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April 2019

Episode #239: FRF — Millionaires, Marxists, and Minimum Wage

What a great Free-Rider Friday! This show moved fast and we covered a lot of ground.

Here are Ron’s topics from the show:

 …and here are Ed’s topics: 

 We had a listener question addressed during the show as well: 

We received a great question from Mark Stiving, Ph.D., Chief Pricing Educator, Impact Pricing LLC, and author of Impact Pricing: Your Blueprint for Driving Profits, and host of the Impact Pricing Podcast.

Mark will be our guest on the June 14th, 2019 episode of The Soul of Enterprise.

Here’s his question: 

Your TSOE episode on the death of the timesheet was very thought provoking.  I’m 99% with you on the idea of killing hourly billing, and could be with you on killing timesheets except I don’t know how to answer one question.  How does a company determine Willingness to Accept (WTA)?  

In every negotiation, the buyer has a Willingness to Pay (WTP) and the seller has a WTA.  This is easiest to understand in products.  If a seller has an ongoing business and can buy a product for $100, their WTA is almost certainly some number above $100.  Usually they have a margin floor, say 20%, so their WTA would be $120.  If the buyer’s WTP is $300, there will likely be a transaction, hopefully at a price significantly higher than $120.  However, if the buyer’s WTP is less than $120, no transaction will occur.  

In accounting or similar service type businesses, how do you know your WTA?  It seems you need an estimate of time, (even though you would pay that accountant’s salary even if you didn’t land that job).  If you need to estimate time, wouldn’t having timesheets to track actual vs estimated in after action reviews be helpful?  As you point out, they are probably not accurate, but is there a better way?  I’m looking forward to your answer.  Feel free to answer on the air if you’d like, perhaps on free rider Friday?  

Cheers,

Mark

Episode #238: The Million-Dollar TIP — Using a TIP Clause

It’s All About Baseball…

To start the show off, Ed just had to reference baseball and we - the audience - would expect nothing less. Enjoy! https://www.baseball-reference.com/postseason/1960_WS.shtml

So What Was The Show Really About…

1M+dollars.jpg

One of the most innovative pricing strategies that should be in every firm’s pricing stack is the TIP clause. Most feedback that firms receive on pricing is negative (“Your price was too high”). Or it is ambivalent: “Your price was just right.”

No customer ever discloses how much money your firm left on the table. Innovative pricing strategies, such as the TIP clause, are outward focused and attempt to capture more of the value created for customers, in extraordinary engagements. Having more accurate cost accounting or better project management won’t help you capture this level of value, which is why pricing is the main driver of profitability.

Making the Wrong Mistakes

In 1997, Tim was the managing partner of top accounting firm, and his best, long-term customer (of 20 years) had come to him wanting to sell his $250 million closely held business. He told Tim (and I am paraphrasing here), “You’ve been my CPA for 20 years and I trust you with my life. It is time for me to sell my business and enjoy my golden years. Here is what I want you to do:

  • Update our business valuation to maximize the sales price.

  • Fly with me anywhere we have to go to meet with potential buyers.

  • Be actively involved at every stage of the sales negotiation.

  • Perform the due diligence, along with the attorneys, of the qualified buyers.

  • Work with the attorneys on the sales contract to make sure my interests are protected.

  • Perform tax planning and structure the deal in such a manner as to maximize my wealth retention.

When Ron asked Tim how he priced this engagement, he proudly proclaimed that every hour charged to this project was at his highest consulting rate of $400 per hour, indicating, right from the start, Tim knew there was more value on this project than he would ever be able to pad on a timesheet.

As a result of Tim’s work, the customer received (and saved in taxes) an additional $15,000,000, and acknowledged Tim was directly responsible for this outcome. In Tim’s own words, the customer was “elated.”

Tim then told how he priced the engagement. He reviewed all of the hours from the work-in-progress time and billing system, believed it did not adequately reflect the value he provided, and marked it up an additional 25 percent over the $400 hourly rate.

He then sent out an invoice for $38,000, which the customer promptly—and happily—paid. He believed he was value pricing. He was not—he was value guessing, since the customer had absolutely no input into the price up front, and only a customer can determine value.

When Ron asked Tim what he thought the customer would have paid if he had utilized a TIP clause (also referred to as the retrospective price, or success price), such as the following:

In the event that we are able to satisfy your needs in a timely and professional manner, you have agreed to review the situation and decide whether, in the sole discretion of XYZ [company], some additional payment to ABC [CPAs] is appropriate in view of your overall satisfaction with the services rendered by ABC.

The TIP is being based on the “overall satisfaction with the services rendered,” and not any financial contingency, which is the origin of the acronym TIP—to insure performance.

This TIP clause would be discussed with the customer before any work began. If needed, you could put a minimum price on the engagement (such as $40,000) to cover immediate firm capacity. But in this case, given the 20-year relationship with the customer, even a price solely determined by a TIP would have been acceptable, since the customer was not likely to take advantage of Tim after the services he rendered and the long-term relationship they had. 

In answer to my question, Tim said his customer would most likely have paid him $500,000, a sum I believe to this day is below the real number—but at least better than the $38,000 he finally charged. Nevertheless, since Tim knows the customer better than I do, let us take his number as correct.

Ron informed Tim he had made the Ultimate Accounting Entry:

Tim was providing extraordinary value to this customer—he was at the top of the Value Curve—yet his cost-plus pricing theory prevented him from capturing a fair portion of it. Are we not ruled by our theories? This is why it is imperative to extinguish the cost-plus mentality from your firm.

No one in any seminar we have shared this story with believed Tim would have received less than $38,000 for his services on this engagement. In effect, Tim paid a reverse risk premium—he was assured he would not go below his hourly rate, but in return he gave up the added value the customer already believed he had created. This is not a risk worth taking if you want to maximize your firm’s profitability.

The deleterious effects of this are deeper than just being deprived the value from the work you provided on any one engagement. The problem lies at the very core of a firm’s measurement system and points out how it does not offer the opportunity to learn from lost pricing opportunities, or pricing mistakes.

In his inimitable way, Yogi Berra explains this situation with his quip, “We made too many wrong mistakes.”

When it comes to pricing, the wisdom from Yogi is profound. Tim made the wrong mistake, and here is why: He will not learn anything from it because the firm’s primary assessment is billable hours—once again the billable hour is the incorrect measuring device for value. When the partners review the realization report on this engagement, they will see 125 percent, which is excellent when you consider most firms realize between 50 and 95 percent overall on each hour.

No knowledge was gained by the firm on how to price the next similar engagement in accordance with value—it will simply perpetuate the same mistake, over and over. Being a more accurate activity-based cost-accountant, or even excellent project manager, would also not have helped Tim to capture the value.

This is not meant to imply with value pricing you will never make mistakes. You certainly will. The difference is they will be the right mistakes, because with value pricing, as opposed to cost-plus pricing, you are forced to receive input from the customer as to your value, and have in place pricing strategies that will capture more of that value (like the TIP clause). If you engage in After Action Reviews (AARs), which perform value assessments on each engagement, and elicit feedback from your customers, you will learn from your mistakes and become better at pricing in the future.

Most feedback firms receive on pricing is negative: “Your price was too high.” Or it is ambivalent: “Your price was just right.” No customer ever discloses how much money your firm left on the table.

Innovative pricing strategies, such as the TIP clause, that are outward focused and attempt to measure value have allowed more and more firms around the world to capture more of the value they provide.

Case Study: The Million Dollar TIP

This story comes from Gus Stearns, a partner in an accounting firm, whom I [Ron] met on September 25, 2000 at a conference in Las Vegas. Gus tracked me down at the dinner party, walked me over to the bar, and over a glass of wine told me his amazing TIP story. Here are the two e-mails I received from Gus explaining his success, the first one prior to our meeting in Las Vegas and the second one after:

April 20, 2000

Hello Ron,

I hope the tax season finds you well. I was fortunate enough to be at the Atlanta conference [January 2000] when you spoke and picked up an autographed copy of your book [Professional’s Guide to Value Pricing], which I devoured on the plane trip back.

The engagement which I refer to ($180,000 price) had already started a month or two before and I had used the old standard rate-time-hours routine and billed about $2,000 at a standard rate of $180/hour. After listening to you and reading the book, I was determined to reevaluate the price structure and simply went back to my customer and said, “Guys, this is what I am bringing to the table. It brings a lot of value which is etc., etc. I don’t believe hourly rates based upon time is appropriate. I am unable to place a value on this. I need your help. You tell me what the value of all this is to you. You are the customer and only you can truly establish the value. I know I’ll be happy with what ever you come up with.” This is almost an exact quote.

I left it at that two months ago. I was handed a check for the first installment of $50,000 on the way out at the end of the engagement. I guess this is what you call “outside-in pricing.” I like it.

Gus Stearns, CPA

It gets better, since this engagement was in two phases. Here is the follow-up e-mail from Gus explaining the final result after the job was done:

Hello Ron,

Basically the large engagement was for a previous client that I had hired a controller for. He took over the tax work, at my suggestion, as he was a CPA. The engagement was an exit and management succession strategy, which involved some fairly hefty income tax savings as well. The total time expended was about 100 hours, although a lot of the time was on unrelated things that I did not want to charge for due to the magnitude of the price (we quit using timesheets some time ago).

I used a flip chart in the presentation, pointing out the value of what they were getting. At the end of the presentation, I asked how much they thought it was worth, and suggested $300,000, $500,000, a million? I wanted them to think in big numbers. The CEO was rather excited and said a million. Knowing that this would be difficult to obtain in one fell swoop I suggested $400,000 down and a retainer of $4,000 per month. They agreed but asked that I serve on the board of directors and attend quarterly meetings through 2008, when the note to the previous owners would be paid off. They were also kind enough to put me on salary so I could participate in their pension plan, which is a 25 percent direct contribution from the company. This all adds up to a little bit over $1 million.

Never once was the word “time” used or referred to by myself, or my client. They could have cared less about time. In all of our engagements, I never use the word. By concentrating on value and encouraging the client to participate in the valuation of the engagement our prices have skyrocketed. You were absolutely on-target when you said that accountants are terrible at valuing our services (myself included).

Keep up the wonderful work,

Gus

These types of engagements are certainly not the rule in any firm, they are the exception. Nonetheless, they do arise, and when they do it is critical to recognize the value you are creating, and to utilize innovative pricing strategies to capture it. This also demonstrates why pricing is the most potent lever you have in terms of increasing your firm’s profitability, much more than cutting costs or increasing efficiency. 

We include these stories not because I believe you will earn a $1 million TIP, but rather to illustrate how the cost-plus pricing mentality has placed a self-imposed artificial ceiling over the heads of firms. Never in his wildest dreams would Gus have placed a $1 million value on his work; but the customer did. Does he not deserve it? 

Baldridge Award–winning firm Graniterock instituted such a policy, calling it “short pay.” This provides, in essence, a line-item veto to customers and allows them to deduct any amount of the invoice in accordance with their subjective value of the service provided.

It is not a refund or discount policy; it is a pure service guarantee, because the customer is not required to return the merchandise. Here is how owner Bruce Woolpert explained the advantages of this guarantee:

You can get a lot of information from customer surveys, but there are always ways of explaining away the data. With short pay, you absolutely have to pay attention to the data. You often don’t know that a customer is upset until you lose that customer entirely. Short pay acts as an early warning system that forces you to adjust quickly, long before we would lose that customer.

Will some customers take advantage of Woolpert’s policy? Probably. But consider Nordstrom, legendary for taking back merchandise not even purchased from its stores. It estimates that 2 to 3 percent of its customers take advantage of this policy, yet 97 to 98 percent appreciate the policy and are more loyal—and pay a premium price—as a result.

Do not let the tail wag the dog. If any one customer were to abuse your service guarantee, he would actually be doing you a favor by self-identifying himself as a problem customer. Gladly refund his money and fire that person from your company.

Case Study: Mission Impossible

Santa Monica Freeway

The January 1994 Northridge, California earthquake devastated the Santa Monica Freeway, leaving 350,000 daily commuters no access to Los Angeles. Early estimates predicted at least 12 months to rebuild, at a public cost of $1 million for each day the freeway was shut down.

Innovative constructor C.C. Myers saw it differently. He saw it as a 4.5 month project. Staking his wealth and reputation, C.C. Myers signed a $14.7 million contract with the city, which allowed a maximum completion time of 140 calendar days, with a penalty for late completion of $205,000 per calendar day and an incentive of $200,000 per day for early completion and opening the freeway to traffic.

Mission: Impossible

Approach: Change everything.

Results: Spectacular

Contract time commenced on February 5 with materials and equipment moving to the jobsite that same day and through the weekend, even the final construction plans were not available until February 26. C.C. Myers immediately went to work on a 24/7 schedule with up to 400 workmen on the job. On-site inspectors were used to eliminate delay and rework. Workers were running on the job. Special quick-setting concrete was used. Subcontract bids and awards were made on a daily basis. Work flowed.

Sixty-six days after the contract was signed, the Santa Monica Freeway was opened to traffic, 74 days ahead of schedule.

Source: The Elegant Solution, Matthew E. May, 2006, pg. 135.

 

Episode #237: Interview with ADP's Chief Behavioral Economist Jordan Birnbaum

Another Great Show, This One Featuring Jordan Birnbaum of ADP

Here is some background on Jordan…

Jordan Birnbaum has been with ADP since 2015, as VP and Chief Behavioral Economist. He directs the application of behavioral economics principles into new product development in the human capital management market.  Prior to joining ADP, Jordan was the owner / operator of The Vanguard in Los Angeles, a hybrid media production and live music venue, employing more than 150 people for close to a decade.  He was a founding employee and Senior Vice President, Business Development, of Juno Online Services, playing a key role in a successful IPO and then beating analysts’ estimates for six consecutive quarters.  Jordan graduated from Cornell University with a BS, Policy Analysis, and from NYU with an MA in Industrial / Organizational Psychology. 

We asked and Jordan answered…

This is an instance in which no amount of show notes, regardless of how thorough, could capture the energy and excitement of Jordan as a guest. Our questions for him are below but you really should listen to the show (audio is linked above) in order to truly understand how much depth Jordan brought to the show as a guest.

Ron’s Questions…

  • Tell us about The Vanguard?

  • Did you ever meet the South Park creators?

  • Give us the second answer to Ed’s question on the difference between nudging and manipulation.

    • We had on the show Rory Sutherland. He created a Nudge unit inside of Ogilvy in the UK, and when he was president of the IPA in the UK he was saying: “Hundreds of agencies have developed models for ‘how advertising works.’ What’s needed now is for agencies to base their business on how people work.” Basically, that if ad agencies don’t become behavioral economists they are going to become irrelevant. You read about how these Silicon Valley companies employ behavioral economists, such as Airbnb, Uber, etc. Can you share any examples of how you specifically apply these principals at ADP.

compass.png

Check out the white paper on Compass a next-gen assessment and coaching development tool to drive leader and team effectiveness with no installation needed at http://Compass.adp.com .

Ed’s Questions…

  • So, you’re hanging out with Bill Maher on the weekends, you have this great club in LA, and now you’re the VP and  chief behavioral economist at a payroll company. You’ve got to make that leap for me?

  • Ron and I are big fans of behavioral economics, and one thing that has puzzled me that I struggle with in my mind is, where do you see the difference between nudging and manipulation?

  • Then the question becomes who decides what is in someone else’s interest, right?

  • We often talk about pricing and proposal construction. I wanted to get your thoughts on three choices being optimal, is that something you’re seeing as well. Also, what about add-on to options, does that become confusing at some point? Where’s the line between complexity and creating effective choices?

  • If you’re creating a business proposal for a relativity complex engagement, is there a difference between three choices and four choices?

  • Throughout the course of the questions, we touched on many of these: https://en.wikipedia.org/wiki/List_of_cognitive_biases

Episode #236: ET HORA LIBELLUM DELENDA EST

What did we talk about in this episode? Glad you asked!

In ancient Rome, during the Punic Wars, Cato the Elder is said to have ended every speech he delivered before the Roman Senate with the phrase, “ET CARTHAGO DELENDA EST” (and Carthage must be destroyed!). He did this without regard to the subject of his speech. It is in this spirit that we present ET HORA LIBELLUM DELENDA EST which, loosely translated, means, “and the timesheet/billable hour must be destroyed!”  

Topics of Discussion:

  • We discuss an article from Accounting Today, which touches off the debate over the necessity of recording time. The article is, “Timekeeping: Stop wasting time!,” by Alan Conway, published March 18, 2019.

  • We also discussed VeraSage senior fellow Tim Williams’ article, Re-Engineering Your Firm Around Value, from March 20, 2019, reproduced below.

Re-Engineering Your Firm Around Value
Published on March 20, 2019

Tim Williams 

We are what we measure. In life and in business, it’s human nature to align our behavior with the metrics by which we are judged. So if the key measurement in our firm is billable time, guess what kind of internal behavior we’ll get?

The incentives that drive behavior in your firm create either a culture of utilization or a culture of accountability. A culture of utilization promotes and rewards “busyness.” A culture of accountability is centered around productiveness. 

In a firm that makes its money by selling hours, the individual incentive is to record as much billable time as possible and the corporate incentive is to bill as much of this time as possible to its clients. In a firm that makes its money by selling solutions to business problems, the motives are to spend time wisely and effectively. The cultural difference between these two business models can be astounding. 

As the business innovator W. Edwards Deming taught, if management sets only quantitative targets and makes people’s jobs depend on meeting them, “They will likely meet the targets — even if they have to destroy the enterprise to do it.” In Deming’s estimation, more than 90 percent of the conditions that affect a company’s performance can’t be easily tracked and measured. Yet managers spend more than 90 percent of their time monitoring and analyzing some form of measures; most notably, time tracking.

A shadow economy in every time-based firm

This approach creates a shadow economy that saps the time, energy and initiative of professional firms. As H. Thomas Johnson and Anders propound in their book Profit Beyond Measure, “It is not an exaggeration to say that in most organizations today, each person whose work eventually serves customers’ needs is 'shadowed' by another person whose job is to keep track of other people’s work.” Extensive time tracking is “shadow" work that adds an incredible amount of wasted cost to the firm. While professionals in the firm are attempting to create value for the firm and its clients, the “time beast” extracts value. 

Johnson and Anders go on to say, “The perception that the world is quantitative and that business is therefore mechanistic has for the past fifty years shaped all the variants of strategic planning, financial analysis, budgeting, cost management, and management accounting that have been taught by graduate business schools and practiced in large organizations. Executives versed in such practices and who believe that reality is defined by quantitative measurements are like the puppies who believe that the fence defines reality.”

The focus in professional firms should be on doing the work, not manipulating quantitative abstractions about the work (time tracking, billable time targets, etc.). 

A tale of two firms

In Firm A, its time and energy are spent: 

-     Asking team members for estimated hours

-    Preparing estimates of hours

-    Logging hours on timesheets

-    Tracking actual hours spent

-    Collecting and policing timesheets

-    Inputting time data in software systems

-    Producing time reports

-    Comparing and reconciling actual time against estimated time

-    Justifying hours to clients

-     Transferring or writing off hours

Firm B, on the other hand, devotes its energies to:

-     Identifying the scope of value (desired outcomes)

-    Clarifying the scope of work

-    Collecting complete information about assignments

-    Developing more complete briefs and briefings

-    Investing more effort in developing effective solutions

-    Pricing the value of the work (instead of just estimating the costs)

-    Pricing and invoicing the work in phases

-    Managing projects based on actual work completed, not hours spent

-    Paying more attention to scope creep

-     Re-pricing work that exceeds scope

Which of these two firms is likely to be most effective? Most profitable? Which would you prefer to lead or work for?

Value-Led vs. Cost-Led

In place of monthly report detailing how their time was spent (which often takes the form of an invoice), value-led firms produce reports of work completed, problems solved, and results produced. Internal discussions revolve around the effectiveness of the work, not the “efficiency” of the team. 

Instead of obsessing about hours spent, value-led firms turn their attention to measuring what really matters: deadlines met, promises kept, work delivered, and results achieved. One of the notable firms that put value first, the marketing firm Anomaly, puts it this way:

“We don’t do timesheets, ever. We believe they are dishonest and incentivizes the wrong behavior. Our view is that the right people will solve a challenge quickly and should be rewarded for the value of that answer to the client. We’ll back ourselves up on that by putting a significant percentage of our fees against the fact that our work will work. The result is that our meetings are only attended by people who are adding value, not billable hours.”

It's time to stop managing your firm as though your inventory is a fleet of rental cars that must be “busy” to be generating revenue. Your inventory is intellectual capital, and what you sell is value created, not time spent.

 Friend of VeraSage Thomas L. Bowden Sr, an attorney, posted this comment on our VeraSage & Friends Facebook page in response to an article defending the importance of recording time to determine cost:

Thomas L. Bowden Sr. So, you take an arbitrary segment of your staff, assign them an arbitrary number of hours to record and/or work each year, then take an arbitrary portion of your overhead and add it to the salaries of the arbitrarily selected staff, add to that an arbitrary figure for your desired profit, and divide by the arbitrarily chosen number of hours, and voila, that’s your ever so precisely determined “cost” per hour. Now measure your actual hours very precisely or all of those completely arbitrary choices will be completely useless. Of course, they’re useless anyway, because no matter how precisely you measure the wrong thing, it’s still wrong.

Videos Mocking Hourly Billing and Timesheets