VeraSage Institute

Journal of Accountancy Publishes Pricing on Purpose: How to Implement Value Pricing in Your Firm

ron@verasage.com (Ron Baker) — Sat, 12 Sep 2009 09:33:11 PDT

The June 2009 issue of the Journal of Accountancy has published our latest thinking on Pricing on Purpose.

This article explains an eight-step method for establishing a price, including the now infamous Nienbach model (a nine square thought experiment to aid in setting pricing options).

There is also a sidebar on price psychology.

There are eleven exhibits that accompany the article on the Website version—you’ll find the links at the end of the article.

There are 3 exhibits included in the print version article. The other eight are:

Disadvantages of hourly billing
The Five Cs of Value
Pricing Council and CVO Purpose and Criteria
Sample Fixed Price Agreement (FPA)
Explaining the the Sample FPA
Sample Change Order
After Action Review for the CVO/Pricing Council
A Lesson in Value Pricing Ice Cream—From an Accountant!

Once again, I’d like to thank my VeraSage colleagues who helped me with this article, especially Ed Kless (who informs me one of his ancestors actually knew Barron Joseph von Nienbach).

Also, Loanna Overcash, my editor at the Journal of Accountancy. This is the second article she has had the herculean task of getting through peer review, all the while maintaining a great sense of humor in dealing with an incredibly controversial topic, not to mention author. Just wait until the next article, Loanna!

Thank you Mark Koziel, AICPA’s Senior Technical Manager, Specialized Communities—Firm Practice Management/PCPS, for your indefatigable support.

We’d love to hear feedback on what you think of this new approach to pricing.

The Chisconsult Newsletter

ron@verasage.com (Ron Baker) — Fri, 06 Nov 2009 09:56:11 PST

John Chisholm from Melbourne Australia is a third-generation attorney, a consultant to the legal profession, a wine connoisseur, and a terrific guy.

John hosted me last August for a tour in Australia talking to legal firms, young attorneys, general counsel, and government officials.

He publishes a newsletter that is quite good.

His Spring edition is now out, which you can access at The_Chisconsult_Circle_-_Issue_2.pdf

You can also register to receive the newsletter at John’s Web site. Well worth reading if you have an interest in the legal profession, or wine—John’s daughter Kate offers reviews of some fantastic Australian wines.

The Legatum Institute Prosperity Index

ron@verasage.com (Ron Baker) — Fri, 06 Nov 2009 09:56:59 PST

There are many political and economic freedom indexes you can follow, such as the Heritage Foundation’s Index of Economic Freedom or The Fraser Institute’s Economic Freedom of the World report, among others.

The Legatum Institute was founded by Christopher Chandler, a New Zealand billionaire. In the institute’s view, man does not live on bread along, or merely political freedom and economic growth. Thus, there are two halves to prosperity, economic competitiveness and comparative liveability, which includes freedom of choice, ethical values, good health, equality of opportunity, civil liberties, spiritual faith, low unemployment, strong family life, and a temperate climate.

As its Web site reports:

The 2009 Legatum Prosperity Index is the world’s only global assessment of wealth and wellbeing. The Index finds that the most prosperous nations in the world are not necessarily those that have only a high GDP, but are those that also have happy, healthy, and free citizens. Now in its third year, the Index builds on the previous versions with expanded data and refined analysis and assesses 104 nations covering 90 percent of the world’s population.

The top 10 countries are:

Finland
Switzerland
Sweden
Denmark
Norway
Australia
Canada
Netherlands
United States
New Zealand

Sure, it’s a bit subjective, and is unsure about how to weigh religion in the Index, but it’s interesting and worth pondering.

It adds another dimension to assessing political and economic freedom without degenerating into meaningless platitudes that you find in some “happiness” and “environmental quality” indexes.

You can access the report here.

The New VeraSage Logo

ed.kless@choosegreat.com (Ed Kless) — Tue, 03 Nov 2009 13:58:02 PST

Sage Summit Sessions

ed.kless@choosegreat.com (Ed Kless) — Mon, 02 Nov 2009 16:14:59 PST

A few Sage business partners have inquired as to what sessions I am doing at the upcoming Sage Summit customer conference in Atlanta next week.

Without further ado, here they are:

Tuesday, November 10, 2009

Time	Session
8:30 AM - 9:30 AM	GEN02 - Altruism, Profit, and the Basics of the 7S Model
11:00 AM - 12:00 PM	GEN03 - Creating Shared Vision
2:15 PM - 3:15 PM	GEN04 Creating Strategy in a Small Business

Wednesday, November 11, 2009

Time	Session
8:30 AM - 9:30 AM	*GEN05* - Initiating Projects in a Small Business or Small Team
11:00 AM - 12:00 PM	*GEN06* - Building Community: A New Paradigm
2:15 PM - 3:15 PM	*GEN07* - Fundamentals of Strategic Pricing

It would be my honor to meet your customers, so bring them by if you can.

Stop with the “Trusted Advisor!”

ed.kless@choosegreat.com (Ed Kless) — Tue, 13 Oct 2009 19:28:10 PDT

I have been bombarded this week with people saying they are “trusted advisors.” So much so that I must react.

While being a trusted advisor is certainly a worthy goal of any professional, please realize that it rarely happens. David Maister in his book entitled The Trusted Advisor says relatively few relationship are truly of the trusted advisor variety. He defines them as a relationship, “in which, virtually all issues, personal and professional, are open to discussion and exploration. The trusted advisor is the person the client turns to when the issue first arises, often times of great urgency: a crisis, a change, a triumph, or a defeat.”

With this definition in mind, I find it the height of hubris to say to a prospective customer, “I want to be your trusted advisor,” or, “We like to think of ourselves as trusted advisors.”

My response, “Keep thinking and keep walking!”

Book Review: The Management Myth

ron@verasage.com (Ron Baker) — Tue, 06 Oct 2009 10:48:07 PDT

The schism between management theory and economics is profound, and one of the reasons is the study of management theory is relatively young compared to its older sibling economics, which dates back hundreds of years. In their piercing book The Witch Doctors: What Management Gurus Are Saying and Why It Matters, John Micklethwait and Adrian Wooldridge, two staff editors for The Economist, level this charge against the immature discipline of management theory:

Management theory, according to the case against it, has four defects: it is constitutionally incapable of self-criticism; its terminology usually confuses rather than educates; it rarely rises above basic common sense; and it is faddish and bedeviled by contradictions that would not be allowed in more rigorous disciplines. The implication of all four charges is that management gurus are con artists, the witch doctors of our age, playing on business people’s anxieties in order to sell snake oil. The gurus, many of whom have sprung suspiciously from the “great university of life” rather than any orthodox academic discipline, exist largely because people let them get away with it. Modern management theory is no more reliable than tribal medicine. Witch doctors, after all, often got it right—by luck, by instinct, or by trial and error.

This book gave voice to the backlash against the “profession” known as consulting. The four defects of the witch doctors of our age are mortally accurate. The profession has yet to refute successfully the charges against it, so eloquently articulated in this book. I thought I’d never see another book as good this one on the shortcomings of consultants.

Until, that is, The Management Myth by Matthew Stewart, which is destined to become a classic, advancing tremendously The Witch Doctors criticisms and shortcomings of the consulting industry with the added bonus of taking on business education in general, and the ridiculous idea that management needs to be a profession.

Whereas The Witch Doctors pulled its punches, Stewart is fearless, equating consultants to viruses and their clients as hosts.

Even though Stewart was hired by a consulting firm in 1988, his real passion is philosophy, in which he holds a PhD, specializing in 19th century German Philosophy. This focus on philosophy and the humanities shines through this work, adding an impressive dimension to his case against consultancy and the myth of management science. He writes:

Gradually it dawned on me that management is indeed a neglected branch of the humanities, and that the study of management belongs, if anywhere, to the history of philosophy. Management theories lack depth, I realized, because they have been doing for only a century what philosophers and creative thinkers have been doing for millennia. This explains why future business leaders are better off reading histories, philosophical essays, or just a good novel than pursuing degrees in business.

Stewart lays out his bold and ambitious purpose of the book this way:

...the modern idea of management is right enough to be dangerously wrong and it has led us seriously astray. It has sent us on a mistaken quest to seek scientific answers to unscientific questions. It offers pretended technological solutions to what are, at bottom, moral and political problems.

My aim in this book is to trace the genealogy of this idea, to expose its flaws, and to replace it.

The management idol, I hope to show, stands in need of a good, hard knock.

Stewart indeed punches hard, taking down, one by one the gurus of management, beginning with historical icons Frederick Taylor and Elton Mayo to the modern titans, such as Michael Porter, Jim Collins, Tom Peters, and yes, even Peter Drucker.

Intertwined with Stewart’s deconstruction of the management myth is his personal story of his experiences in the consulting industry, and the founding of his new firm during the Dot.com boom which grew from 140 to 700 employees and $50 million to $250 million in revenues, in four years. It’s a fascinating and suspenseful story, eloquently retold by Stewart, giving life to his many criticisms of the industry.

Taking Down the Gurus

Stewart’s first victim is Frederick Winslow Taylor, the father of Scientific Management. He shows that there was never any evidence that Bethlehem Steel realized any significant benefits from Taylor’s Pig-Iron (Tall) Tale. Taylor “became famous for the idea of what he was supposed to have achieved—not for what he actually achieved.”

There’s no such thing as a universal science of efficiency, a point Thomas Sowell and economists have made so well for centuries. Efficiency is inextricably linked to your purpose and what you are willing to pay for. Positing a universal science of efficiency as Taylor did was nonsense, as Stewart humorously illustrates:

One can go grocery shopping with a scientific attitude. But it does not follow that there is a science of grocery shopping.

Rather than being a falsifiable theory, Taylorism was a tautology: “An efficient shop is more productive than an inefficient shop.” Stewart rightly points out that Scientific Management was never a science; it was, and is, a business, today reincarnated as Lean and Six-Sigma and other dogmas peddled by consultants. Even Peter Drucker, Gary Hamel, and a lot of others pay homage to Taylor, recognizing him as the world’s first management consultant. Stewart proves he lied and fudged his experiments.

In a skillful twist of the McKinsey Maxim—If you can measure it, you can manage it—Stewart says consultants motto might well be ”If you can’t manage it, measure it!” This measurement for measurement sake is endemic among organizations and consultants, thanks to Taylor’s obsession with time-and-motion studies.

Stewart’s next victim is Elton Mayo, father of the infamous Hawthorne experiment, which his posthumous critics described as “worthless scientifically” and “scientifically illiterate.” Stewart writes that Mayo’s Hawthorne experiments proved a tautology:

If you are nice to people, they will usually be nice back to you. But this is a timeless precept, grounded in ethics...It is not and never will be a “scientific” finding.

Even Peter Drucker fell for Mayo’s work, citing the Hawhthorne experiments in his 1954 book, The Practice of Management, and declaring:

the reports of [Elton Mayo and his associates] on the work at Hawthorne are still the best, the most advanced and the most complete work on the subject of [human relations.]

Douglas McGregor‘s Theory X and Theory Y are also knocked down, as they depend on Theory U according to Stewart—for utopian.

Even Michael Porter, the academic father of business strategy, is not immune to Stewart’s indictment. He recounts a meeting at Boston Consulting Group wherein founder Bruce Henderson was trying to decide how to compete with McKinsey. They needed to specialize, but in what?

“What about business strategy?” Henderson proposed.

Robert Mainer, another partner at the meeting, objected “That’s too vague. Most executives won’t know what we’re talking about.”

“That’s the beauty of it,” Henderson replied. “We’ll define it.”

Stewart defines strategy consulting as “extremely expensive,” before critiquing Porter’s work. His major indictment is Porter’s use of “frameworks” as opposed to “models.” A model makes predictions about the future, which is the ultimate test of its value. A framework merely justifies its utility “if it helps practitioners change the world in positive ways.”

This test is far too weak, as astrological charts and voodoo dolls have high utility for many people as well.

Porter’s framework claims that there are three generically successful business strategies, and that strategy-making processes should aim at the singular goal of excess profits. Stewart believes these hypothesis are mostly false or unsubstantiated. Another tautology according to Stewart:

To say that a company has a “sustainable competitive advantage” is thus merely to restate the fact that it makes excess profits. ...[Porter’s] framework may explain excess profits, it does nothing to predict them.

The self-contradicting Tom Peters is delivered many body blows by Stewart. He cites Peters admitting that In Search of Excellence was “phony baloney.”

Jim Collins of Good to Great fame is also taken down, with Stewart observing that the “384 million bytes of computer data consists chiefly of press clippings.”

You have to love Stewart’s wit here:

Reading through the guru’s favorite companies from the past two and half decades is like watching a parade of homecoming queens from years past. The sad procession serves mainly to prove that time destroys every conceit.

Best of all, Stewart doesn’t spare Peter Drucker, who claims to have established management as a discipline and as a field of study. Here is what Stewart writes:

In fact, neither [Drucker] nor his successors established a discipline; they merely asserted the idea of a discipline. (And, for what it’s worth, it was Taylor, not Drucker, who had the idea first).

This is by no means an exhaustive list of gurus that Stewart deconstructs in the book, and he even mentions in the Bibliographical Appendix “there is a large population of gurus on whom no comment should be offered. They are best left in the trash can of history.”

5 Easy Steps to Becoming a Guru

Amusingly, but poignantly, Stewart lays out five easy steps to establishing a popular management religion, citing the gurus major achievement as transforming the religion of management into a demotic one—a people’s religion:

We are all going to die! The guru’s obsession with the instability of the present—that is, a dynamic capitalist society.
The bureaucracy is killing us! An expression of the democratic and egalitarian instincts of American culture, and it can serve as an important check on the excessive concentration of power.
There is good news in America! The necessity of a happy ending.
You have the power! We are all CEOs now. Presumably it’s just our paychecks that have to catch up.
Just look at me! What the medieval theologians called “the argument from authority.”

Stewart thinks the management religion is a form of false consciousness:

Although it promises freedom, it in fact delivers a more refined form of servitude. As the semiestablished church of our times, its global effect is to perpetuate rather than to challenge managerial authority.

If religion is the opium of the people, as Marx suggested, then management theory should probably count as a kind of amphetamine. It causes agitation and hyperactivity. It does have the unfortunate side effect, however, of making people feel much more efficient than they actually are.

Should Business be a Profession?

Stewart points out that the “professionalization” [of business] project rests on a fatal misunderstanding about the ethical foundations of a profession, pointing out that trust is a critical component of a profession, along with standards of admission, licensing requirements, and disciplinary procedures.

Scholars have long agreed that there are, primarily, three necessary characteristics to be a profession: A common body of knowledge. Autonomy. And a Spirit of Service. Business management only meets the last of these, as any one can be labeled a “manager.” This is also why journalism is not a profession.

As Stewart rightly points out about the new Harvard Business School pledge to consider oneself a “professional”:

Most managers, to be sure, are good people; and it seems unlikely that a couple of years of pseudovocational training will spoil them. But it is foolish to imagine that they will behave well merely because they are told in business school that they should regard themselves as professionals.

Insofar, as an education can have any effect on the ethical life of the individual, it can do so only by forming intellect and character. For that purpose, the study of obtuse textbooks on organizational behavior will always rate as a very feeble alternative to the study of Aristotle or Shakespeare.

The movement to make management a profession is not only misguided and misinformed, it’s not necessary. Business is all about serving the public within an ethical and moral framework.

In fact, as Michael Novak as argued so compellingly in Business as a Calling, business is a serious moral enterprise, since it teaches many virtues—risk-taking, prudence, accountability, serving strangers (i.e., customers), etc.

Trying to elevate it to the level of a profession would be asking something of it which it is not capable. Business is based on creative destruction, not the slow, plodding progress of most professions.

The Future of Management Education

Businesses routinely confuse “training” with “education.” We train our pets, but human beings are educated. Stewart offers some very innovative thinking with respect to what should happen with management education in the future:

After 100 years of fruitless attempts to produce such a discipline, it should be clear that it does not exist. Preparing managers to manage, in fact, is not different from preparing people to live in a civilized world. Managers do not need to be trained; they need to be educated.

If business schools would drop the pretense of providing practical training and engage in disinterested, critical study of business and management practices and culture, they might actually make a significant contribution to society.

The fact that business schools pander to its customers—the students—is not a new charge, but Stewart makes another compelling case:

At the end of the game, the business schools will be all business and no school. “Customer satisfaction” is a good way to sell shoes; but it is a bad way to relieve ignorance. It is fundamentally stupid to base the content of an education on what the as-yet uneducated person decides is best.

Stewart goes on to illustrate the number of functions that a business school performs that has nothing to do with knowledge: recruiting festival; signaling device; status symbol; language school; and network maker. Economists have been pointing out these functions of college degrees for decades.

I also wholeheartedly agree with Stewart’s conclusions:

The central insights of management theory are, in fact, the stock in trade of the humanities disciplines.

Management theory, in fact, is already a branch of the humanities—it just may not know it yet.

The questions that the management theorists raise and the insights that they offer belong not to a speciously practical discipline of management, but to the history of philosophy, and they should be taught and studied as such.

By this definition, of course, a good manager is nothing more or less than a good and well-educated person.

In all fairness, Peter Drucker did believe that business was a branch of the humanities.

This is not to say I agree with everything Stewart writes. He seems to have an inherent trust in government regulation, stating that markets aren’t born free, they are made free. Made free by government? Is he kidding? I’ll take liberty and occasional abuses over the loss of liberty due to the stifling foot of a nanny-state government trying to protect us from ourselves.

Disagreements aside, this is a masterful book. Stewart’s book has laid out a compelling case against management consultants, just as The Witch Doctors did 13 years ago.

My conjecture is the gurus will ignore The Management Myth, not having the intellectual firepower to counter its arguments.

Those who hire consultants, however, can’t afford to ignore this book.

Measure Your Discounts

ed.kless@choosegreat.com (Ed Kless) — Tue, 29 Sep 2009 19:35:13 PDT

I was recently reminded of a great practice for all professional firms to get into the habit of doing, namely measuring discounts. Most firms I work with do not, but I think this is serious mistake.

I would measure discounts on all aspects of your business. For those of you who sell products in addition to services and knowledge this means measuring the amount of discounts you are giving in each area.

Many of you know I am not a big fan of measuring anything financial other than the basics, but I truly think measuring discounts will provide you with insight on how to become a better, more confident pricer.

A Rabbi argues for effectiveness over efficiency

ron@verasage.com (Ron Baker) — Mon, 28 Sep 2009 10:39:48 PDT

Those who know me know I listen religiously to Rabbi Daniel Lapin on KSFO 560AM every Sunday from 1-4 pm.

He’s one of the most astute observers of human behavior, and even though I’m not Jewish, as he says, no matter what your faith “Everyone needs a rabbi, and for those who have no faith, you definitely need a rabbi.”

He’s written a fantastic book, Thou Shall Prosper, which I reviewed here.

Every Thursday, Rabbi Lapin sends out his Thought Tools, a short story that deals with various issues we face in our life, to which I highly recommend you subscribe.

I just finished reading his September 23rd Thought Tool, ”Retreat to Advance.”

As you’ve probably read, I’m involved in an intensive debate with Pat Lamb on the issue of efficiency vs. effectiveness.

I argue that knowledge workers work with their minds, which is an iterative process not subject to the rhythms and cadences of an assembly line.

For this reason, the “efficiency” metrics that are used in most PKFs—such as output per hour, realization, utilization, etc.—are a complete joke.

Knowledge workers aren’t machines.

Rabbi Lapin, I believe, would agree, given what he wrote in this thought-provoking Thought Tool:

Like all of us, I spend my day tackling challenges. Sometimes there’s a problem baffling me. Then I put it out of mind and retire for the night. Often in the early pre-dawn hours I will awaken and am instantly aware that I have had a creative thought breakthrough. Grabbing the pen and pad I always keep alongside my bed, and which I recommend as a vital business tool, I can hurriedly scrawl down the answer to the daunting problem from the day before.

Every time this happens I am amazed, yet it shouldn’t astound me. After all, this is one of those timeless truths of ancient Jewish wisdom. Human creativity thrives in an environment of thrust, retreat, and then thrust again. Work the problem, back off, and then return to the problem. It will yield more rapidly than it would in one long protracted push.

This is a physical parallel to a spiritual reality. Just as our bodies require sleep, so do our minds and souls. Creativity and productivity are enhanced by regular periods of withdrawal.

But where do I log this withdrawal on my timesheet? If I’m measured by output per hour I’ll feel like crap if I do this (and used to when I billed by the hour).

Isn’t it obvious that knowledge workers are different? They simply can’t run at 100% efficiency, day in and day out.

I’m completely baffled why this is so hard for some innovative leaders to understand.

I’d be grateful for your thoughts and input.

The Debate Continues with Pat Lamb

ron@verasage.com (Ron Baker) — Tue, 29 Sep 2009 13:30:35 PDT

Pat Lamb commented on my recent post on Lean Client Service.

Since I don’t want to repeat the entire post along with his comments, I will just respond to his comments, as shown below in all capital letters.

On the distinction between “value billing” and “value pricing” Pat writes:

[I APPRECIATE THE DISTINCTION AND APOLOGIZE FOR THE ERROR. BUT TO ME, THE CRITICAL ELEMENT IS THE PRICING AND SUBSEQUENT BILLING SHIFT TO THE LAWYER OR OTHER KNOWLEDGE WORKER THE NEED TO PRODUCE THE OUTPUT AT THE LOWEST COST IN ORDER TO MAXIMIZE PROFIT MARGINS].

This comment explains most of the differences between Pat and me.

Pat, you seem to have a “penetration” pricing strategy, which means any costs you drive out of the system are passed along to your customers, like Wal-Mart.

I think this is a strategic error for Valorem, especially if you offer “alternative” pricing and great customer service.

At worst, you should have a “neutral” pricing strategy, or better yet, a “skim” strategy. Little wonder you are still arguing for cost savings everywhere. You should re-read the story from Ben & Jerry’s from my book Pricing on Purpose (which you reviewed on Amazon and gave 5 stars), where they discuss their pricing epiphany. [In fact, I’ve reproduced it at the end of this post].

Your penetration strategy dictates your views, while most of the firms we work with are implementing a skim price strategy.

On the issue of “professional service” vs. “professional knowledge” firm, Pat writes:

[TO ME, A DISTINCTION WITHOUT A DIFFERENCE].

Really? Then Peter Drucker was wrong about knowledge workers, and the enormous differences between them and industrial/service workers? You can apply the same metrics to a KW as an industrial or service worker?

The difference is enormous, and I’m not just talking about the name. Knowledge workers own the means of production, and they are the system when it comes to many functions. I side with Drucker on this one.

If we can’t agree on this, then nothing else I say will matter to you.

Pat writes:

[IS YOUR POINT THAT WE WANT TO DO THE RIGHT THINGS INEFFICIENTLY? IF SO, I BEG TO DISAGREE].

No, not my point at all. My point is that in many cases, as I cite in my post, at the margin trading less efficiency for more effectiveness is a wise strategy.

Doing the right things efficiently, or to the best of our abilities, is just plain common sense. I don’t mow my lawn with my BB gun. I’m saying that your ruthless attention to efficiency is not a competitive advantage, because despite your penetration price strategy, most law firm clients are not price sensitive.

Pat writes:

[I THINK THIS IS WHERE THE PARSING OF WORDS GETS EXTREME, RON. FRED AND I LIVE I A WORLD WHERE PEOPLE KEEP SCORE AND NEITHER OF US IS MAKING CEMENT LIFE JACKETS. WE ADVOCATE, AND LIKE IT OR NOT, IT IS AN EVERYDAY PART OF THE BUSINESS WORLD].

Keeping score is one thing, but keeping score doesn’t make you more efficient. That’s like arguing measuring yourself more accurately will change your weight.

I’m not against keeping score (hell, I’m a CPA), I’m against keeping score of the wrong things.

Pat writes:

[FRED AND I, AMONG OTHERS, HAVE USED THE BUGGY WHIP MAKER ANALOGY TO DISCUSS BIGLAW. BUT THE PRODUCT BEING SOLD BY LAWYERS IS RESULTS—SOLVING CLIENTS PROBLEMS. I DON’T KNOW OF A CLIENT WITH A PROBLEM WHO WOULD ARGUE THAT HER LAWYER’S ABILITY TO ACHIEVE A RESULT AND MAKE THE PROBLEM GO AWAY IS AN ANTIQUATED BUSINESS].

I’m not arguing that lawyers will go the way of buggy whip makers, though other thoughtful people are. I’m saying a focus on efficiency at the expense of innovation and creativity will make you irrelevant, or less able to create services that customers value.

Pat writes:

[EFFICIENCY DOES NOT ALWAYS NEED TO BE MEASURED, BUT ARE YOU REALLY ARGUING AGAINST DOING QUALITY WORK FASTER AND CHEAPER?]

Please give me an example of an efficiency metric that is not measured?

When you attempt to do this you will make my point about the difference between a measurement and a judgment.

Even your definition contained in your comment further below is a measurement, where you write:

[EFFICIENCY, AT LEAST IN THE LAW, IS GREATER OUTPUT—RESULTS—PER UNIT OF TIME].

Looks like a measurement to me. You can measure the output, but the results must be judged.

Further, it’s greatly flawed, especially from a value/pricing standpoint.

Are you saying the Jonas Salk’s polio vaccine is worth the amount of time it took him to develop? Are you saying that if it took him decades to develop it would be less valuable?

Sure, we would have loved it if he came up with it sooner, but we are dealing with human beings, not machines. You seem to think lawyers can run at 100% efficiency all the time, or at least your measurements argue for that logic. I reject this as industrial thinking.

Pat writes:

[BUT A DOCTOR DOESN’T WASTE TIME NEEDLESSLY. IT IS BAD FOR THE PATIENT’S HEALTH].

Again, Pat, this depends. I want my doctor to spend as long with me as necessary for a complete exam, diagnosis, etc. Ever been to a Dr. who stands by the door ready to rush out to the next patient, probably because some Lean consultant imposed a patient per hour quota on them? Not very effective. The Mayo Clinic does not do this, for this very reason.

Now if you’re saying that a doctor shouldn’t waste time in surgery, I have no argument. But even if he does, that’s his judgment, and if I trust him and it leads to a more effective result, why do I care? Maybe he needed a consult, or to think about a procedure more carefully. Are you really arguing that there’s no room for inefficiency? Then we really need to stop this debate.

Pat writes:

[THIS IS A GREAT EXAMPLE THOUGH. TOY STORY AND OTHER COMPUTER GENERATED CARTOONS ARE JUST AS GOOD BUT PRODUCED AT A FRACTION OF THE COST, ALLOWING THE PRODUCERS TO INVEST MORE AT THE IDEA DEVELOPMENT STAGE AND STILL MAKE MORE MONEY].

I doubt Pixar movies are cheaper to make than Disney’s, given the price of human capital. Pixar wasn’t about lowering the cost, it is all about making a more awesome (effective?) animated movie.

Even if I accept your argument that they did it at a lower cost, did they pass that cost savings onto the moviegoer?

Ha! They skimmed it for themselves. This difference in pricing strategy, again, explains most of the differences in our worldviews.

Pat writes:

[LEAN IS ABOUT LOOKING AT PROCESSES TO SEE WHAT VALUE THEY PRODUCE FOR CLIENTS. ARE YOU SAYING THAT WE SHOULD BE INDIFFERENT TO THE USE OF TECHNOLOGY IN DOCUMENT REVIEW FOR EXAMPLE, EVEN THOUGH STUDY AFTER STUDY HAS SHOWN IT PRODUCES EQUIVALENT RESULTS AS HUMAN REVIEW FOR A FRACTION OF THE COST?]

No, I’m not saying that. I’m saying that you using technology for document review does not convey a competitive advantage, since your competitors are using it too. It’s like having restrooms.

I rather have you focus on how to create more value for your clients than worrying about how you can increase efficiency by 1%.

Pat writes:

[SO WE’D RATHER HAVE LARGE NUMBERS OF EXTRA COMPUTERS FOR EXAMPLE, RATHER THAN TRYING TO PURCHASE ONLY THAT WHICH IS NEEDED? WE LIKE TO HAVE EXTRA BODIES AROUND FOR THE RARE TIME THEY ARE NEEDED RATHER THAN LOOKING FOR ALTERNATIVE APPROACHES?]

This is not really addressing the point of the hammer example. That was made to prove that the efficiency measurement did not convey the underlying realities of the situation.

But to address your point, I do believe your firm should have spare capacity. Too many firms run at full tilt, they burn out their team members, don’t have time to effectively market for better customers, and are always playing catch up on hiring at the last minute.

Spare capacity is a good thing for knowledge workers, giving them time to invest in marketing, social media, education, thinking, creating, innovating, and just recharging their batteries.

Pat writes:

[NO, BUT YOU WOULD LOOK AT THE COST OF TRANSPORTING THE MUSICIANS FROM ONE ENGAGEMENT TO THE NEXT, OR THE COST OF PROCURING THE NECESSARY INSTRUMENTS FOR THESE PEOPLE TO PLAY THEIR EXCEPTIONAL LEVEL. YOU ARE LOOKING AT THINGS FAR TOO NARROWLY.]

Oh come now, Pat. Are you really going to transport these folks on Southwest because it’s cheap? Again, this is a mechanical view of knowledge workers. Most airplanes’ business and first-class are filled with business passengers. I wonder why?

Pat writes:

[RON, YOU WRITE AS IF PROCESS AND JUDGMENT ARE MUTUALLY EXCLUSIVE. THAT MAY TRUE IN THEORY OR IN YOUR WORLD. I CAN ASSURE YOU, HOWEVER, THAT IN THE WORLD MY CLIENTS OPERATE IN, THEY ARE INTEGRATED. YOU HAVE TO PROVIDE GREAT JUDGMENT AT A LOW PRICE.]

I work in the real world, Pat. I’ve transformed thousands of practices around the world. I’m able to do that because the theories I use are sound and predictive. Accusing me of not being in the real world lends zero credence to your arguments.

You also seem to think that customers only care about lowest cost. Do you buy the cheapest toilet paper? Customers aren’t price sensitive, they are value sensitive. But given your penetration pricing strategy, maybe you are dealing with the most price sensitive segment of the market.

In any case, it does not alter the fact that a judgment is far different than a measurement. Enron was not theoretical, it was a perfect illustration of the difference between a measure and a judgment.

Pat writes:

[RON, I JUST THINK THE MAJORITY OF PEOPLE ARE GOING TO REJECT YOUR ARGUMENT THAT WE SHOULD BE INDIFFERENT TO COST. NO ONE CAN AFFORD THAT THESE DAYS].

I’m not arguing to be indifferent to cost. Your costs should be driven by your price (not the other way around!), and your price should be driven by the value you create.

Again, if we can’t get past this basic economic fact, this debate is futile.

In the price-led costing world, your costs are determined up-front. You can only recover the costs you incur if you can command a price that covers those costs, plus profit. The only way to do that is to create value above the price, so your customer makes a profit on the transaction as well.

That, by the way, is how the real world works. It doesn’t work on a cost-plus basis, otherwise GM wouldn’t be in bankruptcy.

Pat writes:

["TOTALLY FOCUSED” MY POINT EXACTLY, IF YOU FOCUS ON ONE OR THE OTHER TO THE EXCLUSION OF THE OTHER, YOU LOSE. BOTH NEED TO BE PURSUED].

It depends on your pricing strategy. BMW of course cares about costs, but not to the point that it reduces the value of its cars. If customers value your product enough, they will pay for high costs, and even inefficiency (again, see the Ben & Jerry’s pricing epiphany below).

Pat writes:

[BUT EVEN THE BEST AIRLINES PAY ATTENTION TO COST, BUYING OIL WHEN IT IS CHEAPER, FOR EXAMPLE, OR HEDGING INCREASED OIL PRICES].

Sure, so what? Look at how they price. They change their airfares 11 million times in one day in the USA. They don’t do this because costs are changing that often, but because the value of the flight is changing the closer you move to take off.

Pat writes:

["IN AND OF ITSELF.” AGAIN, YOUR OWN WORDS SHOW YOU ARE CASTING THIS AS EITHER/OR WHEN I CERTAINLY DID NOT AND NO BUSINESS PERSON I KNOW OR HAVE HEARD OF DOES EITHER].

I stand by the statement, and you haven’t successfully refuted it. Efficiency, in and of itself, will not convey a competitive advantage.

Pat writes:

[BUT THEY DO HAVE PIANISTS ONLY DURING PEAK HOURS, NOT EVERY HOUR THE STORE IS OPENED].

It’s not that the dog dances poorly, it’s that he dances at all. No Lean/Sig-Sigma consultant would dream of putting pianos in a Nordstrom, even during peak hours. It’s not efficient.

Pat writes:

On doing the Right Thing, not Doing Things Right [IT SEEMS WISER TO ME TO DO THE RIGHT THINGS THE BEST WAY, OR AT LEAST A BETTER WAY].
Forget about efficiency. Worry about effectiveness. [IN MY WORLD, RON, I HAVE TO WORRY ABOUT BOTH. IF I DIDN’T, I WOULDN’T HAVE CLIENTS].

But which drives success? Effectiveness does. You have to worry about both to a point, but when your efficiency interferes with your effectiveness, which has to go?

Pat writes:

[BUT SOUTHWEST MORE THAN MOST ANY OTHER BUSINESS I KNOW LOOKS TO STRIP OUT “STUFF” THAT DOES NOT IMPROVE THE CUSTOMER EXPERIENCE, WHICH IS THE VERY DEFINITION OF LEAN].

Yes it does, but they don’t use Lean, or any other management fad. They’ve rejected those since they were founded. My point is that Lean isn’t the only way to eliminate waste.

Pat writes, in response to our replacements for Lean/Six-Sigma:

[I AGREE WITH ALL THESE CONCEPTS, NONE OF WHICH ARE FUNDAMENTALLY AT ODDS WITH THE CORE CONCEPTS OF LEAN. AGAIN, THEY ARE NOT MUTUALLY EXCLUSIVE].

Well, in the real world, I can tell you that companies I’ve seen use Lean/Six-Sigma have focused on the one while driving out the other.

Leadership attention is a fixed resource, and you can only have so many iniatitives. Lean and Six-Sigma is a low-value undertaking, compared to focusing on creating and capturing value.

Every study undertaken proves that a 1% increase in price adds far more to the bottom line that a 1% improvement in reducing costs, or even rainmaking.

Pricers have an axiom: Innovate for growth, price for profit. This is why Google gives 20% Google Time, which I notice you didn’t comment on? That’s not very efficient, so why do they do it?

To give a real world example: I know a PKF that uses Lean/Six-Sigma, it even has Black Belts in Six-Sigma on their team (yes, it’s a real designation). After one year of implementing Lean/Six-Sigma here are the results:

Historical Metrics:
Increase in Realization: 6.0%
Decrease in Write-offs: 51.6%
Increase in Revenue: 1.9%
Increase in Cash Receipts: 10.0%
Decrease in Charge Hours*: 7.50%
Increase in Hourly Rate: $17/Hour

Now, I’ve been working with a similar sized firm on implementing Value Pricing, and over the same past year they report a 25% increase in revenue, and an even greater increase in profit.

Which result would you rather have? You may answer both. Ok, but I think you will find that low-value ideas crowd out high-value ideas, since they are easier to implement.

Your own comments tell me that you find value pricing very hard. It is, damn hard. It’s also a high-leverage activity, so is creating more value.

It’s much easier to sit around and gaze at our navels and discuss how to increase output per hour by 1%. It’s just nowhere near as profitable.

Pat writes:

[RON, WHEN WE FIRST MET, I ASKED YOU HOW YOU WOULD APPLY YOUR VALUE PRICING MODEL IN THE CONTEXT OF A CLIENT WHO HAD JUST RECEIVED A COMPLAINT AND WAS LOOKING AT 3 LAW FIRMS WHO WOULD HANDLE IT, TWO OF WHICH WERE PROPOSING SPECIFIC BUDGETS. IN MY WORLD, THAT PROPOSED PRICE WOULD BE WHAT THE CLIENT LOOKED TO AS THE BOGEY YOU WOULD HAVE TO MEET OR BEAT. INSTEAD OF RECOGNIZING THAT REALITY, YOU SHIFTED THE DISCUSSION TO THE THEORETICAL BENEFITS OF VALUE PRICING, MUCH AS YOU HAVE DONE IN THIS DISCUSSION BY FOCUSING ON ONLY CERTAIN ASPECTS OF WHAT LAWYERS DO. REALITY IS TOUGH THING TO DEAL WITH, BUT IN POSTING ABOUT THE POSSIBLE VALUE OF LEAN TO CLIENT SERVICE, I WAS SUGGESTING THAT LAWYERS WOULD BENEFIT FROM A CRITICAL ANALYSIS OF THE MANNER AND PROCESS BY WHICH THEY HANDLE ALL ASPECTS OF MATTERS FOR CLIENTS. THIS DISCUSSION HAS ONLY REINFORCED MY VIEW OF THE VALUE TO THAT CRITICAL ANALYSIS].

Again, Pat, if you don’t understand the value that you create then how will your customers? Taking a budget as a price is a serious mistake, unless of course you really do have a penetration pricing strategy.

You seem to think that all customers care about is low price. This is nonsense on stilts. I’ve talked to hundreds of General Counsel who confirm this view, and elasticity studies by economists back it up.

They want to understand value, and if firms can’t do this, then the only thing left to discuss is price and/or hours.

Even Fred Bartlit doesn’t have a “penetration” pricing strategy, as I’ve read he’s turned away a case at $5,000 per hour. What customer in their right mind would be willing to pay that?

A customer looking for value. That’s not theoretical, that’s the real world.

Focus on your value and your customer service, and stop thinking you can price for 100% efficiency in a knowledge firm (and don’t make them fly on Southwest for crying out loud).

Your people aren’t machines, and I’ll let Ben & Jerry make my point:

The history of business is the history of epiphanies. Sometimes the fog clears up, and the right path is seen. This certainly happened—with respect to pricing—for Ben Cohen and Jerry Greenfield, founders of Ben & Jerry’s ice cream. Before they sold the business in 2000, to Unilever, the British-Dutch food company, they wrote an essay in 1997, titled “Bagels, Ice Cream, or...Pizza?” in which they explain their “famous pricing epiphany”:

Each year we would break even and say we needed only to do a little more business to make a profit. Then the next year we’d do a lot more business and still only break even. One day we were talking to Ben’s dad, who was an accountant. He said, “Since you’re gonna make such a high-quality product instead of pumping it full of air, why don’t you raise your prices?”

At the time we were charging 52 cents a cone. Coming out of the ‘60s, our reason for going into business was that ours was going to be “ice cream for the people.”

Ben said, “But Dad, the reason we’re not making money is because we’re not doing the job right. We’re overscooping. We’re wasting ice cream. Our labor costs are too high—we’re not doing a good job of scheduling our employees. We’re not running our business efficiently. Why should the customer have to pay for our mistakes? That’s why everything costs twice as much as it should.”

And Mr. Cohen said, “You guys have to understand—that’s human. That’s as good as people do. You can’t price for doing everything exactly right. Raise your prices.”

Eventually we said, either we’re going to raise our prices or we’re going to go out of business. And then where will the people’s ice cream be? They’ll have to get their ice cream from somebody else. So we raised the prices.

(Quoted in The Book of Entrepreneurs’ Wisdom, edited by Peter Krass, John Wiley & Sons Inc., 1999, pp. 462-463.)

I don’t expect to alter your view on any of this Pat, and that’s not why I’m debating you.

I’m actually using this debate to illustrate how obsolete the industrial/service model thinking is in a knowledge economy.

Our metrics come from Frederick Winslow Taylor in the late 19th century, and they are obsolete with respect to knowledge workers.

That said, I truly appreciate your debating skills. I, of course, believe the empirical evidence supports my view.

The market, ultimately, will decide, and I have faith it will make the right decision.

Ron Replies to Pat Lamb’s Lean Discussion

ron@verasage.com (Ron Baker) — Sat, 26 Sep 2009 09:27:12 PDT

Pat Lamb posted on Lean Client Service, which inspired me to post a comment.

Then Pat replied in another post.

This led to another post, incorporating several comments from Legal On Ramp’s discussion board.

The debate is critical, and regular readers of VeraSage already know how much ink and mind power we’ve devoted to this topic.

Attacking efficiency is the equivalent of criticizing motherhood and apple pie, so my position is highly contentious. I believe this is good, since we only learn from people we disagree with. And, it illustrates how we have not yet come to grips with the consequences of no longer being an industrial/service economy, but rather a knowledge economy.

In that spirit, I thought it necessary to comment on Pat’s latest post, while expanding the discussion.

Here is my letter to Pat.

Hi Pat,

Fantastic discussion, thanks so much for provoking this much thought on what I consider a critical issue for professional knowledge firms.

We have two problems with this debate. The first is a linguistic issue. We all seem to be using a somewhat different definition of efficiency and effectiveness.

We believe all change is linguistic, so we should agree on terms. For example, you say in your post that I am one of the “leading thinkers on the issue of value billing,” but we at VeraSage don’t use the term “value billing,” since billing is done in arrears, whereas pricing is done up-front, before the work is started. There’s an enormous difference in these two approaches.

We also don’t believe law firms are “professional service firms” but rather “professional knowledge firms (PKFs),” terminology more in line with Peter Drucker’s famous definition of knowledge worker and knowledge economy.

So let me begin by defining how I am using the terms efficiency and effectiveness, which I take from Peter Drucker:

Efficiency focuses on doing things right.
Effectiveness concentrates on doing the right things.

Now many people argue that both of these are important, and up to a point I agree. However, past some point—which we argue occurs sooner on the graph in a knowledge firm than, say, in a factory—the two become mutually exclusive. I can cite hundreds of examples where a decrease in measured efficiency still leads to an increase in effectiveness.

However, I can’t find many examples of where an increase in efficiency has increased effectiveness (as defined here). I know Fred Bartlit says that “increased efficiency almost always results in increased quality,” but quality is not necessarily effectiveness as I’m using the term here. One could make an incredibly high quality cement life jacket, but it wouldn’t be very effective (this crack was made by Tom Peters with respect to ISO 9000 standards).

Peter Drucker believed that a business wasn’t paid to be efficient; it’s paid to create wealth for customers. A business could be highly efficient at doing the wrong things. Examples abound: buggy whip, dot-matrix printer, slide rule, and typewriter manufacturers, etc, all models of efficiency before they were decimated in a gale of creative destruction by more effective technology.

In fact, a company at the apogee of their measured efficiency is probably in a perilous position, which is why Google allows its professionals to spend one day per week working on projects that excite them. This is not very efficient per your timesheet or billable hours; however it has led to many of Google’s innovations—Gmail, Google Earth, Google Books, etc. Other companies such as 3M and Gore have similar strategies.

This is why Peter Drucker wrote The Effective Executive, and not The Efficient Executive.

But let’s get back to efficiency.

What, Exactly, Is Efficiency?

Efficiency is always a ratio, expressed as the amount of output per unit of input. Mathematically, it seems straightforward, as if there was one widely agreed upon definition of the components of the numerator and denominator. In an intellectual capital economy, however, it is a conundrum.

Take the denominator in the ratio. Which inputs should be included? If we are dealing with wine, we could count the costs of the grapes, the bottles, corks, etc., none of which would help us define—let alone value—the final product. As they say, it is much easier to count the bottles than describe the wine.

If we were dealing with Rembrandt’s efficiency, we could sum up the cost of paint, canvas, brushes, and even the amount of labor hours spent plying his craft. Would there be any relationship to the final value of the output?

We can calculate how many surgeries the cardiologist performs in a given number of hours, but it doesn’t tell us anything about the quality of life for the patient.

Was Einstein efficient? How would you know? Who cares?

Firms have learned costs are easier to compute than value, so they cut the costs in the denominator to improve the efficiency. This is the equivalent of Walt Disney cutting out three of the dwarfs in Snow White and the Seven Dwarfs in order to reduce the inputs, thereby making the resulting ratio look better. Since Snow White contained over 2 million painstakingly crafted drawings, this reduction would have been quite efficient—but hardly effective. The Two Little Pigs probably would have been more efficient, but nowhere near as effective.

The fact of the matter is, we do not know how to measure the efficiency of a knowledge worker. And this is true for a very fundamental reason, which leads to the second problem with this debate: The Grand Fallacy—that is, the idea that there is such a thing as “generic” law firm efficiency.

There’s No Such Thing As Generic “Efficiency”

Efficiency cannot be meaningfully defined without regards to your purpose, desires, and preferences. It cannot simply be reduced to output per man-hour. It is inextricably linked to what people want—and at what cost people are willing to pay.

Consider the example of a hammer in a poor country. It’s likely to drive more nails per year, since it’s most likely shared among more people and sits idle less of the time. But that does not make the poor country more efficient; it just proves that capital tends to be scarcer and more expensive in those countries.

During the Cold War, the old Soviet Union used to boast that the average Soviet box car moved more freight per year than the average American box car. Yet this didn’t prove they were more efficient. On the contrary, it proved that Soviet railroads lacked the abundant capital of the American industry and that Soviet labor had less valuable alternatives to engage in than their American counterparts.

Your automobile is not very efficient, since it’s idle a majority of the time. So what? When you want to go somewhere, it is incredibly effective, since it meets your purposes at a price you’re willing to pay. (I am indebted to Thomas Sowell, and his masterful book, Basic Economics, for these examples).

Princeton economist William J. Baumol asks this thought-provoking question: How would you go about increasing the efficiency of a string quartet playing Beethoven? Would you drop the second violin or ask the musicians to play the piece twice as fast?

Adam Smith explained how the specialization and division of labor were the major causes of productivity increases and the creation of wealth. However, even some of Smith’s insights are not effective in a knowledge environment. Shakespeare could not specialize in writing the verbs while a colleague wrote the nouns of his many works, even though this would, no doubt, increase “efficiency,” at least given the way firms currently measure that statistic.

Judgment vs. Measurement

Efficiency is always a measurement. Effectiveness, on the other hand, is always a judgment, which is far more important in a knowledge environment. Some of the comments on your blog post support this position, especially Fred Bartlit’s.

There is no generic way to “measure” the quality of legal output; it requires a judgment, based on the results it creates. This is one of Drucker’s major insights about the difference between a factory worker and a knowledge worker. If I’m placing tires on an assembly line it is much easier to measure my quality (and defects) than if I’m a lawyer writing a crappy brief, which will only be discovered by a judgment, usually from another lawyer.

I was hospitalized last year. My surgeon ordered a CAT Scan. The procedure was done very efficiently, as measured by outputs and inputs. I was in and out very quickly, comfortable, etc.

However, when my surgeon saw the scan results he “judged” the radiologist screwed up, didn’t scan far enough down my thigh. The measured efficiency could not inform him of this defect—it had to be judged. This defect led to a much longer hospital stay and other serious complications.

The scan was highly efficient, but it was nowhere near being effective.

I’m all for process, and you mention audits. However, judgment is still superior. Take Enron. The auditors followed the “processes” and the “checklists.” What they didn’t do is apply professional judgment by asking “Do these financial statements reflect the underlying economics of this entity?” The result was an efficient audit that was entirely ineffective.

Anthony Kearns makes an excellent point when he says: “In law...it will be difficult if not impossible to determine in advance where efficiency in process can be achieved without unsatisfactory compromises in quality.”

This is another way of stating what economists have known for centuries: there is no generic efficiency without respect to purpose, and what you are willing to pay.

Anthony also makes another excellent point about expertise driving efficiency (I would say it drives effectiveness), and this supports my argument even more.

When we are undergoing education, we aren’t very efficient as measured by a ratio of outputs divided by inputs. New skills take time to learn, and beginners make tons of mistakes. If all we cared about was efficiency we’d never educate our team members. But the only way a knowledge worker can become more effective is through education, so the cost of less efficiency is a price worth paying.

Scott Irwin’s formula is interesting: Effectiveness + Cost Control = Efficiency.

But I reject this, for the many reasons cited above. Too many companies focus on cost control and efficiency at the expense of effectiveness, which I believe is dangerous.

Gordon Bethune, former CEO of Continental Airlines, made this very point in his book, From Worst to First. He said Continental’s management culture was totally focused on driving down cost per passenger mile, by piling more people into the planes like sardines, cutting down beverage sizes, taking out pillows, blankets, and magazines, etc.

He wrote “you can make a pizza so cheap no one wants to eat it, and you can make an airline so crappy nobody wants to fly it.” This cost mentality was precisely why Continental filed bankruptcy twice in one decade before Bethune took over and began to focus on effectiveness.

Efficiency in a law firm, in and of itself, is not a competitive advantage. It’s the equivalent of having restrooms. If your firm isn’t using the latest technological tools that is incredibly inefficient; but if it is using those things, so what? All of your competitors are too.

The differences in firm revenue and profit cannot be explained by efficiency, only effectiveness in customer service, as well as the ability to create, communicate and capture value. Efficiency is a table stake—the minimum you need to be in the game.

Competitive advantage is built on effectiveness, not efficiency.

It’s not very efficient for Nordstrom to have pianos in its stores, as it lowers sales and profit margin per square foot (the efficiency metric for retailers). It is, however, incredibly effective to serenade your employees and customers everyday, creating an ambiance they want to come back for.

The ultimate manifestation of the efficiency mentality was Robert McNamara, president Kennedy’s secretary of defense from 1961 to 1968, thereafter becoming president of The World Bank. McNamara was an accounting instructor at Harvard Business School before World War II, then he served as a specialist in operations research projects with the U.S. government during the war. After the War, he was hired by Henry Ford II—along with the so-called Whiz Kids—to revitalize the sagging profits of the Ford Motor Company.

He brought a mechanistic mind-set to the War in Vietnam, trying to micromanage it by the numbers. He apologized for this ill-conceived strategy in his 1995 autobiography In Retrospect: The Tragedy and Lessons of Vietnam.

Blindly relying on measurements can obscure important realities. The ultimate problem with numbers and measurements is what they don’t tell us, and how they provide a false sense of security—and control—that we know everything that is going on. I think the mentality among many leaders in professional firms is “If we can’t manage it, let’s measure it.”

What is the Purpose of a Law Firm?

What are firms trying to accomplish? What is the goal? Is it simply to crank out more work per labor hour?

If that’s the case, then under the hourly billing model their revenue actually decreases. That seems ludicrous.

Is it to crank out more work per labor hour to increase firm capacity? For what purpose? To add more “F” customers? That, too, doesn’t make much sense.

As Kurt Siemers, CEO of Kennedy and Coe, LLC (a Top 100 accounting firm) says:

And since becoming more efficient is a zero sum game over time, we have been left with working more hours to earn more. The historical business paradigm of our profession found itself on a collision course with our commitment to the well being of our people.

Simply stating that a firm wants to be more efficient is meaningless. They need to define what they are trying to accomplish long before they can begin to consider the best way to achieve their objectives. This is, I believe, precisely what Fred Bartlit is saying, which I agree with wholeheartedly.

The ruthless quest for increased efficiency contains within it a grave moral hazard. It’s encouraging behavior from firm leaders that is driving out creativity, innovation, dynamism, customer service, as well as talent from the professions.

I know you are a big fan of Total Quality Service, Pat. So are we. In fact, I came to Value Pricing through TQS, as the hourly billing method is a lousy customer experience.

The giants in TQS, thinkers such as Karl Albrecht, Stanley Marcus, Walt Disney, J.W. Marriott, among many others, didn’t have much use for efficiency, knowing that dealing with people requires effectiveness. Karl Albrecht criticized TQM, Six Sigma, etc., for this very reason, and thought the mechanistic mentality it fostered killed customer service.

Doing the Right Thing, not Doing Things Right

Forget about efficiency. Worry about effectiveness.

Better still, focus on efficaciousness; meaning having the power to produce a desired effect. This term is used to describe the miraculous power of many drugs since it suggests possession of a special quality or virtue that makes it possible to achieve a result—exactly what we are trying to accomplish in law firms for customers.

In an intellectual capital economy, and within firms, where wealth is created using the power of the mind—as opposed to the brawn of the body—these characteristics better explain the value created by knowledge workers.

Yet all of the so-called “efficiency” metrics and protocols such as Lean and Six Sigma have their origins in the late 19th century time-and-motion studies for manual laborers in factories, not knowledge workers who don’t work to the rhythms and cadences of an assembly line.

Firm leaders need to stop looking at input-output tables based on labor hours. Rather, they should define what their purpose and strategy is so to be different than the competition in order to command premium prices.

I believe lawyers are more artists than technicians. By all means, put processes in place for the low value work that can be streamlined and is repetitive. But when it comes to the thinking, strategy, synthesizing information, and creating results, use your minds, creativity, expertise, wisdom, and judgment.

I can increase an artist’s “efficiency” by providing them with paint-by-the- numbers kits, but it will produce crappy art.

Do I have a higher opinion of lawyers than do those who have commented on this board?

What is Superior to Lean/Six-Sigma?

It’s one thing to light a candle in the darkness and point out flaws in the status quo, a function incredibly valuable if we are to improve our theories.

However, it’s also important to offer an alternative to the present darkness.

A Professional Knowledge Firm is not a factory, which is why I believe Lean and Six Sigma are the wrong talisman. Companies such as Google and Apple don’t use these tools; Southwest Airlines doesn’t even use them.

As a knowledge worker, I have seen far too many firms implement this type of thinking, turning their artists into a caricature of Charlie Chaplain in Modern Times, getting sucked into efficiency metrics, quotas, etc. I believe the price we pay for this is a lack of focus on effectiveness and customer service.

I, for one, don’t want to work in an organization that has a ruthless focus on efficiency. It’s not very inspiring or meaningful.

We offer the following cognitive tools as superior to Lean/Six-Sigma in a Professional Knowledge Firm:

Key Predictive Indicators—measuring the success of the law firm the same way the customer does;
Before and After Action Reviews—a concept developed by the U.S. Army and one of the most innovative tools that can be used in a PKF.
Knowledge Management—knowing what a firm knows so it can be leveraged is one of the most effective ways to create wealth for customers.
Project Management—we believe this is a critical skill for all firms, no matter how they price, even if by the hour. PM looks forward, planning capacity, resources, risk, etc. Timesheets look backwards. Timesheets have allowed firms to do a lousy job on PM (not to mention capturing value through more strategic pricing). By the time you see a problem on the timesheet, the milk has been spilled, the damage already done.

I have one final question: Is this debate efficient? What are people putting on their timesheets when they participate in these types of Social Media discussions, which are quite time consuming?

I don’t think this is efficient at all.

I do, however, find it very effective.

Thank you, Pat.

Ed’s Top Ten Business Myths

ed.kless@choosegreat.com (Ed Kless) — Thu, 24 Sep 2009 06:29:47 PDT

While going through some old notes I found this list I developed of the top ten myths in or about business. Without further ado, they are:

1. Business is a zero-sum game

2. Price is based on cost

3. Excessive profits must be because the company is doing something evil

4. Increasing market share leads to increased profitability

5. Any focus on efficiency

6. Leadership is about changing others

7. Strategy is about analyzing, planning and doing

8. Business is science, and requires data to back up decisions

9. The customer is always right

10. Differentiation can be achieved by saying you are customer focused

Do you agree or disagree with any or all of these? If so, please comment.

FORD – a model for consulting

ed.kless@choosegreat.com (Ed Kless) — Mon, 14 Sep 2009 20:07:30 PDT

A little over three years ago, a dialogue began in one of my consulting classes that I teach for Sage. The conversation focused around the levels (I am not convinced levels is the right word) of consulting. In the end, the group proposed the following four levels: Findings, Options, Recommendations, and Decision. Serendipitously, this yielded the acronym FORD. (I personally own a Honda Pilot.)

This model has served me quite well over the last few years, so I thought it worthy of a post wherein I will briefly define each level and provide some overall thoughts about the model.

Findings - these are the issues (problems, opportunities, and desired results) that the consultant uncovers through a question and answer process, referred to by most as discovery.
Options - these are the different possibilities that the consultant proposes for solving the uncovered problems, seeking the opportunities, or achieving the desired results. A great consultant always includes, “Do nothing,” as an option.
Recommendations - this is the option (or options) that the consultant believes would be the best course of action for the customer. Making recommendations would usually include a list of advantages and disadvantages (pros/cons, positives/negatives, strengths/weaknesses, whatever you want to call them) of each options and a rationale for why the option(s) was(were) selected.
Decision - one of the various options or a variation of the options is selected for implementation.

A few observations about the model:

Each incremental level increases the level of risk on the consultant and requires an higher degree of knowledge. Since risk and knowledge required are factors in setting price, an engagement to just collect findings will be less expensive than an engagement to present options and an engagement to present options will be less expensive than an engagement to provide recommendation.
If you are making the decisions you are not a consultant, but what Peter Block would call a surrogate manager. He defines this as “a person who acts on behalf of or in place of a manager.” Surrogate manager-hood is not bad in and of itself, but it is way more risky and deserving of a premium price.
Being a consultant or a surrogate manager is a strategic decision. Some people may choose to never enter the fray as a surrogate manager and only remain in the role of consultant. This leads to what could be another blog post - the paradox of consulting - which is that consultants are paid to not make decisions.
It is critical to have a conversation early on with every customer or prospective customer as to the level of consulting in which they would like to engage you. Failure to do so causes not only pricing problems, but myriad of other problems that are out the scope of this post.
I believe that all professionals are consultants of some kind. Doctors are consultants on the anatomy and physiology of the human body; lawyers, on the law and legal system; accountants, on accounting practices, etc.

I welcome any comments and any suggestions on a better term than my proposed levels.

Are Hourly Rates Justifiable: A Debate with an Australian Consultant

ron@verasage.com (Ron Baker) — Sun, 13 Sep 2009 12:04:00 PDT

On my recent trip to Australia, I met Colin Jasper, Director of Jasper Consulting.

An actuary by education, Colin was an incredibly interesting person with whom to discuss the merits of Value Pricing versus hourly rates.

We agree, as Colin suggests, on 95% of the issues. We have an enormous disagreement over whether there are instances where hourly rates still make economic sense.

This debate was launched again when Colin sent me an article he had written, with Libby Maynard, for the September, 2009 Asia-Pacific Professional Services Marketing Association’s Journal.

Colin and Libby have kindly granted me permission to post the article, and our subsequent debate surrounding its contents.

It may seem odd that I am engaging in a debate with someone who agrees with 95% of what we stand for, but I do so because economics is concerned with marginal activity—that is, the next unit of production, spending, etc.

Thought experiment: you have an incredibly large bag of straws and a camel. You begin placing individual straws on the camel’s back, one after the other. At some point, the proverbial camel’s back will break.

If straws could think and talk, they would shout: “Hey, everything was fine until that last straw got here—he broke the camel’s back.”

The arenas where Colin is arguing that hourly rates are still appropriate is when firms are at the top of the Value Curve—at the margin, where using hourly rates is obviously the most sub-optimal.

I find his reasoning unconvincing, but I thought you might like to read the debate, draw your own conclusions, and hopefully, join in.

Here was my initial response to Colin’s article:

Hi Colin,

It was great to meet you as well and have a robust discussion on pricing.

I read your article with great interest. As you can imagine, I have many disagreements with its premise.

Here are just some:

Page 9, you say “few practitioners have sought to truly master the concept of alternative pricing structures...” This may be true as a percentage of firms overall (we estimate somewhere between 5-7% are doing real Value Pricing), but that overlooks that there are thousands of firms across all professional sectors—advertising, accounting, IT, consulting, and law—around the world that have adopted Value Pricing. Some advertising agencies are doing 100% Value Pricing and no timesheets, such as Crispin Porter and Anomaly, and Coca-Coca and P&G have their own Value Pricing compensation models with their thousands of agencies. Neither look at timesheets. These are significant numbers that are hard to dismiss, and they have proven that alternatives to the billable hour exist for all sorts of complex engagements.

On page 10, you say both client and firm should be involved in exploring and choosing the pricing approach. Yet this is not the way most industries have changed pricing strategies. Did the airlines or hotels consult their customers and ask if they could adopt Yield Management? Sellers change pricing strategies, and competition insures that customers get value. I have no problem with firms discussing alternatives with clients, but the onus is on firms to bring innovative ideas to the table, not their clients. General counsel have their own businesses to run, and don’t sit around and think about the economics of their law firms. Nor should they, anymore than you and I should be innovating the next Apple iPod or its replacement. Firms have used this very logic as an excuse to do nothing, since clients have not driven this change to date (though there are exceptions like Cisco, Pfizer, etc.).

You also state that using the wrong pricing structure can destroy value and damage relationships, and that is certainly what hourly billing has done, with its misalignment of interests, and considering it’s the wrong theory of value. The alternatives you list on page 10 are simply the billable hour in drag, and in no way are they alternative pricing structures. A price is given up-front, hourly billing is done in arrears. I assure you customers want a price, not a bill after the fact—this is basic economics. And these alternatives are still measuring value in terms of time, which is the wrong economic theory of value—and that is irrefutable, as my books and many others make clear.

On page 12 you say hourly rates are criticized because they encourage and reward inefficiencies. But that’s certainly not my major argument against them. My argument is the whole idea is based on the discredited and falsified Marxist Labor Theory of Value. Eradicating the “we sell time” mentality does lead to greater value creation, because it’s a different theory. This has been proven again and again, as all of our Trailblazer Case Studies prove. You can just read a few and see how the entire mentality of a firm is transformed to an obsession with value and results, rather than hours, inputs and costs.

You say that a tradesman complaining that his saw won’t drill a hole in the wall, etc. But hourly billing the wrong tool. It’s plunging a ruler in the oven to determine its temperature, and you’ll never get the right answer with it, period. This is why it’s universally hated in the professions, and it’s also why NO OTHER BUSINESS ON THE PLANET PRICES THIS WAY. There’s a reason for this. It simply is not a measure of value. You are arguing that Jonas Salk’s polio vaccine is valuable to the extent of the time it took him to develop, and that is economically illiterate. Period. This was settled by the Marginalist Revolution of 1871, and is well understood by economists.

You then argue that since a firm can’t define a scope, hourly rates are appropriate. This is nonsense on stilts. A scope of what the firm does know can always be done, as Chris Marston of Exemplar, Mark Chinn, Fred Bartlit (Bartlit Beck, which has never billed an hour for large clients) and Jay Shepherd, have proved in complex litigation cases. Marston’s concentric circles are the answer, as is phasing. To say that every job is a complete black hole with no “known knowns” defies reality. It also makes me, as a customer, question the expertise of my firm. As Jay Shepherd has written on his blog (The Client Revolution), there’s only one question you need to ask your law firm to determine if they are experts: “What is the price?” If they can’t answer that, they are not experts. He’s right.

You cite the Johnson and Kaplan book, which was the launch of Activity Based Costing. Have you read the book that Johnson wrote after that one? Profit Beyond Measure. It shows how Toyota doesn’t use a standard cost accounting system, and how firms should not let cost accountants drive strategic decision making. It’s a seminal book, and I have discussed it in great detail in my Firm of the Future, Pricing on Purpose and Measure What Matter to Customers books.

Hourly billing rests on the wrong theory of value, that’s our major case against it. If you begin with the wrong theory, I don’t care how efficient a firm is in implementation, it will be suboptimal. There is no right way to implement a wrong idea. Cost-plus pricing—of which hourly billing is a cousin—is dying in industries around the world, as part of the pricing revolution.

VeraSage has destroyed every single argument for hourly billing. We haven’t heard a new argument in over a decade, and your article is no exception. There are answers to every one of your defenses, and they are being done in firms around the world. You can find many examples all over our web site.

All that said, I still enjoy our dialogues and hope we will keep in touch.

Thanks Colin, enjoying the debate!

Sincerely,
Ron

Here’s Colin’s reply to mine:

Hi Ron,

I appreciate your thoughtful response and I too enjoy the dialogue. I have spoken to the article’s coauthor and we are both happy for you to publish it on your website.

With regards your specific comments:

I think we both agree that all professionals and their firms can benefit from building their value-pricing capabilities. Jasper Consulting was established with the purpose of helping professional service firms create value for their clients and capture a fair share of the value for themselves.

I take your point that firms should the lead the change. I do see differences however in consumer pricing (e.g. Apple iPod) and B2B pricing (e.g. Legal services to corporates and governments). If a consumer does not like a price their only option is to vote with their feet—or wallet. In a B2B environment, particularly at the big end of town, clients negotiate. They do not simply negotiate the price level but also the price structure. The challenge is how to overcome client buying behaviour. Most large organisations have legal panels with multiple firms on these panels. To get on a panel they put out tenders, largely based on hourly rates. If a firm says they do not provide hourly rates, in all likelihood they will not win a spot on the panel. No large firm can afford to be excluded from all of these large panels. Hence I see a role in educating clients as well as firms.

Firstly I don’t understand why you think the pricing structures listed are ‘simply the billable hours in drag.’ Do you not advocate that a value-based price be a fixed fee?

Secondly, with regards to providing a price up-front, I believe this is exactly why some clients seek hourly rates. In the panel example, they don’t know what the work will be in 2-3 years but they want embedded relationships rather than a range of quotes for each individual transaction. The only way they can be sure that the relationship price is fair is to agree a mechanism for charging up front. On a separate example, a law firm has just been awarded the first stage of an extremely large, one-off major infrastructure project in Australia. This first stage might be between 2-5% of the entire project. The client’s preference is for a single firm to serve them throughout the project but as the full requirements of the project can’t yet be scoped (i.e. the project could take an almost infinite number of directions) how other than hourly rates can the client agree a price that is fair up front?

You misrepresent me when you say that I’m arguing the polio vaccine is valuable to the extent of the time it took to develop it. I agree that in most circumstances hourly rates should be avoided. The only point we disagree on is that you believe their is no role for hourly rates and I believe there are some occasions when it is the most appropriate pricing structure (as indicated above).

I agree with you that the mindset must be first and foremost on creating value. Where firms do this really, really well—they can justify charging a higher rate (Ron—I can sense your response to this statement from 8,000 miles away).

It’s not about the firm not defining the scope, it’s about the client not being able to define the scope of their requirements. Back to the panel example. If the client wants you to work with them for the next 4 years they are not going to know what their legal needs will be, nor which of this work they will want your firm to do. They don’t want to enter a relationship where for each individual matter that seek competitive bids to ensure your price is fair. From an economics perspective perhaps hourly rates are appropriate where a) the cost of scoping is enormous relative to the amount of work to be done and b) switching costs are high.

I think we both agree firms must focus first and foremost on value (creating value).

I think we both agree that firms should develop their value-based pricing capabilities (capturing value).

I think we both agree hourly rates are over-used in the profession.

The only area I think we disagree on is that I believe there are occasions where time-based billing is the fairest structure for both clients and firms.

Kind regards
Colin

Finally, a short reply to Colin, as this post is already too long:

Thanks for letting us publish this on our Website.

I still find your arguments unconvincing.

I don’t think there’s much of a difference between B2C and B2B. Economics is economics, and only humans buy things—there’s nobody here but us people as economist Herbert Stein used to say. This is why IBM’s slogan of “No one ever got fired for buying IBM” was so effective.

I heard stories while in Australia from both firms and general counsel that firms that only offer fixed prices, and no hourly rates, were put on the panels of some very large companies. It seems to me that if a firm is able to differentiate itself effectively, then clients will work with them no matter how they price. Firms such as Advent, Optim, Marque in Australia, and Bartlit Beck, Wachtel Lipton among others in the USA prove this point.

If the only way a firm can get on a panel is to have hourly rates, that’s a very uninspiring reason to hire a law firm. This is a purpose, strategy and positioning issue, not a pricing issue.

The alternatives you suggest are the billable hour in drag because firms are still comparing the rates to an hourly rate. Even though a fixed price is quoted, the firm is measuring value by time. If Jasper Consulting wants to help law firms create and capture more value, why are you still letting Marx’s labor theory of value drive your thinking?

I don’t buy your argument that clients will only put firms on panels if they commit to an hourly rate. A fixed price is a mechanism for agreeing to price up-front. This actually is far more transparent than hourly rates, and can easily be shopped.

And an hourly rate is not a price. How can a client know what a price is by getting an hourly rate? This reminds me of the communist obsession with inputs over outputs.

Why would you want to use the hourly rate in complex jobs. It is precisely these jobs where firms are adding the most value and need to move away from hourly rates. For the life of me, this makes no sense. You’re telling firms such as those that defended Bill Gate’s Microsoft against anti-trust violations to use the hourly rate because the job cannot be scoped? Any firm that did this would find its pricing to be incredibly sub-optimal.

Alright, enough from me, let our readers join the debate.

Thanks again Colin, feel free to post a reply.

Baker quoted in Australian Financial Review

ron@verasage.com (Ron Baker) — Sat, 12 Sep 2009 19:45:04 PDT

I had the opportunity to discuss hourly billing vs. Value Pricing with Brad Hatch of the Australian Financial Review.

His article “Billing Time” was published on September 11, 2009.

The article also discusses Advent Lawyers, an innovative firm that offers fixed prices.

Thanks Brad!