How Partner Compensation Affects Strategy in Professional Services Firms

The way the partners are rewarded in professional services firms can have a dramatic effect on the development and, more importantly, the implementation of their strategic plans.

Why?  Because in the same way that ‘what gets measured gets done’, ‘what gets rewarded gets focused on’.  The reality is that the two – measurement and reward – run hand in hand. Consequently. getting both correct is critical to the success of the firm’s strategic plans.  Information about which activities are most rewarded affects the firm’s culture. Importantly, it also influences how partners choose to spend their time.

While this is true to some extent in all businesses, it is particularly problematic in the professional services sector. This is because the responsibility for the management and development of the business lies in the hands of the same people who are responsible for delivering the service. This dichotomy, along with its issues and possible solutions, are discussed in the following articles:

“The Unique Challenges of Developing Strategic Plans for Professional Partnerships” and

“Creating A Better Business Structure for Professional Partnerships“.

How reward systems affect the performance

This article looks at how reward systems affect the performance of a traditionally structured professional services firm.

In many professional firms, the billable hours are the primary measure of performance. This is because they are considered to be directly proportional to the revenue earned. Conversely, time not spent on billable work is seen as wasted.  However, such methods fail to reward many important non-billable work that can’t be easily measured. Time spent on non-billable work could, for example be spent on improving the efficiency of the business. While the time spent on this can’t be charged out, it will result in better performance which will have a positive impact on the bottom line.

Focusing on billable hours creates a short-termist philosophy in the firm. This often results in many people adopting an “I will look after myself and to hell with everyone else” attitude.  This means that there is little or no focus on the future. Consequently, these firms tend to lack direction and structure. This can have a negative impact on the firm as a whole as people end up pulling in different directions, In addition, there is little or no cross-functional cooperation.  The net result is that the firm does not achieve its full potential, Consequently both the firm, and therefore the partners, make far less money than they are truly capable of.

Another consequence of this type of structure and reward system is that partners are reluctant to take responsibility for managing their team. They also resist taking on a larger managerial role in the business as a whole. The reasoning is that this would take time away from their ability will do billable work, This in turn can have a negative impact on their reputation within the firm and perhaps even in their remuneration.

Solving the issues.

These issues can be solved by aligning the firm’s compensation system to its strategic objectives. This means rewarding non-billable time that is spent working on the activities that are important to implementing the business plan.

When designing the firm’s compensation system, it is important to strike the correct balance between recognising billing performance and the contribution to the firm’s future.  For example, if the strategic plan sets the objective of getting the name of the firm known in a particular target market, then people should be a recognised for undertaking that activity. If this is not done the message delivered to partners is that the activity is not valued so they will not pursue it.

In fact, non-billable time spent by partners and fee-earners often impacts the success of the firm’s strategic plan.  Every partner and fee-earner will have non-billable time. The key question is how do they spend it? They should be encourages to spend it constructively, helping to develop the firm.

Examples of this type of activity includes the following:

• Researching future client needs,
• Developing new services that meet client needs
• Improving administrative systems
• Developing their professional skills
• Training junior staff, etc.

Adjusting the compensation system

It is important to note that as professional firms grow, individuals will tend contribute in different ways. As a result, the compensation system needs to be capable of being adjusted on a partner by partner basis.

For example, more emphasis will tend to be placed on billable hours for newer partners while more experienced partners will tend to have more weight placed on business development and management activities.  It should, however, be noted that this is not a hard and fast rule, It is possible that some new partners will have a natural ability to generate new business so their compensation should focus on that strength.

Furthermore, different groups of professionals might have different goals (see our article entitled “Practice and Sector Focused Strategies In Professional Service Firms“). Therefore, the compensation system may have to be adjusted to ensure that it is aligned with the different strategies employed by each group.

Summary

In summary, a firm’s performance measurement system should be aligned with its strategic plan. This clearly communicates the value the firm places on achieving its objectives and goals. In these circumstances the partners and senior fee-earners will be more likely to share in the firm’s vision, align their actions with the firm’s objectives. They will also be more willing to share their knowledge and expertise. In this sense, the compensation system can affect a firm’s strategic direction.

Measuring the Results of Strategic Activates

Creating a new strategy for your business almost always results in introducing new ideas, initiatives and change. Measuring results can help people embrace change. Naturally, there will be people who are sceptical about the changes that are being made.  Some may even be resistant to the change.

This does not mean that people are being deliberately difficult or obstructive.  Think about it.  If you have been doing something a particular way for years and someone comes along and tells you to do it is a very different way your natural reaction will be to be sceptical.

When people can see positive outcomes from their actions and activities, they will be more likely to buy in to the changes that will inevitably result from the introduction of a new strategy.

Creating and implementing a comprehensive measurement system that enables people to see the results of the new ideas will help achieve this.

What is the SMART Criteria?

SMART is an acronym for Specific, Measurable, Achievable, Relevant and Time Bound. It is most often used to guide the setting of objectives and goals.

The principal advantage of using the SMART criteria when creating outcomes, objectives and goals is that it adds clarity. This means that they incorporate all of the necessary criteria required to help focus efforts. This increases the chances of achieving them.

There are many variations of the SMART acronym. This creates confusion and unnecessary complexity which makes it difficult to apply in a consistent manner.  For the sake of clarity and simplicity, we will stick to the original definition. George T. Doran first introduced this in the November 1981 issue of Management Review. The title of the article was “There’s a S.M.A.R.T. way to write management’s goals and objectives”.

Specific:

Clear and well-defined goals that explain the importance and method of accomplishment are essential to ensure everyone involved knows what the goal. This means that the SMART goal should unambiguous so that there is no room for confusion or misinterpretation. A specific goal should answer the questions “What?”, “Why?” and “How?”. As a result,  the goal is precise so everyone involved knows why it is important and how to accomplish it. By making goals specific, individuals and teams can focus their efforts and resources on the most important tasks. This which can increase the likelihood of success and improve motivation and commitment to the goal.

Measurable:

Measurability is an important concepts in the SMART criteria, as goals or objectives need to be measurable to track progress and evaluate success objectively. This means that specific criteria must be included in a goal. As a result, SMART measurements can be used to evaluate progress and determine whether the goal has been achieved. Measurable goals can help to motivate individuals or teams by providing a clear sense of progress and accomplishment as they work towards the goal. Measuring progress can also help to identify areas for improvement or adjustment, so that individuals or teams can stay on track and make necessary changes along the way.

Achievable:

Achievable refers to the concept that a SMART goal is realistic and attainable given the available resources, knowledge and skills. In other words, it should be possible to achieve the goal without requiring extraordinary effort or a significant change in circumstances. The SMART criteria’s Achievable element ensures that the goals can be accomplished within a reasonable timeframe. It also means that they are practical enough to be achieved with available resources. This can increase the likelihood of success and improve motivation and commitment to the goals. An achievable goal can be challenging but not so difficult that it becomes impossible to achieve, demotivating or discouraging for the individuals or teams working towards it.

Relevant:

Relevant refers to the concept that a SMART goal is important and aligned with the broader objectives of the organisation. This means that the goal should have a clear purpose and be relevant to the current needs or priorities of the organisation. In other words, it should make sense within the context of the organisation’s overall strategy. It should also help move the organisation closer to achieving its overall mission and vision. Setting SMART goals ensures that they are relevant. This means that organisations can prioritise their efforts and resources on the things that matter most. As a result, it can improve efficiency and effectiveness.

Time-bound:

The concept of having a specific timeframe or deadline for completion is what this element of the SMART criteria refers to. This helps to provide a sense of urgency and motivate individuals or teams to take action towards achieving the goal. By setting a specific deadline, individuals or teams can focus their efforts and prioritise their tasks. It also ensures that the goal is completed on time. The time-bound element of SMART goals also make it easier to track progress. This allows adjustments to be made along the way, as there is a clear endpoint in sight. Additionally, setting specific deadlines can help to avoid procrastination and increase accountability. This is because individuals or teams know that they are working towards a specific timeframe.

Summary

The SMART criteria is a useful framework that can be used to set effective goals and objectives. By making sure that goals are Specific, Measurable, Achievable, Relevant and Time-bound, individuals and organisations can improve their chances of success and increase motivation and accountability. Setting clear and actionable goals is important for any individual or organisation that wants to achieve its desired outcomes. Using the SMART criteria can help to ensure that everyone involved knows what they are working towards. It also allows progress to be tracked and evaluated effectively. Overall, the SMART criteria is a simple and effective tool that can help to drive success and progress in any setting.

The Unintended Consequences of Setting Performance Targets

Setting targets and subsequently measuring performance against those targets is a common management practice in many organisations.  When done properly it can be an effective way to motivate people to deliver a level of performance that is required by  the organisation.

You should, however, be aware that this practice of using performance targets as a way to motivate people to take the actions that are required by the organisation can back-fine and can have the opposite effect – making performance worse rather than better.

This happens when people take actions to attain the targets they have been set that are not aligned with their intended purpose.  This is best explained using an fictitious example:

A consultancy company is made up of a number of teams and each team has responsibility for delivering financial results (sales) in different markets.  Each team is made up of a senior consultant, one or two consultants and up to four junior consultants.  The nature of the business is such that each team works in a specialised area of consultancy but there are often opportunities to refer work internally to teams with expertise in areas that their clients need.  The work done by the junior consultants tends to be research-based and while they work primarily for a specific team, they can be utilised on projects  managed by other teams within the organisation.

The management decided to set each person an individual billing target, as well as setting a billing target for each team.  These targets were based on the one-third rule whereby the target is made up of 1/3 their salary, 1/3 to cover overheads and 1/3 profit.  The results were closely monitored and remuneration was directly linked to their attainment.

While this may seem like a perfectly logical (if simplistic) way to encourage people to perform to a desired level and achieve the financial results that they required to generate a profit for the business, the reality was very different.

An analysis of the business found the following issues in the business:

• Poor profitability
• Large variation in individual performance levels
• Low levels of internal referrals
• High levels of staff turnover, especially at the junior level

Further investigation found that the primary causes of these issues included the following:

• Work being done at the wrong level (i.e. senior people doing work that could be done by more junior people) as a result of poor delegation
• Low value work being done (made worse by the above issue)
• A ‘my client’ attitude resulting in a reluctance to refer work internally

Deeper investigation revealed that the root cause of these issues was the performance targets that had been set.  These targets meant that senior consultants tend to keep work to themselves rather than delegating as much as they should which means that the low value work is bring done by the people who are being paid the most, leading to profitability being lower than it should.  The lack of delegation also means that more junior staff are not getting work that will help them to develop resulting in them leaving and hence the high level of staff turnover.

In order to fill their time and in an attempt to reach their targets, junior staff take on/are given low value work that is not profitable and, in some cases, run at a loss.

It also results in people being unwilling to look for opportunities for others within the company as they are afraid that the work will not be done to a sufficiently high standard and may result in problems with their client.  The net result is that the company suffers as they are losing the opportunity to sell more services to the client and the client suffers because they are not been given the most holistic advice/service from the company.

The solution to these issues was to change the way in which targets were set and what was measured.  Instead of measuring billing (which is effectively turnover) they measured profit.  Instead of setting targets for individuals they set profitability targets for the team as a whole.  In addition a new target was added for each team – resource utilisation.  This measures the extent to which the time of each member of the team is utilised for the benefit of the team and, consequently, for the company as a whole.  In addition new metrics and incentives were introduced to encourage the referral of work among the teams within the organisation.

Hopefully this relatively simple example gives you so idea of how setting targets to drive a certain behaviour can result in a completely unintended set of behaviours.  When developing any target-driven performance system you should consider the following:

• What behaviours are you trying to influence – in other words, what outcomes do you want to achieve?
• Is setting performance targets the best way to achieve the desired behaviours?
• What targets are most likely to result in the desired outcomes being attained?
• What incentives should be put in place to encourage the performance targets to be met?
• How might the performance targets be manipulated?
• How might the performance targets and incentives drive unwanted behaviours?

When the proposed performance system has been agreed it should be tested on a small scale if possible in order to identify any flaws before it is implemented company-wide.

Once the new system has been implemented it should be carefully monitored to ensure that it is creating the desired outcomes.

 

How The Balanced Scorecard Helps Implement the Strategic Plan

Implementing a strategic plan can be a complex process, involving many components, both inside and outwith the organisation.  This includes the management a number of groups of people (including managers, employees, shareholders, other stakeholders, etc.) who will have an interest in the performance of the business.

In addition, the plan will include projects and activities that need to be management, as well as possible changes to culture, processes, procedures, and much more. Furthermore, strategic plans are often “based on assumptions that are often wrong and, as a result, the strategy has unintended outcomes that could be potentially damaging to the organisation” (see our article entitled ‘Prescriptive Vs Emergent Strategies‘).

Performance measures

With so much going on, it is essential to have systems in place to measure the results of strategic activities. These systems will test strategic assumptions, monitor the outcome of strategic activities and projects and provide information to the organisation’s various interested parties.

The problem is that measuring performance has a cost associated with it (relating to data capture, analysis, reporting, etc.) so there is a tendency for an organisation to try to develop a generic set of performance measures intended to satisfy these disparate groups and their differing requirements. The danger is that such an approach produces a generic set of performance measures that are not linked to the strategic plans and consequently do not provide any information that helps with the implementation of the organisation’s strategy.

What is required is a cost-effective approach that can be adapted for the different needs of the different groups and is integrated with the organisation’s strategic plan. The Balanced Scorecard provides such an approach.

Performance measurement and feedback

At the operational level, feedback on performance is required for managers and staff to allow them to link the service results achieved to the implementation of service plans, often on a day-to-day basis. Differences, or deviations, between actual results and those planned need to be identified and acted upon. These performance measures are largely required for control purposes: controlling performance and service delivery to meet standards, targets and objectives.

A feedback loop is also required to the service planning stage so that both management control and management learning can take place. Management and organisational control links to continuous improvement, so that in the next planning cycle learning and experience from the last set of planned and achieved service results can used to improve performance further.

The same control and learning feedback must also occur at corporate level so that progress on corporate goals can be reviewed. In addition, the continuing appropriateness of these goals can be assessed and informed decisions can be made about priorities and resource allocation.

What are the wider issues in performance measurement?

There are a number of wider issues relating to effective performance measurement:

• Performance measurements need to support organisational learning so as to contribute to the continuous improvement approach required of any organisation’s performance. Managers and staff need to be able to use performance information to help them do better next time.
• Achieving service quality is about more than performing well financially or delivering at minimum cost. There is a need for a balanced set of performance measures across all aspects of performance. Whilst the financial performance perspective is, and will continue to be, critically important, measures of customer satisfaction, service quality, and effectiveness are also required. Such measures must relate to the overall strategic direction that has been set and that they provide a comprehensive view of performance.
• Managers, and stakeholders, will inevitably have to make subjective decisions about trade-offs between different aspects of performance. Improved financial performance- lower unit costs for example – may be at the expense of improved service quality. This needs to be explicitly recognised and accepted. However, such decisions should be based on reliable and appropriate measurements so that managers and stakeholders can assess to what extent improvements in one area may have been achieved at the expense of another.
• Given the potential plethora of measurements that might be collected at different levels and across different services, there is a need to focus on a ‘favoured few’.  Over-detailed reports of performance measures distract managers from seeing patterns and major interrelationships.

What is the Balanced Scorecard?

Measuring performance is critical to the efficient management of any business. It is, however, important that the correct performance metrics are being measured.  Information relating to the performance of the organisation is, therefore, a key management tool. for many areas of the business. This includes planning, resource management and strategy implementation. For further information see our article entitled “Prescriptive Vs Emergent Strategies”.

Financial measurements

Historically the focus of performance measurement has tended to be primarily on financial measures. These include profit, turnover, ROI, actual vs budgeted expenditure, cost ratios, etc.  The main reason for this is that there are legal obligations to report some of these measures. In addition, investors tend to want to know how the company is doing from a financial perspective.  These measurements tend to be historic and, therefore, backward looking – telling how the organisation has done in the past.

On their own, these measures are inadequate since they fail to measure how the organisation is performing in terms of its operational goals and strategic goals.  Consequently, an effective performance measurement system needs to include forward looking elements. It should be directly linked to the organisation’s strategic plan. This provides the information that will help the organisation gauge the outcomes of the strategic activities . In addition, it shows their impact on the organisation’s ability to attain its strategic goals.

Effective performance measurement

Effective performance measurement cannot, therefore, take place in isolation. It must relate directly to the overall strategic goals as wells as to the key activities undertaken to achieve these goals. A measurement system needs to be able to track overall performance so that managers are able to gauge what progress they are making in achieving these goals.  The Balanced Scorecard provides such a system.

The Balanced Scorecard

The Balanced Scorecard is measurement system originally developed Kaplan and Norton. It provides managers with a comprehensive and timely view of an organisation’s performance Importantly the measures are linked to the organisations its long-term strategic goals.

This is achieved by first identifying the key activities (projects, actions, etc) that are critical to the attainment of the organisations goals. The scorecard then measures the outcomes of these activates in order to measure their effectiveness. It also measures the degree to which they are helping the organisation attain its strategic goals and vision.

In addition, they can provide an early warning system that tells management that some of the activities are not producing the expected results.  This allows management to examine the reasoning and/or assumptions on which the activities are based. As a result, corrective action can be taken before the situation becomes untenable.

Originally the Balanced Scorecard established measures across four inter-related perspectives. These were the customer, internal business processes, continuous improvement and financial performance. Additional perspectives could be introduced depending on the specific needs and situation of the organisation.  Examples of additional perspective may include a people perspective, an environmental perspective, etc.  I tend not to get too caught up with the idea of perspectives. A perspective is just a name given to a grouping of related measurements.

A better approach

A Balanced Scorecard approach is thus intended to supplement traditional financial measures of performance. It adds measures that assess performance from the additional perspectives that are aligned with attaining your strategic objectives and goals. Developing a comprehensive set of performance measures across and between different perspectives enables an organisation to monitor its overall strategic performance.

If you try to follow the idea of having pre-defined perspective too strictly, you can end up trying to force square pegs in to round holes.  It is, therefore, not what perspective you use but rather how you identify the perspectives and the measurements that relate to them for your organisation and more specifically for your strategic plan.

It is important to realise that the Balanced Scorecard should not be restricted to use at the organisational level.  The scorecard can be adapted for use at different levels in the organisation as well as individual parts of the organisation. Individual scorecards should be linked to each other using the strategic plan as the glue that binds them.

How a Firm’s Remuneration System Can Impact Attaining its Strategic Goals

In many professional services firms their partner remuneration is often based on their personal performance rather than the performance of the firm.

There are four main ways in which a firm’s compensation system can support the its strategic plan.

First, the remuneration and profit-sharing system can help to create a common understanding of the direction in which the firm wants to go. Secondly, it the can support the firm’s strategy by identifying and rewarding those who create value that supports the strategic plan. Thirdly, it  can encourage partners and fee-earners to take action to help differentiate the firm from its competitors.  Finally, a well designed compensation system can help the firm to achieve its objectives by rewarding the implementation of key strategic activities .

Professional firms need a system for dividing and distributing its profits. It is important that this system is aligned with the firms strategic plan and goals. The difficulty is that many partners are not motivated solely by money. Consequently, it can be difficult change a partners behaviour through the compensation system alone. This is because the reward may not be enough of a motivating factor.  The compensation system can, however, give partners a clue to what behaviour the firm is seeking from its fee-earners. This is because changes in the behaviours that are rewarded can send a message to the partners about where their focus should be. It also shows what specific performance and behaviours are required by the firm.

Once a compensation system has been implemented, there is only one test it has to pass. Does it encourage the behaviours needed to successfully implement the firm’s strategic plan?  To apply this test, the partners have to understand what the measures of success are. They also need to know what skills and the behaviours are required to enable the firm to achieve its objectives. In fact, compensation decisions are an integral part of what defines the firm, its objectives and its strategy.

However, professional firms frequently fail to motivate partners to focus on behaviours that will help the firm succeed. This is either because the firm is rewarding the wrong aspects of performance, or because partners don’t understand what is being rewarded.  There is often a mismatch between what professional firms say they value in their partners and what they reward. The key is to ensure that the behaviour that is required to achieve the firm’s strategic objectives is understood. Consequently, the firm’s compensation system must reward and encourages the desired behaviours. This will help ensure partners take the actions they need to take to move the firm forward.

How do we Measure the Progress Towards Achieving our Business Goals?

Establishing goals is only part of the work in a business plan.

Once the goals have been explained to the employees and a plans have been developed to achieve those goals, it is important to review those goals at certain times during the year. A business manager needs to take a ‘time-out’ every so often and ask themselves the following questions:

• Is the business on target to achieve our goals?
• Is a course direction needed to get the business closer to achieving the goals?
• Are the goals still relevant with the ever-changing business world we live in?
• Are the employees still focused on helping the business achieve its goals?

The answers to these questions will help management decide if corrective action is needed. For example, if a business is not headed in the right direction, the manager might want to get all the employees together to review what is happening and make changes to help achieve the goals. Whether the management is good or bad, it still needs to keep the employees informed about how the business is performing and how the employees are doing with respect to the goals.