O PINION
cont’d
agreed strategy across all of Directors of Finance, functional levels. Sound Marketing, Human Resources management will no longer and Professional Development S ORIGINALLY PUBLISHED IN consist of optional measures to to take another exponential maximize profit per partner; it leap: a law firm director ERMA ARTNERS UARTERLY will constitute non-negotiable position will no longer limit investment SSUEconditions that any one’s choices for the future. financial investor will monitor Indeed, these are interesting tightly and manage rigorously times. How will these changes with little sympathy for impact your firm? Whatever individual partner you do, start thinking about the idiosyncrasies. As a result, we impact today. While every firm also expect the professionalism clearly cannot be a first
A K I
P 1, 2008
Q
,
adopter, those who take a waitand-see approach until 2010 about how ABS might impact their competitive position will be undoubtedly caught on their back foot.
Michael Roch advises professional services firms on the economics of their practice and works with accounting firms on their competitive positioning.
DECLARING WAR ON MEDIOCRITY: ARE WE HIDING PERFORMANCE POTENTIAL BY LOOKING AT AVERAGES? by Friedrich Blase
A law firm board member’s outrage at a recent strategic planning meeting caused me to pause and think about the concept of average and how much it affects the management of professional services firms. Following a healthy debate on what his firm’s ambitions for net income per partner profit (NIPP) should be — and, more fundamentally, whether to set a measurable goal in that direction at all — this senior partner spoke up against the firm’s proposal to “earn NIPP
22
equal to the average of the leading firms” in its market. “That is no stretch goal with which to motivate the partners — that is a lame duck,” he exclaimed. Getting there meant an increase in NIPP of 7% above the leading firms’ growth, equal under certain macroeconomic assumptions to approximately 75% compounded over five years. Most people would call that a pretty significant stretch by any measure — one that is hardly reflected in the soothing word “average.”
The concept of averages allows you to predict a change to the bottom line by looking at the average change of one of its factors. They move in parallel — a 10% increase in average billable rates means a 10% increase in total revenue. But what the concept of averages does not show us is where that 10% average comes from. It could mean that work which was already “above average” to the bottom line grew by 30%, while the lower paid work did not grow at all. Average is a
THE
CONCEPT OF AVERAGES ALLOWS YOU TO PREDICT
A CHANGE TO THE BOTTOM LINE BY LOOKING AT THE AVERAGE CHANGE OF ONE OF ITS FACTORS . IN PARALLEL
—
RATES MEANS A
T HEY
MOVE
10% INCREASE IN AVERAGE BILLABLE 10% INCREASE IN TOTAL REVENUE. BUT A
WHAT THE CONCEPT OF AVERAGES DOES NOT SHOW US IS WHERE THAT
10%
potpourri in which nonstrategic and unhealthy performance can hide. In fact an average can show a picture of the firm that does not exist at all. Such is the case in some firms where a select few partners draw more than $3 million per year, while the vast majority draw less than $1.5 million. This firm’s average NIPP of $1.8 million makes it look comparable to another firm where each partner’s compensation is within $200,000 of the same average. That these firms have little in common in how they go about their business is clear. If one were thinking of combining these firms, one had better predict how these actual differences that are not shown in the averages will play out in the merged firm. Averages in key performance indicators are proxies for measuring large-scale performance by aggregating independent elements of performance. Managing by these averages can be deeply flawed and can inhibit real
AVERAGE COMES FROM .
performance progress. The problem is that they do not differentiate between the good (wanted) and the bad (unwanted) elements of performance that make up the average. By trying to increase performance, firms that do not look beyond the average invest equal amounts of money and time into improving both the wanted and the unwanted elements. The late Peter Drucker comes to mind: “There is nothing worse than being good at doing something that you should not be doing at all.” All efforts should focus on increasing the good elements. The bad parts need to be addressed in a different way. What does this mean for our clients? In the case of the firm that committed itself to a 75% increase in NIPP over five years, it helps enormously to realize that a small percentage of its revenue stream is already able to deliver that significantly higher NIPP today. So, if you got rid of everything else (and assuming no diseconomies from downscaling), the firm
could achieve that goal in one big clean sweep. While the thought is theoretical, it leads to the realization that the firm must focus on finding underperformance not in the average but in the detail — at the granular level. How much of the revenue stream is not profitable today assuming the higher profitability targets, and how far is it off the required mark? The firm then needs to assess whether it should fix the quality of that revenue stream or simply get rid of it. The latter will lead to firing of clients, partners and practice areas — not because their averages are too low, but because the portion of unwanted revenue is too large. Maybe it is the prospect of having to make these tough decisions that has caused firm leaders to manage by averages. Those smart firms around the world that are changing their approach and ceasing to manage by averages will pull ahead significantly in terms of performance, leaving the rest to aim for — well — mediocrity.
Friedrich Blase advises primarily law firms in transformation projects for organizational structures, management systems, intellectual capital development, and compensation schemes.
23