Updated: Sep 24
At a high level, most businesses balance two things to drive success:
They deliver value to customers TODAY; and,
They invest in delivering value to customers in the FUTURE.
If they balance this well, they will have happy customers, employees, owners, and communities where they work and serve. Getting the investment tradeoff right between the TODAY and the FUTURE is what creates a SUSTAINABLE business model. This is really hard to do....in my experience, consistently getting the TODAY / FUTURE investment mix right is the hardest thing we do as business leaders.
Where this is particularly hard, are industries where the core factor inputs are mostly people. That is, industries where people are the primary raw materials used to build and deliver client products and services. To be clear, all industries include people, but "including" people is not the same as using people as a raw material. For example, the banking industry manufacturing raw materials are mainly customer data and contracts. The auto industry manufacturing raw materials are mainly plastics, metals, computers, and batteries.
However, in professional services (legal, accounting, tax, advisory, medical, management consulting, etc.), the primary raw material is people. It is people that are the raw material to build and deliver professional services. This article is about why people-dominated factor input industries, like professional services, make it particularly hard to manage the TODAY / FUTURE investment mix and drive a long-term sustainable business model. We will also explore high-impact solutions.
Not a new idea
As a concept, the TODAY / FUTURE investment mix balance is certainly not a new idea. Adam Smith's concept of the "Invisible Hand" (The Wealth Of Nations, 1776) is central to considering multiple business stakeholders and with multiple time frame needs. Alexis de Tocqueville's discussion of "Enlightened Self-Interest" (Democracy in America, 1835) is similarly consistent:
“…they (Americans) show with complacency how an enlightened regard for themselves constantly prompts them to assist one another and inclines them willingly to sacrifice a portion of their time and property to the welfare of the state.” (1)
More recently, global businesses have given more emphasis to the TODAY / FUTURE tradeoff with an eye toward business SUSTAINABILITY. For example the "Statement on the Purpose of a Corporation" (The Business Roundtable, 1997) explicitly commits to a longer term business framework.
How the TODAY / FUTURE investment mix works
TODAY - This is where professional services consultants are utilized to deliver a particular service. This could be many different services but is essentially based on some existing and practiced methodology that is tailored to meet the current client's need. It is very likely the majority of the consultant team has previously delivered this service. Most professional services firms are organized as "practices" which literally means they are practiced at delivering the service. The firm will make money as the difference between the consultants' bill rate and salary. Hence, this is why the "people as a raw material-based direct cost" analogy makes sense.
FUTURE - This is where professional services staff and consultants are utilized to research, design, test, and roll out new services. Since the exact FUTURE is unknowable, placing bets on highly probable FUTURE services becomes important. As an example, if it costs $100k for each FUTURE bet and only 1 in 10 future bets successfully pays, that is only a 10% success rate. However, if the revenue payout on a single successful solution averages $10mm, then the payout rate is a very profitable 10x. [$10mm bet payout / (10 bets x $100k cost/bet)] By the way, this is a similar payout model used by private equity/investment funds that manage portfolios of companies. Our client businesses are generally very dynamic. As such, staying ahead of client demand, making FUTURE bets, and quickly ramping up successful payout solutions are critical to long-term professional services growth. (2)
The MIX - Getting the TODAY / FUTURE investment mix correct is so important. Think of TODAY like paying rent. This is how the firm pays bills today. Think of the FUTURE as how the firm will create revenue tomorrow. If a firm doesn't invest enough in the FUTURE they will get caught flat-footed when tomorrow comes. If they invest too much in the FUTURE, they may not be able to make rent TODAY. The graphic shows a solution investment approach, which requires taking existing talent that could be working on TODAY services and diverting them to FUTURE solution development.
In particular, step 3 envisages a formal investment or capital planning process. This process marries objective investment information with the professional judgment of senior professional services leaders. The optimal investment process outcome includes:
A precise investment result based on the objective and judgmental proposal solution information,
An accurate investment result based on the firm's goals and objectives (3),
An actionable investment schedule, implementable by the firm's valuable consultant resources, and
Results tracking and audit to record investment decisions and rationale.
A common concern I hear is: "My leadership is not always forthcoming with investment budgets. They tend to be more opportunistic and reactive." All the more reason to have a disciplined investment or capital planning process! As the old saying goes: “Opportunity does not waste time with those who are unprepared.” As such, when budgets do become available, those that are ready are more likely to receive investment funding.
The TODAY or FUTURE investment mix
So far you may be thinking, "Hey Jeff, this makes sense, but this seems relevant to all industries, not just professional services. What am I missing?"
First, you are correct in that this thinking could be applied to almost any industry or organization. The uniqueness of professional services is the people component. Professional services companies generally hire really smart and experienced professional talent. These are highly disciplined and creative-based people that are attracted to other really smart, creative people and industries. Here is the thing, the talent is generally attracted to the TOMORROW investments and considers the TODAY work as paying rent. They do not mind paying rent, but do not want to overpay rent and will only tolerate paying rent as a means to get to the creative, fun TOMORROW stuff.
Back to how professional services firms make money and create a SUSTAINABLE business model, they do so by getting the TODAY / FUTURE investment mix correct. I have not found a magic investment mix formula, but I do know having an ongoing organizational investment focus is a sign the firm takes the FUTURE seriously.
The main danger is that professional services firms over-invest in the TODAY. This may happen for a variety of reasons. Not least of which is when these firms are beholden to investors or other organizational incentives that may drive the professional services arm to over-invest in the TODAY. A good exemplar mechanism to “over-invest in the TODAY” is by taking advantage of the "Exempt / Non-Exempt employee" arbitrage. Consultants are hired as professional exempt employees. Under the U.S. Fair Labor Standards Act (U.S. FLSA), exempt employees do not have to get paid overtime.
As an example, a consultant may work an 80 hour week, but only get paid for 40 hours of work. As such and to the firm, the arbitrage is valued at a 2x salary multiple [80/40]. Whereas, culturally, many employees do not value this arbitrage in the same way. Many take it as a given they must work unpaid overtime. Culturally, many Americans are taught at a young age that competing on "who can grind more" is an honorable pursuit, like a badge of courage. The U.S. FLSA is a remnant of the Industrial Age and the arbitrage, in part, relies on the culturally-based unpaid overtime willingness of the exempt employee. As such, the arbitrage is a labor market trade, where the firm effectively sells a 40 hour a week resource and buys a resource with the cultural expectation to work a multiple of 40 hours a week.
Regardless of whether you personally believe in our “badge of courage” cultural heritage, it is the main source of employer success as to the "Exempt / Non-Exempt employee" arbitrage.
In effect, a consultant "practicing" delivering TODAY's consulting service is not much different than a factory worker "practicing" on an assembly line. But the factory worker is non-exempt, which means they get overtime pay and have other legal protections.
This "Exempt / Non-Exempt employee" arbitrage may accelerate current period revenue. But, this arbitrage comes with significant risk. Persistent over-investment in TODAY also leads to employee lack of creative satisfaction, burn-out, employee attrition, and firm under-investment in the FUTURE. Remember, in the case of professional services, an employee is the same as raw material. To me, burning out a single professional services employee is like lighting $100,000+ on fire. But sadly, this happens all the time.
And now, the risk kicker: The FUTURE under-investment starts a reinforcing downward feedback loop because when the under-invested FUTURE becomes TODAY, professional services managers will necessarily further exploit the arbitrage because of past under-investment. This causes even more TODAY over-investment, burnout, and attrition. This is particularly poignant in the 2021 pandemic-effected world, as a number of professional services firms are losing their best talent. To make their numbers they may increase the "Exempt / Non-Exempt employee" arbitrage and dig an even deeper future revenue hole and further accelerate attrition.
I think of solutions in terms of "adapting to the rules” and "changing the rules."
Adaptation means finding a better way to manage the rules as they currently exist. Adapting to the rules is within the direct control of individual professional services firms. Adaptation is generally quicker to implement in the short term.
Changing the rules is external to the professional services firm. It would mean convincing lawmakers or other policymakers to change industry-wide applicable rules and regulations. Changing the rules is more of a long-term endeavor and may include industry groups or consortia.
1. Adapting to the rules - Professional services firms manage client-facing employee utilization to optimize availability for client work. No matter the employee level, generally, everyone is afforded some non-client "investment" time. This time can be used in a variety of ways, including investing in new solutions or other high-value, creative endeavors. This challenge is that utilization targets are often managed as a floor, or minimum billable hours. When only the utilization floor is managed, this essentially leaves an uncapped utilization ceiling, This may create an environment where staff is over 100% utilized for long periods of time. The "rent overpaying" environment causes a large bandwidth tax (4) and the challenges mentioned earlier leading to burnout and attrition. A solution is to manage utilization targets as a ceiling, where managers would be held accountable for allowing staff to exceed the ceiling. While the target is the same, the difference is how the target is managed. With “rent overpaying” set as an organizational control or exception, this approach should provide organizational incentives to work on investment-oriented FUTURE projects.
This approach would cause engagement managers to schedule more resources on jobs, as a strategy to manage utilization ceilings. This adaptation would effect an 1) increase in the number of resources involved in the TODAY's firm practice, and 2) provide a motivated and stable human resource raw material to invest in the FUTURE using the framework described earlier. This would lead to more consultant job fulfillment and lower attrition. The industry would “stop burning $100k bills.”
2. Changing the rules - in most industries and from a competitive parity standpoint, it is important for industry participating firms to play on a level competitive playing field. All firms will seek to maximize profitability under a current competitive ruleset. Changing the U.S. FLSA would maintain competitive parity and create an environment that decreases the incentive for the "Exempt / Non-Exempt employee" arbitrage and increases the incentive for long-term / FUTURE investment. Simply, the suggested rule change is to make professional services employees that deliver client services as a "raw material" non-exempt from FLSA. This would require professional services employers to pay overtime wages and provide non-exempt related benefits and protections. The idea is, with professional services firms having less of a TODAY income benefit from staff billable hours, they will be more likely to invest in FUTURE services and decrease the likelihood of employee burnout.
Conceptually, the U.S. FLSA rule change would be self-funding, as the current revenue decline from paying overtime would be funded by:
Decreased cost of recruiting and training new associates,
Uniform upward industry pressure on professional services client pricing, and
A more productive current employee base.
Professional services leaders may be skeptical of the "changing the rules" proposal. Notwithstanding the current period funding concepts, they still may worry about their ability to meet short-term revenue targets because of increased overtime pay. For this concern, I have no easy answer, but allow me to offer:
Changing the rules will be even across the professional services industry, so the short-term impact will be distributed across competing firms.
Changing the rules will help us get off the burnout treadmill. It will help us improve staff quality of life and “stop burning $100k bills.”
Changing the rules requires effort. Often, doing the right thing may cause the difficult changing of older, less productive habits. As Seth Godin said, “The effort is its own reward.”
Finally, increasing incentives for FUTURE investment will improve the overall industry's client readiness for future needs. Adding more rigor and capacity to the investment planning and solution development process will increase the effectiveness of FUTURE-based investments and enhance the job satisfaction of consultants. Instead of reacting by "backing up the bus" with the equivalent of remediation consultant firefighters, the professional services industry will be better prepared to deliver FUTURE-focused capabilities that reduce the need for reactive / remediation-based firefighting in the first place. Plus, the professional services work environment will improve, resulting in less burnout and less attrition.
(1) de Tocqueville's 19th century language needs a little interpretation for our 21st century world. "Complacency" means "naturally," "easily," or "without trouble." Meaning, it is natural for Americans to give of themselves in an enlightened way. When he writes of giving "...their time and property to the welfare of the state," he considers "the welfare of the state" broadly, meaning giving to one's community, environment, or other priorities outside of self.
(2) See our article Wayne Gretzky and creative-divergent thinking. Creative-divergent thinkers are highly relevant to the kind of talent attracted to professional services.
"In the business context, they [creative-divergent thinkers] are adept at using counterfactual thinking, but in the highly structured context of our current business environment and future market trends. They appreciate the future is probabilistically available. They understand the future is informed by ongoing and rigorous expectations updating. They are both analytical and adaptable."
(3) The definition of "precision" and "accuracy" are often confused. There are subtle but important differences. The following graphic is my favorite way to show the differences. “Team B” is an example where the objective and judgmental information together render a precise schedule of investments. However, "Team B" lacks accuracy because of a goal or objective alignment deficit. "Team C" is an example where there is a lack of precision because of a poor process to make investment prioritization decisions, but the firm is clear on goals and objectives. In my experience, noise is the biggest culprit driving a lack of precision and poor investment outcomes. Leadership teams should prioritize tackling noise as a way to optimize their investment decisions.
For a more fulsome definition, please see the article Good decision-making and financial services: The surprising impact of bias and noise. This article's background section does a nice job explaining the difference.
(4) For a more complete discussion of the impact of time scarcity and the bandwidth tax, please see our article A Business Priority - Managing time as a scarce resource.