The management consulting industry in the United States brought in $228 billion in fees in 2017 according to IBIS World. Yes, that is $billion, not $million. The largest percentage of this figure, 38%, is from corporate strategy consulting. The next largest percentage of the $228 billion is for sales and marketing consulting at 19.5%. In 2017 there were about 707,000 consulting firms in the United States. There are twenty or thirty very large consulting firms like the Big 4 accounting firms, McKinsey, Booz Allen, etc. but most of that 707,000 are very small consulting firms with less than ten people or even sole proprietor shops with just one person.
If you are a buyer of consulting services, how do you pay your consultants? Conversely, if you are a consultant how do you charge your clients for your work? I think this is an important topic. The following statement is based on anecdotal evidence, not hard data: I believe that a good percentage of the work behind the $228 billion billed in 2017 did not produce tangible results for clients. I have been told this by numerous business people over the years and have read this opinion in the business press as well. Sure some good things were accomplished in this work, but not measurable and tangible results that were greater than the fees collected. This is the definition of creating value for the client in consulting work. What is your opinion about the shortfall in tangible and measurable results?
In general, there are two major models for paying consultants today: fixed fee and pay-for-performance. By far the most prevalent is a fixed fee arrangement. Here the consultant agrees to a fixed budget within a specified time period to achieve the “deliverables” in the proposal and contract. For example, the consultant has agreed to be paid $30,000 to plan and run a strategic planning retreat and that she/he will finish all work within two months of the start of the project. There is also a variant of the fixed fee model that is practiced by some of the elite strategy consulting firms. Here, the budget of a project is totaled and then an amount is added to this for a portion of the “future value” the work of the project is expected to produce. Notice this is added now for results that may or may not happen in the future.
The other, but far less used approach, is the pay-for-performance model, which also has several variants. Here the consultant works with the client to jointly achieve specific measurable outcomes within a range of acceptable time horizons. If the measures are not achieved, the consultant does not get paid. For example, here the consultant would contract with the client to say help increase sales by x%, operating income by y%, reduction in inventories by z%, etc. The time horizon would be no greater than say eighteen months. If at the end of that time period the results are not achieved the consultant does not get paid.
I have been a strategy consultant for 35 years, interspersed with assignments as a professor of strategy at three business schools. I believe consultants should be paid via the pay-for-performance model wherever possible. Many of my consultant colleagues just had a mild palpitation reading this. But I believe the consultant should have enough confidence in his or her knowledge and how this knowledge is applied for the client’s benefit and results to use this method where possible. Why would every firm not want to engage consultants in this manner? The main reason is that the consultant in the pay-for-performance model can earn much more in fees relative to a fixed fee arrangement. The pay-for-performance approach is really a form of “gain making-gain sharing”. If the project produces results in excess of that which was planned, the consultant shares in those gains. Many firms would rather pay a fixed-fee and manage to those known costs.
However, many consulting projects are not amenable to the pay-for-performance model, but it is the model I think consultants should aspire to. I predict by 2025 more and more projects will be sold and delivered as pay-for-performance assignments. The main reason is there are too many consultants in my view and some will move to a pay-for-performance model to differentiate their firms. Also, clients deserve and will demand consultants who will share the risk of the project not producing tangible and measurable results.
Let me give a quick history lesson of how one firm pioneered the use of a pay-for-performance model and why this worked. I will also then discuss where the pay-for-performance model cannot and probably should not be attempted to work.
In 1996, I was honored to be hired by the Thomas Group, then one of two leading Operations Excellence consulting firms in the U.S., with some international reach as well. Phil Thomas was a physicist for Texas Instruments and took principles in semiconductor chip manufacturing and applied those to the operating processes of for-profit firms. I was hired to help develop a strategy consulting practice that would bolt on to the very rich disciplines and tools for operations excellence. The key metrics were cycle-time and re-work reduction in the operating processes of the clients’ firms. Cycle time is the speed of the process. Re-work is just that, how much work in the process had to be re-done because of barriers, mistakes, etc. By operating processes, I mean supply chain, manufacturing, sales, new product development and even after-sales service to name a few. A process is a group of activities that run a cycle and then run that cycle again and again. Think of a car manufacturing process. The line is run to say produce 100 cars a day. At the end of the day, the process is shut down, maintenance might be applied and then the next morning the process starts its cycle again. So a process is very different from a project, which has a distinct start and finish and then it is over.
Phil developed the methodology to measure cycle time and re-work reduction meticulously and chart these reductions over a month’s time on what were called “Cockpit Charts”. Everyone could see the lines moving in the desired direction or not. Here was Phil’s genius: in the early years of the Thomas Group, 100% of the possible fees were at risk. Phil would contract for improvement of only one or two processes at a time so that everyone could focus. Each process cycle time and re-work were measured “at baseline” and the improvement goals were determined and contracted for. Say the baseline measure of the sales process was twelve months with a re-work percentage of 30%. The improvement target might be to cut the cycle time to six months with a re-work percentage of 5%, and all of this would be accomplished within fourteen months. If the teams did not accomplish these goals, Thomas Group did not get paid. By the time I was hired, Thomas Group had switched to a 50% fixed fee and 50% pay-for-performance. But the courage to share risks and rewards with the client was still in effect.
Where else in the consulting industry could the pay-for-performance model be applied? I think in any client firm that has clear processes that can be mapped and improved is one. I also think smaller firms that are not multi-business corporations are another. Here one can get one’s arms around the entire business and not be distracted by the inputs from a corporate headquarters that uses transfer pricing between and among business units and other extraneous factors that come into play. These cloud cause and effect relationships.
Where should the pay-for-performance model not be used? In any case where the cause and effect relationship between what the consultant does and what happens with respect to results is obscured. Here you cannot tell if results were gained by the consultant’s work and project, or by some other happening inside or outside of the firm. Here are some of the types of consultant engagements where the pay-for-performance model would not work:
- Facilitators – these consultants plan and execute limited scoped kinds of projects, planning and running key meetings like a strategic planning retreat, etc.
- Educators – these consultants, usually academics, bring knowledge in the form of training when and where it is needed.
- Coaches – these consultants usually work with single executives or managers to shore up weaknesses that are hindering their careers. The coaches hold these executives or managers accountable for weekly to-do lists of things that will improve the weaknesses.
These kinds of consultants should continue to work in a fixed fee type of arrangement as the cause and effect relationship of their work to measurable results is most times lacking.
I guess we will have to wait to see if my prediction of more pay-for-performance work being done pans out by 2025. This is an important topic in that if this prediction holds, I think we will see some consultants exiting the industry rather than trying to perfect a pay-for-performance approach.
This article is part of a series on what causes a firm’s value to increase.
Dr. William Bigler is the founder and CEO of Bill Bigler Associates. He is a former Associate Professor of Strategy and the former MBA Program Director at Louisiana State University at Shreveport. He was the President of the Board of the Association for Strategic Planning in 2012 and served on the Board of Advisors for Nitro Security Inc. from 2003-2005. He has worked in the strategy departments of PricewaterhouseCoopers, the Hay Group, Ernst & Young and the Thomas Group. He can be reached at firstname.lastname@example.org or www.billbigler.com.