Your Costs Are None of Your Client’s Business

Transparency Not for PricingCan you imagine taking a test drive in the breathtaking new BMW 7 series, turning to the salesman and asking “Wow, I’m really interested in buying this 750, bu
t how many hours did it take to build it?”  This question is out of place because buyers don’t generally expect to know what something cost to build before they buy it.  They judge the price based on a variety of factors — the quality of the product, the reputation of the brand, and a whole set of other rational, emotional and sensory factors — but not the actual cost of making the product.

In the great majority of categories, buyers have no idea what actual production costs are, nor do they expect to know.  Buyers accept that costs and margins are the seller’s business.  They know that sellers ha
e to make a profit, and that prices are set above costs, but they don’t presume to be able to dictate what the seller’s margin should be.  The main judgment buyers make is about the product’s value, both real and perceived.


A strange aberration: pricing professional services

These buyer/seller dynamics apply to everything from leasing a car to buying a new mobile phone.  In an Apple store, it’s unlikely you would ever hear a prospective iPhone customer remarking to a blue shirted Apple employee “I can’t really justify spending this much for a phone unless I know what Apple’s actual cost is.  How much exactly do they pay Foxconn to build it?”  A potential iPhone buyer is instead going to make the decision to spend $800 based on the phone’s features, design, functionality, and integration with other Apple services.

So why is it the buyers of most professional services — like advertising, accounting, and law — request to see the actual costs of the services being provided?  At the very least, most procurers of professional services request to see a schedule of hourly rates (which they know are a cost-plus calculation).  Worse, many procurement professionals now consider it their right or privilege to know a firm’s actual costs, right down to salaries, benefits, and overhead.  These professional buyers can then precisely calculate the seller’s profit.  Some will go so far as to dictate what profit margin they consider to be acceptable.

When searching for a new advertising agency partner, a major retail chain distributed a Request for Proposal that contained the language “Requested net profit margin,” as though the winning agency will be granted a profit as some kind of favor.  This same RFP goes on to ask for the agency’s tangible direct labor costs, specifying this “should include but not be limited to vacation, pension plan contributions, 401K contributions, and payroll taxes.”  Are you feeling insulted yet?

Unfortunately, most ad agency execs have come to accept this intrusion into their business as standard operating procedure, dutifully filling out spreadsheets that sometimes even demand to the salaries of individuals by name. The built-in formulas on these client-provided spreadsheets effectively show the agencies involved exactly what will be “allowed” as overhead (regardless of what the agency’s actual overhead is) and of course the resulting maximum profit margin the client will accept.  Many of these repressive vetting processes cap profit margins at around 11%, despite the fact that the stated profit goal of most agencies — especially those owned by the big holding companies — is roughly twice that (20%).  Why would an agency agree to a compensation deal that yields only half of what the firm needs to remain financially healthy?  If you suspect that most agencies find a way to make better margins than those “allowed” you would be right.  And guess how they do it?

The very definition of no-win

This nonsensical buying and selling of inputs (hours, FTEs, time of staff) produces neurotic behavior on the part of buyers (who live in constant fear of getting less than they paid for) and less-than-scrupulous behavior on the part of sellers (who fret about getting all their hours billed by the end of the year so they can earn their full fee).  This serious misalignment of economic incentives produces not only an environment of mistrust, but virtually insures that neither party fully gets what they want.  It also prevents the type of “partnership” that is a stated goal of both the firm and its client.

Curiously, this type of financially-asymmetrical relationship doesn’t really exist anywhere else in the business world except for the buying and selling of commodities (think pork bellies).  Surely professional services, performed by highly educated experts, is not a commodity.  How, then, did this become an accepted practice, and — more importantly — how can we change it?

As for the devolution of agency pricing practices, there is no better recap and explanation than the book “Madison Avenue Manslaughter” by Michael Farmer.  As Farmer points out in his excellent retrospective, the reasons are not really economic as much as they are psychological (lack of confidence) and cultural (lack of effective management practices).

But to the question of how to change it, I’ll offer a simple prescription.  Professional services firm must stop selling inputs (hours, efforts, activities) and start selling outputs (end-products, programs, solutions). They must price the destination instead of the journey; the hole instead of the drill.

Furthermore, it’s the seller’s job to implement new pricing practices, not the buyer’s.  Do you recall the airlines asking your permission last time they changed their pricing structure?

Costs and profits are the seller’s business.  Transparency is for windows, not for pricing professional services.

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Tim Williams leads Ignition Consulting Group, a U.S.-based consultancy that advises advertising agencies and other professional services firms in the areas of business strategy and pricing practices.  He is the author several books, including “Positioning for Professionals: How Professional Knowledge Firms Can Differentiate Their Way to Success.

Twitter: @TimWilliamsICG

Professional Firm, Decouple Thyself

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Before the world was flattened by the personal computer and the Internet, most of the services provided by law firms, accounting firms, architectural firms, and even advertising agencies was considered to be highly specialized and valuable.

In the marketing space – the one I know best – marketers were compelled to work through advertising agencies for almost all of their marketing needs because companies lacked the ability, expertise, or internal resources to produce and place their own advertising. Indeed, agencies were valued as much for their specialized equipment (typesetting, photostat cameras, etc.) as their specialized talent. Agencies offered the creation and production of advertising as a bundled service, because both dimensions of their output – ideation and execution – were equally needed and equally valued.

Magic and logic

Some industry observers have labeled these two sides of the agency business as “magic” and “logic.” Think of “magic” as problem-solving work such as concept development, strategic planning, and recommending new marketing initiatives. “Logic” work, on the other hand, is the production, execution, and implementation side of what agencies do. Both of these service areas are important and must be done well. But today, “magic” work and “logic” work are valued in vastly different ways.

Armed with Apple computers and Adobe software, many client companies feel capable of doing the “logic” work themselves, and some do. At the very least, today’s companies feel that production work is so commoditized it makes little sense to pay high-priced agency executives working in expensive offices in expensive cities to do this type of work. So while “magic” work is still done by advertising agencies in places like New York, London, and Toronto, the “logic” work is increasingly being given to a new breed of marketing implementation agencies, often located in places like Costa Rica, Shanghai, and Buenos Aires.

Supply and demand

Today’s marketers even have a word for it: “decoupling.” Companies are consciously separating the high-value services that are scarce from the low-value services that are plentiful. Many agency executives will tell you that their client for “magic” work is the Chief Marketing Officer, while their client for “logic” work is the Chief Procurement Officer.

The client view is that advertising production services can be “procured” using the same methods and procedures as office supplies, because most production work is standardized, repeatable, and widely available. They often try (much to agencies’ dismay) to apply the same processes to buying “magic,” which by definition is not standardized, repeatable, and widely available. As my consultant friends Gerry Preece and Russel Wohlwerth point out in their book “Buying Less for Less,” you can write specs for marketing production but not for marketing innovation.

But the larger point here is that the decoupling phenomenon is happening in all professional services business. In law, “magic” services are still provided by expensive firms in expensive cities, but “logic” services like discovery work and contract review are being done by lower-cost talent in lower-cost geographies. Accounting, architecture, and IT services are all being decoupled in the same way, due to the same dynamics.

A right and wrong way to respond

The unfortunate response by many firms is to fight mightily to continue to provide their clients with both the high- and low-value services, which they proudly point out they can do as a “full-service firm,” all under one roof. Worse, many of these firms bundle these services together with a blended hourly rate, which is the absolute worst solution because it makes the “logic” work much too expensive and the “magic” work not expensive enough. (Not to mention the perniciousness of hourly billing to begin with, but that’s a subject we’ll leave to other articles.)

Instead of innovating their business model in ways that navigate through the very different waters of “magic” and “logic,” most professional services firms are choosing to sail ahead on the same course. But we should take inspiration from the progressive firms that are choosing to proactively disrupt themselves, often by turning their firm into two different brands. The venerable advertising agency Ogilvy & Mather (“magic”) now has a second agency brand called Redworks (“logic”). The agency Publicis recently formed a second brand called Prodigious. Some smaller independent firms are following suit, realizing that it’s much better to decouple than to be decoupled. Because if we don’t do it, the buyers of our services will do it for us.

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Tim Williams, a Senior Fellow at Verasage, leads Ignition Consulting Group, a U.S.-based consultancy devoted to helping advertising agencies and other professional services firms create and capture more value. He is the author of Positioning for Professionals: How Professional Service Firms Can Differentiate Their Way to Success.

Twitter: @TimWilliamsICG Blog: www.ignitionpropulsion.com

Does Your Firm Need to Reduce its Organizational Overhead?

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Most businesses start out with a fairly simple business model.  As time goes on, they add new services and capabilities and extend out to new markets.  Some of this diversification is strategic and deliberate, but most of the time companies start sprawling in ways they never intended.

Why?  Mostly we unconsciously imitate what competitors do.  If other firms do it, we reason we should too.  Anthropologists say that our propensity to copy is our deepest and most ancient survival mechanism.  Advertising professional Mark Earls and his colleagues prove this point pretty conclusively in their fascinating book on social behavior, “I’ll Have What She’s Having.”

While copying might have served us well in the early stages of human society (what to eat, how to hunt), it does not serve us well in the business world.  By continually duplicating the business models of others, we add layers of complexity to our organizations that sap our energy, blur our focus, and erode our profit margins.

When advertising agencies submit their listing to the Redbooks advertising database (The Standard Directory of Advertising Agencies), of the nearly 100 “areas of specialization” available, most agencies claim nearly half of them.  Apparently these agencies want us to believe that they are experts in cosmetics and Hispanic marketing and aviation and food service and … fill the blanks with 40 more “areas of specialization.”

By attempting to be good at everything, we risk being truly excellent at nothing.  Worse, this kind of complexity drags our firms down with a form of “organizational overhead” that directly affects the financial health of the company and the emotional health of our employees.

Focus and self-confidence

The most destructive manifestation of unfettered, unfocused diversification is that it severely erodes the self-confidence of the organization.  Rather than building on its strengths and doing what it does best, the firm is chronically distracted by every opportunity that floats by and wastes its financial and intellectual capital chasing clients that are not a good match.  Associates are then disappointed that the firm increasingly “comes in second” in new business presentations.

Comments like these — borrowed anonymously from one of the recent surveys Ignition did with a notable advertising agency – illustrate the destructive effects of lack of focus:

The lesson from this past year is that pitching more does not translate to winning more. We would have a stronger win rate if we were more selective. We would also have more confidence in new business, which is something we really lack.

It seems like we are throwing a lot of stuff at a wall and hoping for something to stick. It would be more effective to rest our team and wait for the right opportunities and then go for. This past year was exhausting in many ways.

Right now we have no strategy. We don’t know what we stand for.

We waste time and resources going after accounts that we have no chance of winning, which is extremely frustrating for the teams involved. It truly feels like we just pitch anything.

It’s no coincidence that the most focused firms have the strongest win ratios.  More and more I hear from firms emerging from a new business review process that “We lost to the specialist firm.”  That’s because what clients really buy is expertise.  And no firm can be expert in everything.

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Tim Williams leads Ignition Consulting Group (www.ignitiongroup.com), a U.S.-based consultancy devoted to helping advertising agencies and other professional services firms optimize their business model for the 21st century.

Are You Really In The Service Business?

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By Tim Williams, Ignition Consulting Group

Partners, managers and associates of advertising agencies, accounting firms, and law firms alike are increasingly frustrated by the master-servant dynamic that often characterizes the relationship they have with their clients. We sometimes feel that clients treat us more as a supplier than a partner. We are quick to lay the blame at the feet of the client, but is it possible that the problem really starts with us?

For starters, we constantly refer to our business as a “service business.” Some firms – like advertising agencies — have “client service” departments. We call ourselves a “professional service firm.” Consider how this creates our self-perception.

Many firms lament that they have become “order-takers.” But why? Who turned your firm into an order-taker? You did – not your clients. You did it by forgetting what it is you’re really selling. You’re not selling service. You’re selling important business outcomes.

The firms that understand this invest in better people who can produce a better product. They resist hiring an army of junior people who are good at service, but fail to add the value that clients are ultimately paying for. They realize that the way to deal with demanding clients isn’t to give them exactly what they want, but rather to counsel clients on what they really need.

You only get treated like a servant if you act like a servant

The fact is that we shouldn’t be regarded as professional service firms, but rather professional knowledge firms. Clients don’t just hire us for what we do, but rather what we know.

In the advertising agency business – my domain — clients routinely complain that the average “account executive” doesn’t really add much value to their business. That’s because most account executives view their job as simply responding to client requests.

Over the many years that Ignition Consulting Group has been conducting surveys of advertising agencies, we have discovered that agencies give themselves the highest ratings in the areas of “Responsive service,” “Listening to clients,” and “Meeting timetables and budgets.” The lowest-rated areas? “Developing proactive ideas and delivering marketing leadership to clients.”

Service is a commodity. Smart thinking is not. Clients can get good service anywhere, but proactive marketing leadership is in short supply. In fact, most surveys that seek to diagnose why clients switch advertising agencies usually produce the same answer: “Because our agency never gave us anything we didn’t ask for.”

Think hard about the question of what business you’re in. If you’re in the service business, you can expect to be treated and paid accordingly. If you believe you’re in the knowledge business, then you’d better hire, train, and invest in people accordingly.

There are plenty of smart clients who value and respect what a smart firm can deliver. But respect starts with a firm’s self-perception. You will never be accorded more respect than you think you deserve, and you will never be paid more than you think you are worth.

When it Comes to Compensation, There’s No Right Way to Do the Wrong Thing

The year is 1537. You’re a physician for King Henry VIII and you’re attending an annual conference of royal physicians in Florence, Italy. The theme of the conference? No surprise to those attending, the entire conference is devoted to the leading medical practice of the day: bloodletting. After all, every knowledgeable doctor since 1,000 B.C. has prescribed bloodletting as the main treatment for virtually every serious disease.

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At the conference, you have your choice of three leading-edge breakout sessions:

* Breakout Session #1: The Best Places to Cut
* Breakout Session #2: How Much Blood is Enough?
* Breakout Session #3: Latest Improvements in the Lancet

By attending these sessions, conferring with other doctors, and reading the latest papers you would get better and better at doing the wrong thing. You would be consistently improving your practices, only you would be practicing in what amounts to the wrong paradigm.

Brand doctors are the same

There’s no better analogy for the situation professional service firms find themselves in when it comes to compensation. Agency executives are constantly looking for better time-keeping software, better ways to collect timesheets, betters ways to produce billable-time reports, and better ways to analyze the data. They are improving their practices, but it’s based on the wrong paradigm.

Back in Renaissance-era Florence, imagine that at the end of the conference a bold speaker takes the floor and presents an extremely convincing argument that bloodletting is in fact a completely ineffective practice; in fact it makes the patient sicker instead of healthier. Let’s say that you come away from that speech convinced that bloodletting is actually a faulty (or even malicious) paradigm. Could you then return to your practice and continue cutting people’s arms? Well, could you?

This is why it’s essential to focus on changing your paradigm instead of focusing so much on just the practices; because if you change your paradigm you can’t help but change your practices. In fact, a change of paradigm unleashes a torrent of new thinking about practices. The best approaches to value-based compensation for professional services firms haven’t been invented yet; they’re waiting for you to invent them.

The gulf between knowing and doing

If you really want to get paid what your firm is worth, you must first leave that state of denial in which so many firms find themselves. Sigmund Freud described denial as “knowing-but-not-knowing” — a state of rational apprehension that does not result in appropriate action.” Steven Covey described this phenomenon in an even more powerful way: “To know and not do is really not to know.” Medicine provides some other potent examples of how “knowing” doesn’t necessarily result in “acting”:

* Even though by 1628 it was understood that the heart pumped blood through the arteries, the use of tourniquets in amputations didn’t happen until roughly a century later.

* The microscope was invented by 1677, yet as late as 1820 it had no place in medical research, believed to be nothing more than a toy.

* Germ theory was developed by 1700, yet didn’t take hold until promoted by Joseph Lister in 1865. Prior to that, infections were thought to be caused by stale air.

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In his fascinating study of this topic, historian David Wootton posits that these delays in adoption weren’t practical or even theoretical but rather cultural. The cultural and institutional legacies surrounding the medical profession were (and still are) huge hurdles in adopting the right practices aligned with the right theory.

The same is true for most professional services firms. Professions and institutions have a life of their own, and it’s not enough to say, “I buy the theory.” You must overcome the inertia and adopt a new set of practices.

How to Tell Your Client Your Price is One Million Dollars

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CLIENT: I want to hire you for your expertise and your ability to create and execute transformational business ideas for my company.

FIRM: Excellent, we are ideal for that challenge.

CLIENT: Yes but before I hire you I have a few important questions.

FIRM: Okay, shoot. What do you mean?

CLIENT: What will you charge me?

FIRM: $1 million dollars for our ability to work with your organization to create the idea, and then if we move it forward another million because truly transformational business ideas are valuable and in limited supply.

CLIENT: Why $1 million?

FIRM: What to you mean?

CLIENT: I need to know why you charged me a million.

FIRM: Why?

CLIENT: Well if I don’t know how you arrived at your price, how do I know it’s fair?

FIRM: I don’t understand. What difference does it make how I arrived at the price?

CLIENT: Well if I understand how you arrived at it, then I can negotiate it down.

FIRM: But I do not want you to negotiate it down. That is money out of my pocket.

CLIENT: Yes, but it is a privilege to work on my brand and you will get lots more business from it.

FIRM: I will? Can you guarantee that?

CLIENT: No. But I still need to know how you got to your price.

FIRM: Well OK…I looked at the size and scope of the opportunity and considered the value of us addressing it for you and calculated a price that I am willing to do it for. A price that I believe to be competitive in the market and a price that affords me the peace of mind that I can make a bit of money.

CLIENT: Oh, but I need more than that. I need to know who will do the work… And the amount of time it takes for them to do it.

AGENCY: The team I said will do the work…and it will take as long as it takes until we have an outcome that everyone is happy with.

CLIENT: Yes…but what if just one person cracks it in one day…and you then execute
It with a small team in 3 weeks – that is not worth a million dollars.

FIRM: You’re 100% correct. It’s worth more…. If that happens, we will double it!

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Such is the brilliant defense of Jason DeLand of Anomaly, one of the leading advertising agency luminaries in the realm of value-based pricing. Go thou and do likewise.

Why You Should Fire Your Low Value Clients

By Tim Williams, Ignition Consulting Group
www.ignitiongroup.com

My colleague Ron Baker has coined what has come to be known in professional service circles as “Baker’s Law”: Bad clients drive out good clients.

What is a “bad client?”  A bad client is a low-value client; they don’t add any value to the agency’s bottom line, professional satisfaction, or reputation.

  • For starters, low value clients are unprofitable.  There is simply no rational argument for keeping an unprofitable client.  Look at most agency financials and you’ll see Pareto’s law in effect: 20% of your clients generate 80% of your income and profit.  Generally speaking, about one-third of an agency’s clients actually cost the agency money.
  • Low value clients usually run your team ragged because they’re poorly organized, have unreasonable approval processes, and make constant changes and revisions because they’re not focused enough to give the agency good input and clear direction.
  • Low value clients often treat your team with lack of respect; thereby creating a relationship characterized by lack of collaboration, mediocre work, and strained nerves.

Not every dollar is a good dollar

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So why are so many agencies filled with clients that fit this description?  The excuse offered up by most agency principals is “they at least help cover our overhead.”  They have the attitude that every dollar is a good dollar.  But some dollars actually have negative value when the result is demoralized people who leave for other jobs and a damaged agency reputation that hurts prospecting efforts for both people and clients.

When less is more

Our firm once worked with a 50-person agency that had a roster of 45 clients.  Their profit margins were razor thin, their work was only average, and their staff was literally overwhelmed by the demands on their time.  The principals of the firm made the courageous decision to part ways with the bottom third of their client list – about 15 of their smallest, most unprofitable clients.

They agreed that they would resist cutting any of their key staff positions until they could judge the results of their actions.  The result was a rejuvenatedorganization that suddenly had the time and ability to grow the business of their best clients, resulting in greatly improved profitability, s

taff morale, and work quality.

Bigger versus better

To quote another of Ron’s sayings, “Growth for the sake of growth is the ideology of a cancer cell.”  The only kind of growth you should want is smart growth.  Income is vanity, but profit is sanity.

P.S.  One brilliant way to get rid of your low value clients is to charge them the highest price.  Ironically, most low value clients end up getting our lowest price, because they complain the most.  Do just the opposite and your low value clients will disappear.