Saturday, 22 March 2008

Have all the good economics stories been told?

I've just finished Steven Landsburg's book, More Sex is Safer Sex. I guess I had been led into an expectation of what popular economics books are like, by Freakonomics and by Tim Harford's two recent books, The Undercover Economist and The Logic of Life. And my expectations may not be a good basis on which to judge a book. Still, I suspect many readers may have a similar measuring stick. So I expected a series of unexpected results based on interesting research by contrarian economists.

But perhaps the well of real experiments has run dry. Because what we get instead is a lot of thought experiments. The economic theory is mostly conventional but Landsburg takes it to its logical (and unconventional) conclusion by advocating fully free market solutions for many social ills.

Amusing and thought-provoking to an extent, but ultimately I'm left with the feeling of having consumed a calorie-free intellectual meal. We know very well that few of these solutions will ever be adopted in the real world, so ultimately what are we left with?

The book is intellectually honest and there's a good couple of chapters where Landsburg examines two areas of uncertainty. First in "Go Figure", a series of areas where economics does not yet give a good explanation for outcomes. For example, why have shopping carts continuously got bigger over the last thirty years? Second, "Things That Make Me Squirm", about several phenomena where analysing the economic incentives implies answers at variance with conventional free-market beliefs. These are a lot more stimulating - perhaps because they leave room for a variety of answers - than chapters on how the justice or political system would work better if people were given new financial incentives for different kinds of behaviour.

Not that I object in principle to the answers Landsburg comes up with in these other chapters, but somehow they come across as more smug, and less interesting, than those where he genuinely allows for answers that contradict his own intuition.

However the most intriguing chapter for me was "The Central Banker of the Soul", a good summary of arguments and questions about the time-inconsistency problem. Disregarding all my comments above, this chapter got me thinking about its theoretical content regardless of the writing style. That is probably the best gauge of the quality of a book and I'll be writing more soon on what I've developed in that area.

Wednesday, 12 March 2008

Budget, competitiveness, and SMEs

Last week the CBI suggested that the way to fix the UK's "uncompetitive" economy is to reduce corporation tax from 28 to 18%. Economists might be surprised to hear that a tax on returns to capital investment is meant to have an effect on productivity and boost economic growth; but that is their thesis. Perhaps, to be fair, it would encourage an incremental increase in total investment across the economy, which should bring increased returns to labour productivity - but only if the returns are very marginal indeed will a 10% change in taxation on the profit make the difference between investing and not.

The evidence for the UK's decline in competitiveness is that India and Russia have now overtaken it in a survey of investor preferences by Ernst and Young. Surely there are bigger trends responsible for that change than the UK tax level?

Tax arguments in general are very weak grounds for talking about economic growth and business performance. It reminds me of the old IR35 argument. When people structure their companies around tax breaks, to hang onto an extra 5 or 10% of the cash they take out of the business, they often lose focus on the real opportunities to make more money - which come from transforming the effectiveness of your company through structure, invention or skills. A well-run professional services business should generate growth opportunities of 20-40% a year, which easily outweighs any tax advantage gained by manipulating the form or ownership of the business.

Special pleading from business lobby groups about factors external to your company is not the way to make your fortune. Working on what happens inside the business is.

In other budget news, two interesting points:

30% of government procurement is to go to SMEs in the next five years. At least, an committee is going to advise on the practicality of this goal. I think this is a great opportunity and an excellent way to stimulate overall economic competitiveness. SMEs do have some work to do on this, as the business will not fall into their laps by right, but this kind of carrot is just what will incentivise them to introduce sufficient discipline to their marketing and operations to be able to deliver larger contracts.

There will be a 20% increase in the funds available through the small firms loan guarantee scheme. Also, eligibility requirements will be relaxed and the Enterprise Capital Funds (government-backed mezzanine VC funds) will be expanded. A tricky one this - I said above that capital incentives are not a good way to stimulate productivity and competitiveness. However if we are going to have incentives, they are much better spent at the level where they may make the difference between a new business being started and not - since it seems clear that the rate of new business foundation is closely related to the level of innovation in the economy, which in turn correlates with overall competitiveness.

In classical economic terms this should not make any difference - if the business is going to make a positive capital return, someone will start it up anyway. However there are two reasons why the government may want to make an intervention here:

  • The capital market for SMEs may not be a classical economic market - some of the actors may be, strictly speaking, irrational. If this is the case, the (wise, enlightened) government may have a case for intervening. But a more compelling argument is:
  • There is a clear positive externality in the founding of a new business, going far beyond the return on capital investment to its owners. Some of this is in the increased economic activity from employment and purchasing by the business, and indirect stimulation of economic effects through the services it provides, all of which increase taxation revenue. The more important effect is in the introduction of new ideas into the economy. If a business brings a new operating model, a new process or an invention into being which would not otherwise occur, it will inevitably be copied or emulated by others. This does not provide a direct return to the owners - it may indeed produce a negative return for them - but it can have a transformational effect on the economy as a whole. Naturally we don't want to propose large-scale intervention to artificially create new businesses, since asymmetric returns (high upside, limited downside) means that capital will naturally be invested into innovative ideas anyway; but the externality argument must shift the balance at least a little towards state intervention.

As you would expect from a budget, the effects are mostly macroeconomic and so the subject of this blog - effective structures to use in individual organisations - is not directly addressed. But there are always influences between macro and microeconomics - remember neo-classical endogenous growth theory? This Government has often been accused of meddling in the details at the expense of economic efficiency, but I think this Budget finds a good balance.

Tuesday, 4 March 2008

Unusual structures for professional services

In my last article I looked at typical structures for professional services firms, and why you would want an explicit structure at all. This time I’m examining some less common structures, which nevertheless work very well for some of the firms that have adopted them. Each of these is based on a specific company that we work with, so we know that these models can work in practice.
  1. Bespoke consultancy with process-driven units
  2. Bespoke consultancy with product joint ventures
  3. Fully productized firm
Bespoke consultancy with product-driven units

This firm has evolved from a consultancy providing expert services on a project basis. Having noticed that there was a high demand for a certain specific service, the firm made the effort to analyse the structure of the service and turn it into a standardised range of four products. Each of these can now be offered at a fixed price (with discounts for high-volume clients) and each of them triggers a particular well-documented process.
These processes divide up into a series of specialised steps which can each be carried out by dedicated administrative staff – freeing up the expert consultants to do deeper, more original work. Customer support for the product offering is provided by specific people who know the nature of the products intimately, and usually are actually better at that job than the experts would be.
The bespoke consulting part of the business still exists but the product part is able to handle much greater volume than the consulting unit. The structure therefore contains:
  • Consultants/experts
  • Product delivery staff (subdivided into four different roles)
  • Customer support
  • Process managers
  • Business development
  • Finance team
Bespoke consultancy with product joint ventures
A similar firm which has taken a different route to scalability. In the bespoke business a number of prospective clients had good ideas for projects but without the corresponding capital to invest in them. Therefore the consultancy took the decision to invest its time in the projects in return for an equity stake and revenue share.
Three projects took off and in each case a core product was built. The clients and the consultancy each have a stake in the product, with the clients broadly responsible for sales and marketing, and the consultancy responsible for delivery and support. These latter two are resourced from the core operations team within the consulting business.
The bespoke side of the business continues and is structured as follows:
  • Sales and marketing
  • Operations (delivery and support)
  • Finance/admin

with the joint ventures acting both as an intellectual property holder and an outsourced sales force.

Fully productized firm
In some cases the firm moves away from bespoke service provision altogether and packages all its services into standard products. In many cases this occurs where a law or accountancy firm has a strength in one area such as will writing, trademark applications or company registration, and finds it useful to package that service. Packaging provides:

  • The ability to develop and practise a reliable, efficient process – because every delivery is the same, so you practise doing the same thing hundreds of times
  • Predictable fixed pricing for clients
  • Downskilling – the option to hire less qualified (and less expensive) people to handle repeatable work
  • A simple business model that is easy to plan
  • Lower operational risk

Margins on a single job tend to be lower, because price becomes one of the firm’s differentiators from its bespoke competitors, but the volume can scale up vastly.

The roles within such a firm tend to become dominated by sales and marketing and administrative staff, with fewer if any specialist consultants. If there is a consultancy role it is associated with designing new products and refining the existing process. Often this is the role taken by the founder who may originally have been a solicitor or accountant:

  • Sales and marketing
  • Process/product designer
  • Operational administration
  • Financial and other administration

What is the best structure for a professional services business?

Most professional firms start out with one or two people. If they are successful in winning enough business they may take on more, whether another fee-earner, a PA or administrative person, an IT or other support person, and perhaps even someone responsible for sales or marketing. When there are only a few people in the company, the relationships and systems don’t matter too much – everyone pitches in and does their best to help the company grow. What’s important is cashflow, customer service, and the distinctiveness of the firm’s offering.
But as you grow to a team of ten people or more, it starts to become important how this group is structured. So what does ‘structure’ mean?

According to the dictionary it is:
  • An arrangement of parts to make a whole
  • A repeatable or standardised way of breaking down an object into its components

In a business that means:
  • What different roles are there in the company
  • What business processes do they follow
  • How clear is the information that flows in and out of each role
  • Who is accountable for what
  • And ultimately, how predictable is the activity of the business?

These questions are especially critical for knowledge businesses. In a manufacturing or retail business the structure is more clearly forced upon you by the nature of the work you do. In a knowledge business, work can be very fluid unless you make the effort to define it.
  • Structure provides the following benefits:
  • You can reuse knowledge or skills developed on one project, across other projects or clients
  • Staff know what’s expected of them, and can improve their performance accordingly
  • The company’s performance becomes predictable. That in turn means:
    • Customers know what to expect and are therefore more able to buy from you comfortably
    • You can make investment decisions knowing what the return will be – this lets you grow the business
    • Your stress is greatly reduced

And so, the structure you choose for your business makes a big difference to how well it performs.

What are typical structures for professional services firms?

Partners/managers/administrators (common among accountants). Administrators handle routine work such as billing and reception; managers handle the bulk of fee-earning work such as preparing accounts for clients, or doing tax analysis; and partners oversee the work of managers, work with key clients, and carry out sales and marketing. In law firms the manager role is often called ‘associate’ but the structure is the same.

Account handlers/studio/finance (common with design firms). Account handlers act as the front-end interface with clients, winning new business and receiving client briefs. The studio delivers the actual creative work – often the studio itself is structured into a manager and staff, sometimes with a split between creative and production work, and sometimes with a planning person who schedules the work of their colleagues. Administrators handle billing based on timesheets, and other routine matters.

Expertise units. In larger firms particularly, there will often be a structure of teams which have expertise in particular areas – in a law firm these may be employment, commercial, litigation and property while in an accountant it may be tax, corporate finance and compliance. In these cases the partner/manager/administrator structure may be repeated within each team, often with the administrator resource shared between teams.

If the firm is big enough there may be teams focusing on industry sector groupings of clients. For example a team for pharmaceuticals, a team for petrochemicals and a team for finance. Again within these teams the partner/manager/administrator model is often used.

A structure that’s common within other businesses but less so in professional services is a split between business development, finance and operations. One team or person – business development – is responsible for the public visibility of the company – branding, generating new business, and perhaps negotiating with clients. The operations team delivers the work once a contract has been won by the business development function. And finance bills for it – often the financial role is responsible for support functions such as IT, facilities management and procurement. The closest analogue to this in the majority of professional services companies is the account handler/studio/finance model of the creative industries. However account handlers don’t usually see themselves as being in a marketing role – they often make a contribution to the creative strategy of the client and perceive that as being the main added value of their work.

A business such as a software or IT firm may be structured around a split between delivery and ongoing support. Certain people may be responsible for the specification and building of an initial piece of work, which is then handed over to others to support and maintain. These businesses can also have a marketing and a finance function, but the distinctive feature of the structure is the difference between the need for a big, short-term team to deliver a project and the need for a stable, efficient resource to provide ongoing support.

More mature businesses may have a specific function for the development of intellectual property. Again in a software firm, there can be a clear division between product development (IP), implementation (delivery) and product maintenance (support). Larger management consultancies may have an IP function but it seems rare for midsize professional firms outside of the technology field.

Business development/project manager/technical lead/resource. Often in an engineering company, there will be a specific role of project manager. This person typically acts as the lead and main client contact on a project, sets and communicates schedules, and checks progress internally. A technical lead is responsible for designing the solution for each project and usually for passing on that design to the resources, who implement it under the joint supervision of the technical lead and project manager. Business development is usually a separate function which may be assisted by the technical lead from time to time; finance and administration is also usually separate. Perhaps businesses which have distinguished the roles within their delivery team to this extent are more inclined to clearly separate the other roles.

So what other structures are there, and which of these is best? Naturally the answer will depend on the details of each business – there are good reasons why one system is used by accountants and lawyers, and another by creative firms. But have you considered all of the above models in your business and made a clear decision for one over another? Or have you just fallen into the default model for your industry?

I’d like to know what models you use in your own company and why you’ve made that choice. I’m also particularly interested in unusual models which do not fit into the classification above. I have a few examples which I’ll write up in a future article.