenue estimate of say $10,000. You then go to your unprofitable group and remove $10,000 worth of clients. That way you preserve your immediate revenue, increase your immediate profit and better position yourself for profit growth from that better quality client than was likely to be the case with the ones you got rid of.

You may be thinking “wait there, the people I have working on the low level clients will not be able to do the higher level work our new client requires.”  If this is in your mind then you’ve just fallen into a huge but common practice development trap.  The keys to developing a robust, profitable practice are to be found in client selection, service line offering (hence your pricing options), people development and delegation (hence your productive capacity leverage.)  It makes no sense at all to be looking for higher quality clients if you are not simultaneously creating higher quality team members and offering higher quality services. You will not develop (or keep) high quality people by giving them low quality, less challenging work to do.

I have also heard the argument that “we know some of our clients are not profitable and on a full costing basis, may even be unprofitable but we accept this on the grounds that some of these clients will blossom in the fullness of time.”  This is the “oak trees out of acorns grow” argument.  I don’t have an issue with this argument but I wonder if you should have 40-50% (and in some firms more!) of your clients in the “acorn” category or, more to the point, are you aware that this is in fact the case for many firms?

A healthy cumulative profit curve would be one that rapidly increased to say 80% of your final net profit (probably from 20-30% of your clients and 30-40% of your available capacity) and then steadily increased for the remaining 20% of your net profit.  This would be in keeping with Pareto’s Law — which, in my view, seems to be a natural law of business and it would reflect the fact that not all activities undertaken in a firm yield the same level of profit.  It would also serve the purpose of keeping attention on the return that the firm is getting from a very large proportion of its available capacity and in the process, remind management of the need to continually monitor not only value created by value captured.

A Simple Costing Model

The profit contribution graph illustrated above is a useful framework for analyzing the contribution clients make to a firm’s overall profitability.  Even in cases where there is no decline in the graph it will highlight what percentage of clients account for 80-90% of a firm’s profit.  This in turn raises the question of whether resources consumed in servicing the remainder of clients might be better deployed or, as Kaplan suggests, it indicates there is a need to improve your processes to reduce the cost of servicing these clients.

How long something takes to complete does not reflect what it is worth to a customer.  However, time is one of the major drivers of what it costs to provide the service and is therefore relevant from the perspective of the producer of the service.  The rationale for this is simple, if you are paying a knowledge worker say $30 per hour and that person takes 1 hour to complete a task, part of the cost of that task is $30 – this is payment for the intellectual capital provided to the firm by that team member.

In addition, the knowledge worker will utilize other resources that are provided by the firm to its knowledge workers e.g. application software, telecoms, paper, utilities, postage, internet access, library resources, office real estate etc.  Some of these resources are fixed costs and others are variable but they are an expense incurred by the firm and to determine the profit associated with the work done for clients they should be charged to that work in some way.  In a perfect world, we might use an activity based costing methodology to assign all of these costs.  However, we don’t work in a perfect world so we need to use an alternative simple approach.

I believe that the amount of time involved with each client is a good basis for determining the total cost.  To accomplish that it is obviously necessary to use timesheets.  I have built a spreadsheet costing model that determines client profitability in the following way:

Step 1: The total expense of the firm is determined.  Fully burdened labor costs are separated from other expenses. If owners are not paid a salary an imputed cost for owner salaries is determined and is reflected in the total labor cost – this will include both direct labor (i.e. people who work on client engagements) and indirect labor (i.e. support people.)

Step 2: An estimate is made of the firm’s chargeable capacity.  We start with an estimate of the number of hours that would be available in a standard work year by an effective full-time team member after allowing for annual vacation, public holidays, sick leave, training time and “other” time not available for client engagements.  We’ll call this available capacity for a client-facing team member.

Step 3: Not all available direct labor capacity can be expected to be engaged in client work.  For example, people need to attend meeting’s, they are involved in training, selling, general administration and a wide range of other activities associated with a normal accounting business.  Some people may refer to these activities as being non-productive but that is far from the truth.  They are an essential part of the business of accounting so there is little point pretending that all available time is potentially chargeable time. For costing purposes we use an average firm-wide estimate of the percentage of chargeable time that the firm targets and we apply that to the total available capacity for all of the people in the firm who are engaged in chargeable work. We’ll call this the firm’s Practical Attainable Capacity (PAC).  See the pop-up form used in the software to calculate this.

Step 4: We calculate an indirect charge per hour by dividing total non-labor expenses by PAC.  This is an hourly cost that we suggest should be added to the firm’s costing system so that the “cost” of a job will show separately, the fully burdened labor component and the indirect expense charge based on the number of hours.  When this is done the person responsible for billing can immediately see the cost of resources used.  If it is the firm’s policy to use cost-based pricing it will simply be a matter of applying a mark-up factor.  Alternatively, it may already have a fixed price agreement in place (or a value price in mind) in which case this information will enable it to review the profitability of the engagement and if necessary, revisit its work processes or its pricing next year based on this cost information.

Step 5: It is quite usual for a single client to be associated with several costing entities e.g. a company, trust, personal tax returns, audit, company secretarial services etc etc.  To determine overall client profitability, these need to be aggregated and placed in a spreadsheet that contains the information below shown below.  It is then imported into the costing model:

Client entity name
Total gross revenue
Write-(offs)/ons – if applicable
Total hours involved from all team members
Direct labor cost for all team members (including owner imputation if necessary)

Step 6: Once the data is entered, we simply click the analyze button and the estimated net profit for each client is determined and the client entities are sorted from highest net profit to lowest and the cumulative profit graph and calculations are performed.   An on-screen report pops up to deliver the verdict.

Timesheets, Profitability Analysis and Productivity Monitoring

This costing model requires the use of timesheets that some people consider to be not only a waste of time but, they argue, also negatively impact the firm. I don’t want to engage in this debate here other than to say that in my opinion time sheets used for service pricing are not only a waste of time and effort but have been a major reason why the profession has experienced a real income-per-partner decline of approximately 1% over the past 30 years despite being handed unbelievable commercial opportunities and access to amazing productivity-enhancing technologies during that time.  I refer to this as a Productivity Paradox and have addressed this in an earlier post in November, 2009.

Having said that, if timesheets are used for resource costing purposes as describe here they will provide useful management information.  I have heard of one consultant to the profession who has suggested that timesheets be used to monitor “productivity” but not for pricing and his recommendation was (is) to carry the “cost” at $1 per hour to effectively force a pricing strategy based on value or whatever he had in mind.  That doesn’t make much sense in that if you are already collecting data relating to time spent why not tie it to the direct labor cost and indirect enterprise costs so that you can get a comprehensive profitability picture to review. The “productivity” metric implied by his advice is irrelevant I believe – what’s the point having high levels of productivity on clients you are losing money on?  That’s like traveling faster in the wrong direction–you get nowhere quicker.

On reflection, the traditional concept of productivity being measured by the ratio of hours charged to hours available certainly tells us something about activity but very little about results.  In fact it doesn’t even tell us much about productive efficiency it just tells us how much time a person entered on a time sheet–the idea that the more time a person puts on the time sheet the more productive that person is but it might reflect how unproductive that person is in fact. By that I mean, suppose Bill and Mary each work on a task that is exactly the same and Bill does it in one hour and Mary completes it in two hours, who is most productive?  You might say “the answer is obviously Bill and this will be reflected by him creating more work output in an 8 hour day.”  But what if neither of them has any more work to do on a given day.  Whose timesheet for that day would indicate higher productivity?

A more useful concept of productivity might be one that talks to value created from the customers’ perspective and value captured from the firm’s perspective.  For example, we could say the firm described previously exhibited productivity of 55% that being the percentage of its capacity that actually yielded a profit.

If you would like to download and used the spreadsheet to analyze your own client base, click here.