Staff Leverage in the 21st Century
Modern service firms can be cool places; they are often full of cool people who have fun doing things that clients love, but how do you make sure that all your hard work isn’t wasted, that everyone, including you, makes a fair living in accordance with risk, skills and hard work?
Businesses that charge for hours are traditionally called professional services firms, but the trouble when you say this is that a lot of people immediately think of old fashioned lawyers and accountants. They forget about other important and interesting businesses like marketing, public relations, consulting firms, architects, engineers, software development, IT consultants, digital agencies: people that create things and people that build things. But one thing you can say for sure about the old fashioned lawyers and accountants is that they know how important it is to measure and manage key business metrics. It's been handed down from one generation to the next. Your firm can and should learn from this.
Most modern service businesses, in the absence of key business information, usually construct operational metrics, tactics and processes from first principles rather than looking to see how other people have solved the same problems. This reinventing of the wheel usually just leads to a breakdown in systems, business failure, or worse. And the worst thing, in my opinion, is to just bump along not making a good living for anyone and leave the stakeholders feeling insecure and unhappy.
Lawyers and accountants have always had their own particular way of managing growth. Their business model has been around for centuries. One of the fundamental principles of these traditional firms is called “leverage.” Leverage is basically the assumption that young people joining the firm will work for lower wages in return for the chance to share in the spoils of the partners one day, or to use the reputation of the firm to secure a well-paying job in the industry. They are set up with hierarchical structures and systems. Lately this business model has come under pressure from the new economy, due to both automation and the fact that fewer and fewer young professionals are willing to work very long hours for low wages. Smart young people want to work for the smart cool firms. This is putting pressure on the traditional firms’ margins to the extent that they are being forced to look for new revenue streams.
Disruption is approaching rapidly. I know of a founder of a start-up company who allows lawyers to work whenever they like by signing up to a website and listing their qualifications. The law firms effectively rent their services. They are not recruiters but use a sharing economy model like AirBnB; complete with user reviews, rather than what a recruiter tells them. The firms are able to manage their workload and the lawyers get a much better rate than the full time staff. Not only that, but they also get to have a life, take some time off for travel, maybe even date someone who’s not a co-worker. What developments like this will mean for the law firms is pressure on margins and recruiting issues.
Automation is also causing disruption. This is already happening to a degree around the world but will only accelerate, and you can bet there are going to be some uncomfortable, what economists would call, "reallocation of resources". The best firms will survive, just like the best alternate publishers are doing well in the new age, but the big margins on leverage will be gone.
In this time of automation, of networks like Upwork (oDesk) and Outsourcer, the numbers of “not seen and not heard” low-paid juniors sitting at rows of desks in a back office will reduce. There are some great reasons to employ juniors, and obviously you have to charge more than direct costs to cover overheads and risk, but the amount of leverage is decreasing and will continue to do so.
Service firms will always have to charge more to the client than they pay to the people doing the work but the margins are under pressure. The best firms will thrive by selling their expertise. They know that running a business is challenging and hard work, and that’s why clients need their specialist skills that can relieve them of their headaches.
Changes That Are Happening Now - What Will Be Will Be
Dan Pink's Free Agent Nation told us about a huge increase in the numbers of independent consultants / freelancers that form natural networks and come together for particular projects. That was back in 2002 and it's only exploded since. For many people this is a great way to live and work. But business development seems to be the biggest challenge for most independents; time and cost but mostly how to go about it. Highly skilled professionals that charge higher prices are not necessarily suited to places like Upwork/oDesk. It will be interesting to see if something comes along that can solve this problem well and how long it will be before one gets traction.
Then there are the very small firms. To be honest, I sometimes wonder why some of these firms I see stay together. These are usually made up of three or four people of similar skill level but with slightly different skills and experience. Mostly, in my view, what they do is add administrative overhead and trade off slightly less individual revenue for, what they see as, reduced risk. In reality, if one partner isn't performing this "risk insurance" probably wouldn't pay out for long. Nevertheless most people are risk averse and seem to be more optimistic in groups.
The other reason some people use this model is to share the burden of business development. Most professionals, myself included, dislike doing business development so I completely understand. This seems to be a dangerous size with less of the advantages of larger, better resourced firms, and much bigger overheads than free agents.
A model I sometimes see work well is a solid core of full time professional partners, small overheads, and a network of professional associates. This model requires very strong business development and project management skills, especially the financial management of projects.
Bigger firms (thirty or more mostly permanent employees) still seem to be the most common business structure. Tackling the two biggest problems of business development and financial control is made easier by having the resources and discipline that economies of scale bring. More likely this success is only a product of having conquered these problems. A sort of market based natural selection.
So what should small businesses do?
The trick for smaller firms, I believe, is to pick the best bits from all the models. Do what you love, form teams for particular purposes with differing levels of formality, embrace transparency, and negotiate a fair share of returns for everyone involved. The most important thing of all, however, is to make sure your financial management, particularly around margins, is robust and relevant otherwise the firm won't be sustainable.
Good financial control does not have to be expensive. It's usually more expensive to try to reinvent the wheel. If you want to grow a firm past the dangerously small size of 30 employees, make sure you have solid foundations.