The traditionally accepted  business model for medium and small accounting firms is predicated on a revenue model that is cost based.  Value is driven by cost, and  cost is calculated as hourly rates times hours worked.   Hourly rates are established by comparison to other firms in the same market.  And then of course you have to accept the premise that every firm has identical expertise and will require the same amount of ‘hours’ to complete the engagement.

So if you have an average hourly rate times an average number of hours you have the value of the service provided.  Right?  Wrong! You may have your ‘cost’, but you absolutely, unequivocally do not have your value.   Cost accounting 101 – value is not a derivative of cost.  What you can reasonably expect to realize (value) determines the amount of  costs you are willing to incur to deliver that specific product, not vice-versa.    So why are you predicating value as a function of cost, and you are by accumulating hourly rates and billing them to your clients as the value of your services?

Typically I’ve railed against using hours and rates because I believe they under estimate value.  But be careful.   That knife cuts both ways.  In our current market, the use of hours and rates as a basis for a proposal can almost guarantee you won’t be successful.  In 35 years of practice I’ve never seen a market as cut-throat.  Frequently in our firm it has gotten down to one question.  “How bad do we want it?”  When considering any unique advantages we would normally expect to get an advantage from (industry expertise, idle capacity, contacts, etc.) we use them to get to our ‘walk away price’.  (The amount we won’t go below, regardless).  Certainly we consider ‘cost’ in proposing on an engagement, but we consider it in light of what we believe we can price the engagement at to determine our level of interest.

How do we determine ‘cost’?  Not by a standard rate.  There are other more relevant metrics.  That’s another post.  How do we determine ‘value’?  It’s unique to each potential engagement and to your firm.  Do you have a Pricing Committee?  You should.  Let’s talk about that next week.

Socrates is addressing his student, Glaucon, and describes a ‘world’ where the inhabitants are chained in a cave facing forward, allowing them to see only the wall in front of them.  Projected on that wall, are reflected images of animals. The voices heard were attributed to the images, and since they could not turn their heads those images and voices became their false reality.

Ultimately, one prisoner is taken to the outside world, sees the sun and is exposed to reality.  Ultimately he is returned to his original habitat, but can no longer accept that false reality. When he attempts to share his intellect with the other prisoners he is rejected because it is of course more comfortable and less threatening. A regression to the familiar by the other prisoneres,  if you will.

So ultimately it is the individual choice of each of us to accept the reality of others through their projected images – the accepted body of knowledge and how things are done – or to question that intellect in search of a better business model for service providers.

Going back in the cave is not an alternative.

Seems like a simple answer yet we truly have great people who have a passion for what they do. Employees who enjoy coming to work each day, are respected and know they are an integral part of the firm enable us to provide a work environment that sets us apart.

Recently members of our management team were reviewing software options for project management.  During a web presentation by our British friend and Verasage Senior Fellow, Paul Kennedy of O’Byrne and Kennedy of their software designed primarily for ‘pricing firms’  we were discussing CSAs.  Our document template is very similar to his, with one glaring exception.  Paul includes an automatic bank wiring authorization form.

By signing it the client instructs their bank to wire the agreed upon amounts on the agreed upon dates in advance or concurrently with the work being completed.  Simple, effective and brilliant.  While this works best for those of us who ‘price’, it has definite possibilities for you time sheet junkies as well.

When  the discussion turned to  the current economy the general consensus was that this was an appropriate time to reduce overhead by firing marginal  team members – thinning the herd.  I have two very significant problems with this concept.

First and most importantly.  Your team is not a ‘herd’.  I realize this was probably not the literal sentiment of the speakers, but words are important.  And they influence how you interact with your team.  If you think of those you work with as an amorphous  mass, as opposed to individuals you’re missing incredible opportunities to develop the expertise and effectiveness of your firm.

Second, if you have weak team members who should be fired why are you waiting for an excuse, e.g. a weak economy?  If they need to be fired, they need to be fired.  Please name for me one advantage of keeping a weak team member around.  Great firms have great people – people who perceive themself as great.  If you keep a ‘weak link’ around it effects the professional self opinion of every other member of your firm, indirectly.  Directly it effects your firm by the perception projected to your clients and the community.

That’s not to say you throw away a member of your team without making every effort to help them.  That’s expensive and in my opinion immoral.  But if they are in the wrong profession or wrong situation, what benefit is there to keeping them around.  None to them, and certainly none to your firm

The Gen Xers I know are technologically savvy, intelligent, committed, professional, and innovative.  They are the young partners in the successful firms I am familiar with.  As an entrenched Codger, I’d say they rock. (Codger talk for they got it goin on.)

Last week I had the distinct pleasure of attending a conference sponsored by one of the top accounting firm associations in the world.  The International Group of Accounting Firms (IGAF).  Everyone I met – Codgers, Gen Xers, Millenials – was exceptional, but what absolutely blew me away was the insightfulness of the ‘young’ partners.  The 35 to 50 year old leaders.  The Gen Xer’s.

The estimate is that up to 75% of the partners in accounting firms will retire in the next 10 to 15 years.  Succession is a big concern in our profession.  More important to me is whether or not we have future leaders who will perpetuate the ineffective model we have now – a business model that is over 100 years old and substantially ineffective in many ways – or will someone pick up the torch and challenge the ‘common belief’ that is practice management?  Will the Gen Xers  pick up where we Codgers leave off and employ their ability, motivation, intelligence and most importantly insight and innovation to address what we haven’t?  Based on the group I met at IGAF, there is no doubt in my mind.

I hope they’ll let this old Codger hang out and provide a thought or two.  We’ll have a new progressive business model incorporating service based pricing; a flexible working environment geared to the needs of the professional knowledge worker and integrated with those of the Firm; while re-establishing the accounting profession as the guardian, mentor and champion of world business.

After practicing for over 30 years I can unequivocally say we’ve never had a ‘perfect client’. One who always applied the accounting principles correctly, on time and provided the requisite support. Without exception. (The other assurance partner claims he had one, once, but he drinks heavily.) The only perfect client is the one you are doing a proposal for. He’ll promise to do everything perfectly.

In the proposal process, the Company’s obligation is to get the ‘highest level of service for the lowest possible price’. So of course they are motivated to commit to a course they are entirely incapable of keeping and the assurance team has to endure the shortcomings.  In a time sheet environment this may get passed on to the client, but not likely. And of course if it does the client squeaks that it is not consistent with the original proposal, and you have what my friend and mentor Ron Baker euphemistically refers to as ‘bill and duck’ (and hope they pay). For pricing firms, as we are, it results in scope creep.

My point is that ultimately no client is perfect. Propose based on what they commit to but invoice them for what they actually do or don’t do. Don’t whine because they aren’t perfect. Just implement a system that accommodates that imperfection without penalizing your Firm or creating animosity with your client(s). You might want to try Client Service Agreements. (Oh, and to all you seniors – ‘imperfection’ is why you get paid the big bucks! If all our clients were perfect we wouldn’t need your gray matter. We’d just use checklists. )

In most firms, the engagement letter – conceived / drafted / revised / and re-revised by attorneys attempting to protect us from ourselves – has become the primary, and frequently only, verbal communication with our significant clients prior to performing the engagement. Yet it does nothing to inform the client of their obligations other than to pay, or what our responsibilities or requirements are. It is a legal letter. Not designed to communicate, but rather to provide a defensible legal position.

As a Firm practicing ‘pricing’ – advising the client of the cost in advance of providing the service – we automatically assume the pricing risk of ineffective engagement performance. Of course we can only influence the risk for matters over which we have control, so what happens when the client doesn’t perform as agreed? The scope of the engagement is extended. We refer to this as ‘scope creep’. Without an agreement defining the engagement it is highly likely the service provider, if a pricing firm, will unfairly suffer the financial responsibility.

Poor communication can be even more detrimental to a firm who ‘bills’ – adds up the hours charged and then multiplies the total by some arbitrary rate at the end of the month – and drops an unexpected invoice on the unwary client. (Michelle Golden a national marketing and practice management consultant to service firms referred to this process when speaking with me recently, as ‘bill and duck’.) The frequent result can include non-payment or loss of the client, but at a minimum a deteriorated relationship.  

Does the engagement letter cover either of these possibilities and define the engagement? Contractually, maybe. Operationally, absolutely not.

During my career I’ve noted that when contractual agreements lead to dispute, it is primarily because they were not drafted jointly, but rather unilaterally. One of the fundamental tenets of effective leadership is convincing all parties necessary to a transaction or course of action to take ownership of the process. Undeniably you are more likely to take ownership of decisions you have participated in making than those that have been forced on you. It is no different with written agreements. Unilateral decisions are simpler to make, more convenient and easier to implement, but less likely to be embraced. In other words, they are sometimes more efficient, but typically much less effective.

Engagement letters are unilateral. They are without input from arguably the most important party to the contract. The client. We essentially are telling the client to take it or leave it rather than striving for concurrence. In our Firm, while we obtain engagement letters for every engagement, we’ve also implemented the use of Client Service Agreements.  Ron Baker refers to them as Fixed Price Agreements in his book the Firm of the Future.

We’re primarily an audit firm, and most clients have a very rudimentary understanding of the audit process. The CSA gives us the opportunity to explain the engagement process. Simultaneously, it provides the client with an opportunity to educate our audit team so that we don’t inadvertently or unnecessarily interfere with their work flow. The CSA is not a unilateral agreement. We develop it jointly with the client.

Typically our CSAs cover our approach and what we need the client to do for us to be successful; what the client needs from us to make the engagement tolerable and successful from their perspective; scope of services; timing; responsibilities of all parties; the additional financial cost and potential for missed deadlines if the client doesn’t meet their responsibilities; detailed schedule of payment for services; and our service guarantee. Little of this, if you think about it, is covered in a typical engagement letter but all of which is critical to a successful engagement. Finally, in addition to our service guarantee we include a termination clause allowing either party to void the CSA if they become dissatisfied.

For us, the improved communication embodied by our CSAs has led to significantly improved engagement performance with happier clients. We have completely eliminated invoicing disputes and increased our accounts receivable turnover which has resulted in improved cash flow and profitability.

Certainly there are many factors that influence the strategic direction CPA Firm leaders will choose.  Legal considerations, staffing concerns, regulation, marketing opportunities, lifestyle options, technological ‘advancement’, financial motivation,  and competition just to name a few.  Some we can influence.  A few we can actually control.  Most we can only respond to.

So how have we responded?  In the only way we’ve been indoctrinated.  By trying to improve efficiency.   By demanding ‘more hours’ from our team members; by marginally increasing our hourly rates; by adding technology  and hopefully cutting overhead costs.  All things to make us more ‘efficient’ and thus improve our profitability.   Ultimately we can only attain a finite level of efficiency.

By focusing solely on efficiency we are commoditizing (my word) our services.  We’ve already done that with taxation services in large part.  The key to improving profitability in a mature firm is to focus on effectiveness, not becoming even more efficient.  Ron Baker in his book, The Firm of the Future has several excellent discussions on efficiency versus effectiveness.

To improve your profitability, I believe you have to differentiate your service so that you can charge more for it.  You have likely controlled your expenses as much as possible so to improve your ‘bottom line’ the logical alternative is to increase the ‘top line’ – Revenue.  Guess what!  You’re not going to do that with time sheets.  Not significantly anyway.  Time sheets, are by their nature, tools of efficiency.    You must become more effective, because you are likely already as efficient as you are going to become.

How well you manage an engagement; how effectively you’ve priced and bundled it – in advance; how effective your client relationships are.  These are a few of the areas that can help you differentiate.  We’ve all hit optimal ‘efficiency’.  It’s time to focus on ‘effectiveness’.

One definition of insanity is “Doing the same thing over and over, but expecting different results”.  I have no idea who first said that, but truer words were never written.  And that’s what we seem to be doing too regularly in the accepted approach to practice management in our profession.  So after 25 years we finally recognized the need (and tremendous opportunity) to be innovative.

The catalyst was a presentation by author Ron Baker, on pricing and the Firm of the Future sponsored by CPAmerica and cpaconect.  Ron is a a shameless advocate of trashing the time sheet especially as a tool for measuring the value of the services we provide.  Ultimately, though, for us the derivative (sorry auditors I know you hate that word) benefit was the realization that time sheets are an insidious tool of micromanagement.  And micromanagement creates serious negative repercussions with professional knowledge firms (PKF’s – a Baker term).  This realization, brought about by eliminating time sheets in our firm, led to many positive changes some of which follow:

- a results oriented work environment – team members are ‘invited’ to work on specific engagements and may decline without prejudice; team members have a responsibility to get the job done on schedule, but they decide when, where and how the work will be performed.

- elimination of annual performance evaluations - in favor of a mentoring program.  This improved communication technique provides timely feedback in a non-confrontational manner rather than waiting until the end of the year.

- a true flex time environment - pick your level of commitment and be responsible for your own work/life balance.

- true team work – as a result of eliminating the dysfunctional staff competitive environments found in most firms.

- elimination of turnover – we’re nearly perfect in eliminating voluntary turnover in an industry plagued by the loss of the best and brightest talent.

There is much more.  The obvious result is a healthier professional environment, which has led to better client relationships a happier team and virtually no turnover.  Some of the ‘new’ things we’ve instituted to support this are:

- universal involvement at all levels in the committees that set the direction for the firm, whether it be audit, tax, consulting, pricing, marketing, admin, or social.

- a new pricing model supported by strong proposals, detailed client service agreements, a staffing and scheduling committee, after action reports, budgeting and profit analysis by engagement.

- a mentoring program.

Designing and replacing the system that was time sheet driven  to provide the management tools necessary to have an effective service firm in our current business environment has not been easy, and it’s an ongoing process.  There is much more to say than room on a blog to say it, but the bottom line is ‘we’re not crazy’!  And we have the results to prove it.