In the first part of this article ("Avoid being a firm of the past," Accounting Today, June 2011, page 12), we analyzed the antiquated business model of professional firms based on, "We sell time."

Only a theory can replace a theory. If we reject our old notions of the way the world works, we need a new place to go.

I am not arguing that the old business model is not profitable. That would defy the reality of many profitable CPA firms. Instead, I am saying it is suboptimal. Engineers use this term to describe the mindless pursuit of one goal to the detriment of broader organizational interests.

I want to posit a more optimal model.

 

THE MODEL OF THE FUTURE

It is time to replace the old firm model of "We sell time" with a radical business model.

Why radical? Because it comes from the Latin for "getting back to the root." In this case, the root means customers buy value, not time, which leads us to a more optimal business model:

Profitability = intellectual capital x effectiveness x price

Let's explore each component of the equation; then we will discuss why it is a better theory for explaining the success of firms operating in today's intellectual capital economy.

We start with profitability, rather than revenue, because we are not interested in growth merely for the sake of growth. As many companies around the world have learned, market share is not the "Open sesame" to more profitability. We are interested in finding the right customer, at the right price, consistent with our purpose and values, even if that means frequently turning away customers.

This means you need to become much more selective about whom you do business with, even though that marginal business may be "profitable" by conventional standards.

There is such a thing as good and bad profits. Accepting customers who are not a good fit for your firm has many deleterious effects, such as negatively affecting team member morale and committing fixed capacity to customers for whom you simply cannot create value. Growth without profit is perilous.

 

PRICES, NOT HOURLY RATES

Everything we buy as consumers, we know the price up front. The billable hour violates this basic economic law, and it does so at the peril of the professions. No customer buys time - it measures efforts, not results. Customers demand to make a price/value assessment before they purchase, not after.

The word value has a specific meaning in economics: "The maximum amount that a consumer would be willing to pay for an item." Therefore, value pricing can be defined as the maximum amount a given customer is willing to pay for a particular service, before the work begins.

 

DEFINING INTELLECTUAL CAPITAL

Intellectual capital has been defined as, "Knowledge that can be converted into profits." A firm's IC can be separated into three categories:

Human capital. This comprises your team members and associates who work either for you or with you. The important thing to remember about HC is that it cannot be owned, only contracted, since it is completely volitional. Ultimately, they are volunteers.

Structural capital. This is everything that remains in your firm once the HC has stepped into the elevator, such as databases, customer lists, systems, procedures, intranets, manuals, files, technology, business models, and all of the explicit knowledge tools that you utilize to produce results for your customers.

Social capital. This includes your customers, the main reason a business exists; but it also includes your suppliers, vendors, networks, referral sources, alumni, joint ventures and alliance partners, professional associations, reputation, and so on. Of the three types of IC, this is perhaps the least leveraged, and yet it is highly valued by customers.

The crucial point to understand here is that it is the interplay among the three types of IC above that generates wealth-creating opportunities for your firm.

And since knowledge is a "non-rival" good - meaning we can both possess it at the same time without diminishing it - knowledge shared is knowledge that is effectively doubled throughout the organization. That is why former Hewlett-Packard CEO Lew Platt said, "If HP knew what HP knows, we would be three times as profitable."

 

EFFECTIVENESS TRUMPS EFFICIENCY

Attacking the concept of efficiency is similar to attacking motherhood and apple pie, but I am going to do it anyway. The fact is, a ruthless focus on efficiency is the wrong talisman in a professional knowledge firm, or indeed in any business.

Since all transformations are linguistic, let us start with definitions: "Efficiency" is a measurement, while "effectiveness" concentrates on doing the right things, and is always a judgment.

Productivity and efficiency are always a ratio, expressed as the amount of output per unit of input. Mathematically, it seems straightforward, as if there was one widely agreed-upon definition of the components of the numerator and denominator. In an IC economy, however, it is a conundrum.

Take the denominator. Which inputs should be included? If we are dealing with wine, we could count the costs of the grapes, the bottles, corks and so on, none of which would help us define - let alone value - the final product. As they say, it is much easier to count the bottles than describe the wine.

Firms have learned that costs are easier to compute than benefits, so they cut the costs in the denominator to improve the efficiency. This is the equivalent of Walt Disney cutting out three of the dwarfs in Snow White and the Seven Dwarfs in order to reduce the inputs, making the resulting ratio look better. Efficient, yes; effective, hardly.

Efficiency cannot be meaningfully defined without regard to your purpose, desires and preferences. It cannot simply be reduced to output per man-hour. It is inextricably linked to what people want - and at what cost people are willing to pay.

Efficiency in a professional firm, in and of itself, is not a competitive advantage. It is the equivalent of having restrooms. If your firm is not using the latest technological tools, that is incredibly inefficient; but if it is, so what? All of your competitors are too.

 

CONCLUSION

The new business model offered herein is not about predicting the future; it is about helping to shape and create the future. No one can predict the future, and only a fool tries. But we can influence the future based upon the decisions and choices we make.

Even better, if the business model posited here is someday replaced with a better one, it will contribute to the advancement of the CPA profession - and nothing would please me more.

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