As part of a series of interviews with prominent members of the profession, AccountingWEB sits down with Ron Baker, author, speaker, and self-proclaimed crusader against the billable hour, to get his perspective on what's happening in the profession.
AccountingWEB (AW): You have spoken to many professionals over the past few years regarding changing the way they value their services. What has been the hardest part of your mission?
Ron Baker (RB) Perhaps I should answer first by stating what has been the easiest part of my mission––convincing professionals the hourly billing method is not a profit-optimizing pricing strategy, and that is has many deleterious effects on professional service firms. I think the logic I use is irrefutable, since it is grounded in centuries old economic theory, and clearly describes how customers behave. Professionals are smart, rational, and logical folks, who clearly grasp the logic of my argument.
The hardest part is convincing them to test the theory. Many consultants routinely say CPAs hate change. But I reject this line of reasoning as being too simplistic. I think CPAs have gone through tremendous change, and most people will enthusiastically embrace change if they believe it will lead to a brighter future. With Value Pricing––as perhaps with most change––the real barrier is fear of the consequences of change. I think that is a different issue, and I often point out that if I was Lloyd’s of London, and could insure CPAs against any and all losses from implementing my ideas, many more of them would test these concepts. Of course, I can’t do that, and hence I need to rely on the written and spoken word to change the way they think about value and pricing. Hopefully, that will ultimately lead to behavioral change. And the reality is that change is now happening in a most significant way.
AW: What are the fundamental differences between how accountants perceive your message and how other professionals perceive it?
RB: I have found most other professionals test these ideas quicker, and with much less convincing, than CPAs. Lawyers, for instance, seem to understand Value Pricing easier than CPAs, partly I believe because they are not as tied to the billable hour as we are; they offer contingency pricing, flat rates, probate fees, etc. Some lawyers tend to be more entrepreneurial than CPAs, and are more likely to take risks, since that is the nature of their business. I’ve had law firms throw away their timesheets after sitting in on a two hour seminar, which is something most CPA firms wouldn’t––or couldn’t––do, because they are more risk adverse.
AW: You have a new book out with Paul Dunn, The Firm of the Future. What led you to write this book?
RB: Paul and I wrote the book because we see a gap between where the CPA profession is and where it could be. We are both totally committed to improving the quality of life in the profession, and we’ve talked with enough accountants around the world to know the morale in the profession is on a downward trend. This is a leading indicator of the health, vitality and dynamism of any profession, and we believe we understand some of the causes for this decline. No one entered this profession in order to bill the most hours, yet that is usually the number one criteria they are measured, judged, promoted and paid based upon. And we believe––and set out to prove in a very convincing manner––billable hours have nothing to do with the success of a professional. No customer buys time, so why does the profession insist on teaching two generations of CPAs that is all they have to sell?
In the book, Paul and I describe the Old Practice Equation:
Revenue = People Power x Efficiency x Hourly Rate
There are many problems with this Equation, which we detail in depth in the book. But it is one thing to disprove a theory, it is quite another to supplant it with a better theory. And since I firmly believe all learning starts with theory––and there is nothing more practical than a good theory––we offer what we believe is a superior theory. Then we provide many examples of the theory in practice so professionals can test the result of applying the new concepts for themselves.
AW: With all of the changes hitting the profession today, how much tolerance do you think accountants really have to absorb yet another paradigm shift in the way they do business?
RB: Again, I think the tolerance is there if CPAs believe the new paradigm will lead to a better future. The New Practice Equation we are positing does require some rethinking and reengineering of the way a professional service firm operates, but we believe it better comports to the real critical success factors that makes firms––and their customers––successful. The New Practice Equation is as follows:
Profitability = Intellectual Capital x Effectiveness x Price
This theory has many advantages over the old one. First, rather than focusing on top line revenue, the firm is forced to think about the profitability of each customer. Not all customers are equal, and many firms could stand to lose up to 40-60% of their customers, and they’d be more profitable if they did so. That may sound counterintuitive, but if you study the Pareto Principle––that is, the top 20% of a firm’s customers provide 80% of its revenue or profits––it is definitively true. Marginal customers may contribute revenue, but they also absorb precious, fixed capacity that is better utilized with “A” and “B” customers.
Second, CPA firms don’t sell hours. They create Intellectual Capital (IC). This is a far broader view than thinking about leveraging people and hours. Microsoft didn’t create the wealth it has by pricing by the hour, and I doubt Bill Gates keeps a timesheet. A firm’s IC consists of three components: Human Capital (its people); Structural Capital (its systems, proprietary software, checklists, resources, etc., that enable it to perform its work); and Social Capital (customers, vendors, suppliers, referral sources, alumni, and alliances). These components are the real levers of profitability in any professional service firm, not people hours. You can’t leverage an hour; time is simply time, and all businesses––indeed, all living beings––are constrained by it. So what? There are so many more ways to leverage the three components of IC, but it requires a radical change of mindset to get away from the notion that “billable hours” drive a firm’s profitability. As Archimedes said, “Give me a lever long enough, and I shall move the earth.” The real lever in a CPA firm is its IC, and our book sets out to prove that theory.
Third, the Firm of the Future will focus on effectiveness, not efficiency. A business does not exist to be efficient, it exists to create wealth for its customers. There’s not much the average firm can do to squeeze another 15-20% efficiency from its Human Capital anyway, who are only fallible human beings after all. The focus on billable hours has hindered CPA firms from focusing on being effective with their customers. If you study surveys of how customers select (or fire) their CPAs, efficiency is never mentioned. It is always because of outstanding service (or lack of service). Issues such as they don’t ignore me, they are proactive in looking after my interests, they are aggressive in helping me pursue opportunities, and so on. You can’t do all of these things if you are focused on nothing but billable hour quotas. Therefore, the Firm of the Future measures firm and team member effectiveness by utilizing Key Performance Indicators (KPIs), which are leading indicators of performance. Timesheets are lagging indicators, and don’t offer firm leaders a relevant, or timely, measurement of the right things (effectiveness); instead, they focus on doing things right (efficiency). I will take effectiveness over efficiency any day. Let me be clear: The Firm of the Future does not have timesheets. Today, we know of approximately twelve dozen firms that have trashed their timesheets, and they report quality of life (and profitability) has risen.
Last, Firms of the Future recognize they are businesses just like the airlines, hotels, rental car companies, etc. Businesses have prices, not hourly rates. You’d never fly an airline that tried to charge you $4 per minute. The idea is simply ludicrous. In fact, CPA firms need to start pricing up-front for everything they do, period. No more excuses, no more hiding behind the veil of the billable hour. The retort that a firm can’t do that because it doesn’t know exactly how long it is going to take is specious. The customer doesn’t care how long it takes, they only care about the price relative to the value, and they want to make that comparison before they buy, not after. From the firm’s perspective, it is much better to know the customer doesn’t agree with the price before they do the work, which helps it prevent committing precious fixed capacity to customers who don’t value the work. CPAs are subject to the same laws of economics, price, and consumer psychology as every other business. It is time they learned to price on purpose, and stop hiding behind the billable hour method. We want pricing to become a core competency in CPA firms, just as much as accounting, auditing and tax work. Unfortunately, what we find are many firms only core competency with respect to prices is lowering them. We believe this New Practice Equation––and of course there is much more to it, this is just a brief synopsis––is superior to, and will eventually supplant, the old one.
AW: You have spoken often about your experience with the Disney Institute. What is the fundamental "gem" that has stuck with you about that experience with Disney?
The Disney University course I attended in 1997 was on customer loyalty. I was fortunate enough to write a three part series on my experience, which was very well received. What amazed me about the whole experience was not only did Disney provide cutting edge theory on customer service, customer loyalty economics, etc., but they also took you “behind the scenes” and showed you first hand how they implement these ideas in practice. When they say they are committed to making “moments of magic” for their guests, they mean it, in word, deed and resources. I remember one attendee saying something to the effect of, “Yeah, but that is easy for you guys, you’re Disney, and have a lot of magical moments to create.” And I thought the instructor gave a wonderful reply: “No, he said, we are Disney because we do these things.”
I would wager most everyone reading this has visited either Disneyland or Walt Disney World. The lessons for CPA firms are many. Disney is one of the premier Intellectual Capital organizations. Walt Disney broke the oft-repeated mantra in real estate: location, location, location. He chose walnut groves (Anaheim, CA) and swampland (Orlando, FL) to locate his theme parks, and look how much value he has created with the sheer force of Intellectual Capital. Disney purchased 29,500 acres in Orlando for an average price of $200 an acre. Today, that same acreage is valued at $1 million per acre. This proves the wealth-creating ability of Intellectual Capital.
Disney is also a price maker––not a price taker––in their industry. If CPA firms want to be price leaders, they should study the success of other price leaders––such as FedEx, Nordstrom, American Express, Ritz-Carlton, and so forth. We tell the story of Ben & Jerry’s famous “pricing epiphany” in the book, and you have to admit the profit margins on premium ice cream would make the so-called “Robber Barons” blush. I love to study Disney because success leaves clues, and I believe we learn more from it than failure.
AW: In your view, what are the obstacles within the accounting profession that might inhibit CPAs from applying that "gem"?
RB: In our teachings, we use a wide variety of examples from other industries––Disney, Ritz-Carlton, FedEx and especially the airlines. The resistance we meet here is truly irrational at times. CPAs often will say something to the effect, “I’m running an accounting firm, not an airline or an amusement park.” As if there was nothing to learn from these organizations. We refer to this search for best practices––or simply smart and profitable practices––as benchmarking on steroids. It’s hard to benchmark within the profession, because most firms seem to be doing the same things in the same way. Imagine if you were to take the partners of each of the Big 4 and swap them among each other. Would much change in the way they serviced their customers? Even consultants to the profession are impacted by this myopia, since they tend to spread the conventional orthodoxies to their customers. It is much better if we look outside of ourselves for improvement ideas. True innovation is either coming up with new ideas, or simply applying old ideas in new places.
AW: What are the two or three traits inherent in the accounting profession that you would change if you had the proverbial "magic wand?"
RB: I think about this question on two levels––the macro and the micro. For the micro, or firm level, I of course would want to see the New Practice Equation we proffer implemented by accounting firms throughout the world. This equation is more worthy of a proud profession because it recognizes that CPAs are knowledge workers (not service workers) who work with their minds and brains, not their hands and muscles. It replaces efficiency (doing things right) with effectiveness (doing the right things), and this will lead to better customer service, innovation and wealth creation. We believe it will also move us towards attracting young people into the profession, by creating firms that you would be proud to have a son or daughter work for.
But I want to answer this question in the macro sense––that is, for the profession as a whole. In the book, I detail the flaws of GAAP, and the traditional financial model of the balance sheet, income statement and statement of cash flows. Some very astute observers have made the comment that these financial statements are the “three blind mice.” After all, no significant innovations have been made to this 500+ year-old model, developed for primarily an industrial economy that measures the cost of everything but knows the value of nothing. It simply does a horrendous job at measuring wealth in an economy increasingly driven by intellectual capital––it is easier to count the bottles than determine the value of the wine, as they say. I take a different lesson away from Enron, and the other accounting scandals, than most of my colleagues. I don’t think it demonstrates fraud, malfeasance, or misfeasance, as much as it does irrelevancy. The fact of the matter is the financial statements are lagging indicators, as they only look backwards. What the profession needs to do––and we have forfeited our natural lead in this area––is to posit leading indicators for business and industry. The Balance Scorecard is a prime example of positing testable hypothesis that internal and external users of financial information can utilize to get an idea of where a business is heading, not simply where it has been. Yet these ideas were generated, and are being implemented, by organizations outside of the accounting profession. The book by PricewaterhouseCoopers, The ValueReporting Revolution, is an excellent start, but even it says the CPA profession has relinquished its role in this area.
Next, rather than the recent flurry of regulation, I want to see more deregulation of the accounting profession. Why does everyone automatically assume the problem in the accounting profession is not enough regulation? We have far too much regulation, and none of it prevented Enron, et. al. Think about it: when the market fails, Arthur Andersen goes under, and some executives will no doubt face criminal prosecution. In other words, the market has extracted a punishment. When government fails, they get a bigger budget and more control. And this is where I radically depart from my colleagues and the leadership of the profession, and join the ranks of the economists who have studied the SEC and concluded it has not done anything to help investors, and may in fact have caused a net harm. This is well documented by some economists and think tanks––American Enterprise Institute, Heritage Foundation, Hoover Institution, and the Cato Institute, to name just a few––and I would like to see the AICPA align with one or more of these organizations and take the offensive against further regulation, rather than merely reacting to Congress’ irrational lawmaking. In fact, I discuss one of the most innovative regulatory reform ideas for the SEC in the book. I worry that we are losing one of the defining characteristics of being a true “profession”––that of self-regulation. I don’t want to see the profession go the way of the AMA and family physician by being regulated out of existence.
Last, I would like to see more innovation from the profession. For instance, I thought Cognitor was a wonderful idea, and deserved to be tested in the free market. One of the problems with the CPA profession is a paucity of innovation. Our last truly ground-up innovation were the SSARS––compilations and reviews, which took effect in 1978. That is a 25-year innovation curve, and counting. In any other industry, that innovation record would put us in the museum, where the only interest in us would be from paleontologists.
AW: So many of the issues you push for require significant changes in thought processes and perception. Short of having a "religious conversion," where should CPAs start their journey towards change––i.e., where should they focus their limited resources and energy?
RB: Well, I might be biased, but I have seen many firms who have implemented Value Pricing––and some who have also trashed their timesheets––make dramatic improvements in their profitability and customer service. I think pricing on purpose is one of the low hanging fruits all firms can pluck with relative ease. It simply requires some study, thought, and a willingness to experiment. It is also an iterative process, meaning the more you do it, the more you will learn, and the better you will become at pricing. It also improves team member morale, by finally capturing the value created for customers, rather than a sweatshop mentality of billing more hours. With any change program, though, nothing succeeds like success, and firms need to celebrate and share the successes they have with change initiatives in order to diffuse the change quicker throughout the organization.
AW: If your son or daughter came to you for advice on whether they should become an accountant or not, what would you tell them?
RB: I have heard from many CPAs who have said they are actively counseling their sons and daughters not to become CPAs––another leading indicator that the quality of life in the profession is slipping. I think there is no better time to be a CPA, and the opportunities for young people are limitless. However, not many high school students have a clear understanding of what CPAs actually do, and according to some studies if a high school student takes accounting they are less likely to major in accounting in college. Why is that? Most likely they are not getting an accurate picture of what an accountant does on a day-to-day basis. We help people solve their problems and achieve their goals, yet I think the image at the high school level is one of number crunching. It might help if CPAs were more visible at the high school level and maybe even taught some of the accounting courses there. I have been giving talks to high schools, and the AICPA and state societies offer a wonderful variety of resources for CPAs in order to present an effective message to high school students.
AW: You have been alternately described in different circles as a visionary, an evangelist, a crusader, a one-issue preacher, a radical reformist, and a professional heretic. How would you describe Ron Baker to someone who has never met you?
RB: Those definitions don’t sound too bad to me [laughter]. But in reality, I’m just an average CPA who is passionate about wanting to help his colleagues have a better quality of life. Now that I am no longer practicing, I describe myself mostly as a writer and educator, which are my true passions. To the extent you write on a particular topic that resonates with your readers, you do run the risk of becoming a one-issue preacher. But that is a function of market demand, not because I don’t explore any other topics. I have written and taught courses on alternatives to the federal income tax, everyday economics, the experience economy, total quality service, and this new book covers intellectual capital in depth. Nevertheless, everyone mostly wants to hear about Value Pricing, and since it is an area every business grapples with––not to mention an endlessly fascinating subject––I want to share what I continue to learn with my colleagues.
I agree with the Roman statesman and philosopher Seneca, who said "I delight in learning so that I can teach." That is how I would like to be thought of, and the legacy I would like to leave.