by L. Gary Boomer
Compensation of owners in a professional services firm has always been contentious.
Over the years, several trends have developed based upon the size of the firm. A new trend is developing that is an attempt to take the best from previous systems and blend it with new developments in firm management.
This method is generally referred to as the balanced scorecard approach. It is driven by the need to attain balance and accountability, and to promote teamwork. It requires vision, strategy and time in order to be properly implemented.
When most firm owners hear about the approach they get excited (in either a positive or negative way) about the potential. “How is it going to affect my compensation?” is the first and expected reaction. Few think about whether this is going to be good for the firm. This is normal and should not deter a firm from striving to improve.
Expect it to take some time and require several meetings addressing questions and selling the vision. It is important to understand the evolution of compensation systems in order to move to the next level. Peer firm experiences can also be very valuable and save time.
Motives in compensation
In speaking with partners from many firms, there are many common motives. While I understand the thinking behind them, I don’t always agree with the values that some firms are placing on them and the results the systems are producing.
A good question to ask is, “Who is looking out for the firm?” Some of the terms start to sound “bureaucratic” and subscribe to the “entitlement” philosophy. The following is a brief list of the most often stated motives:
- “Bottom-line” driven;
- Return on investment;
- To recognize seniority;
- One-firm concept;
- Objective versus subjective data (score with hard data);
- Leverage of resources;
- Integration with the strategic plan; and,
- Results-versus effort-based.
First, let’s review the various compensation methods and add a brief comment about each. There are many variations, so don’t be alarmed if your firm’s system is a combination of two or more of these methods.1. Equal: It’s easy, and promotes mediocrity in larger firms.
2. Formula: The more complex the better, in most firms.
3. Spreadsheet: This is based upon the paper-and-pencil method, just automated.
4. Managing partner decision: The CEO form of doing business.
5. Compensation committee: This works in large firms.
6. Points/units: This is used in very large firms.
7. Balanced scorecard: This is new to the professional services firm.
(See Box 1 on p. 25 for the most common usage of these systems.)
Most of these systems are associated with potential problems, and firms tend to stay with a system too long because of the fear of the unknown and change. Let’s quickly look at the potential problems associated with each type of system.
Equal: This system tends to work in newly created firms and those with three or fewer partners. The system tends to promote mediocrity as the firm grows. You also should remember that inequality comes from equal treatment of unequal people. This system can be very limiting to the growth of a firm.
Formula. The biggest risk behind the formula system is the fact that it often promotes the concept of sole proprietors sharing overhead rather than the one-firm concept. Partners may hoard work and not leverage properly. This system also tends to overcompensate for technical skills and places little value on firm management, leadership, improved processes, vision and learning.
Spreadsheet. The spreadsheet system is similar to the formula system with the exception that the spreadsheet allows for more complexity. Accountants like complex formulas that are difficult for outsiders to understand. Perhaps this comes from trying to get every owner’s positive attributes included in the formula. Firms need a strategic plan or shared vision in order to make this or any of the systems work properly.
Managing partner decision. In firms where there is a strong and visionary leader, the managing partner can successfully administer the owner compensation system. However, few firms are able to maintain this system. Typically, the MP does not have a book of business or chargeable hours when this system is utilized.
The compensation committee. This is an attempt at balance, or the managing partner may not want the sole responsibility for administration of the system. This system requires excellent communications and often comes into existence due to the perception that there isn’t any better system. The committee should be small and the managing partner should be a permanent member of the committee. The other members should be elected. Not all owners should expect to participate on the committee.
Points/units. This is the system that most large firms use, and is generally combined with the compensation committee. While the system may work, it has a tendency to overvalue technical skills and managed book of business. It can be the foundation for the balanced scorecard method, which we will discuss in more detail later.
One of the most disruptive results of all of the systems appears to be regarding the differences in compensation levels among owners, rather than the total amount of the compensation pool. Therefore, many firms have gone or are moving toward closed systems, where partners do not know each others’ compensation. Typically, owners can calculate approximate amounts in firms with a limited number of owners.
The balanced scorecard. While the newest system in the accounting profession, it is not a new system and has been employed in corporate America for over 10 years. The purposes of the balance scorecard are:
- To communicate strategy throughout the firm;
- To inform owners/employees of how they fit;
- To teach owners/employees to focus on what is important;
- To create control over life balance;
- To link firm and owners’/employees’ success;
- To provide feedback on a timely basis;
- To reward results rather than effort; and,
- To provide opportunity for success at all levels.
The scorecard is typically categorized into four categories: learning and growth, internal operations and processes, client development and satisfaction, and financial. The tendency of all companies that implement the balanced scorecard approach is to over-focus on the financial measures. Accountants know how to measure financial results but have trouble with the other three categories. Experts say that the financial results will come if proper focus is given to employee learning and growth, improved processes, and client development and satisfaction. Financial success is a result.By now you probably have several questions about the balanced scorecard.
What is it? Why are accounting firms interested? How do they use it? How do they implement it? We will attempt to answer your questions.
The concept was developed at Harvard Business School in the early 1990s by R.S. Kaplan and D.P. Norton. It is an organizational performance measurement system that has received widespread acceptance and is now being introduced into professional service firms. Some refer to it as a pay-for-performance system.
The steps to the process are to clearly define the business objectives and strategy, and then to communicate, measure, motivate and reward.
The obstacles are numerous. Accountants are notorious for being able to identify the obstacles, but they generally don’t take the time to develop the necessary strategies to overcome the barriers. Some of the more important obstacles are:
- Vision — the inability to see and communicate what the future will look like. In most firms, the employees fail to understand the business vision. It must be clearly and consistently communicated both internally and externally. Employees are the key assets in a knowledge-based business. Communication and understanding of the vision are the keys to successful execution. Strategic goals must be translated into tasks, performance standards and desired outcomes. It is much better for initiatives to be well-defined and consistently communicated.
People — the inability to attract and retain quality people. In today’s commoditized marketplace, quality people are becoming more difficult to attract and retain. Compensation must be linked to performance and performance measured correctly. Employees tend to focus on what is measured, particularly if it is tied to compensation. The key measurement in the accounting industry has been chargeable hours. Some will still argue this is a key indicator.However, a balance is needed among financial, training/learning, process improvement and client satisfaction-related initiatives. Compensation plans that reinforce the firm’s objectives are very important. The scorecard should be cascaded down to the individual level. Reward employees for creating value.
Caution: Start with the owner group before you apply the balanced scorecard to the staff. Wait at least one year before taking the system to the staff level. Get the problems at the owner level resolved first.
Management — the inability to focus on the business rather than simply working in the business. Where is management focused? What is being measured? These are key questions in aligning management and the strategic plan. The management team needs to focus beyond just financial results. While financial results are important, so are investments in training/learning, processes, technology and client satisfaction.With firms only averaging around 50 percent chargeable, there appears to be adequate time for the important initiatives. Management’s responsibility is to balance among conflicting priorities. Someone must provide the necessary leadership and discipline.
Resources — with limited resources, firms must focus on a limited number of strategic objectives and initiates. Often, firms try to do too much and accomplish very little. Resources must be budgeted and allocated in accordance with firm strategy. Without a firm strategic plan, firms often get caught in spreading too few resources across too many objectives and initiates. Long-term goals must be balanced with short-term performance. Many firms get caught in the trap of maximizing current profits while avoiding the necessary long-term investments in technology, re-engineered processes and training/learning.Unfunded retirement benefits based upon owner salaries can be a detriment to making the necessary investments. The firm should always come above any one partner’s compensation or retirement plan. Be careful not to allow senior partners to over-commit the firm to unfunded retirement benefits that are dependent upon future earnings. Everyone wants a great deal, but the firm must be able to excel and afford the benefits.
The balanced scorecard
A graphic of the balanced scorecard appears on p. 27. Note that vision and strategy are at the core with the four primary perspectives linked.Each perspective can be valued differently depending upon the firm’s valuation system. As a word of caution, make sure you give internal business processes, learning and growth, and customer satisfaction adequate value. We assume that they are part of your firm’s strategic plan. If not, then you will simply substitute your firm’s areas of strategic objectives.
Establish what you are going to measure and how you will measure it. Most firms are comfortable measuring lagging indicators (dealing with history). Leading indicators are just as important in managing a well-run firm. Indicators such as client contacts, number of proposals outstanding and absenteeism are leading indicators. Cause and effect are most important when dealing with leading indicators. Remember that goals are measurable, while slogans are not measurable.
If you think the balanced scorecard approach has value for your firm, you should get additional training and do some research. Once this is complete, you will need to make the decision to take action and obtain the buy-in of your partner group. This is never an easy task, as partners tend to resist change.
Their biggest question, even though they may not want to admit it, will be what effect it will have on their own salary. It will require a trial run to calculate what salaries would have been in the previous year if the system had been in place. Getting everyone striving for the same firm goals and completing their individual 90-day game plans will ensure success.
Alignment and consensus are big factors in determining success. It may require coaching from someone outside the firm. It is generally very difficult for the managing partner (or any partner) to change a firm’s compensation system. The saying that if you are part of a system, it is impossible to change the system, holds true. It requires objectivity, education and confidence to ensure success.
Tips on getting started
1. Start with your strategic plan — without a plan you will have a weak foundation.
2. Don’t start without the total commitment of the managing partner or CEO — leadership is a requirement.
3. Commitment is different than support — this is for all partners, not everyone but “me.”
4. Use a facilitator/coach — it will reduce time and increase partner confidence.
5. Start with the partner group — do not include the staff the first year.
6. Use progress reports and 90-day game plans to reduce time (simple tools to reduce management time).
7. Schedule quarterly meetings in advance — meetings scheduled in advance have more importance.
8. Insure performance funds — financial rewards will change behaviors.
9. Focus on limited objectives — maximize your return by focusing resources on priorities.
10. Use graphics for positive visuals around the office — communicate consistently and often.
The balanced scorecard approach is new in the accounting industry. Few accounting firms have used the approach for over two years. The system requires management time and communication at all levels within the firm. It will improve the alignment of firm and personal objectives.
If your current owner compensation system is not producing the results that promote the one-firm concept, you should consider the balanced scorecard approach. It will hold owners accountable while focusing on priority objectives. It will also increase confidence as the firm grows and improves.
L. Gary Boomer, CPA, is the president of Boomer Consulting, in Manhattan, Kan.
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