I received an incredibly thought-provoking email from Jonathan Iannacone, CPA, who blogs as well:
I would like your thoughts on a question that continues to bother me regarding the K[ey] P[erformance] I[ndicator] we use at the firm, Revenue per Employee.
Recently a list from Inside Public Accounting (IPA) came out listing the Best of the Best accounting firms for 2008 (top 25 and then next 25 honorable mentions). Using the data from that table, you can crunch the numbers to get partner/staff, revenue/partner, and revenue/employee results. For me, the revenue/employee is most important since it lets me fact check my own firm goals.
Looking at the numbers it made me questions a few things:
Is there a terminal velocity for Revenue/Employee for CPA firms? Data seems to suggest that whether your $6M or $600M, California or Arkansas, that $200K per employee is pretty much what the best firms do.
How can we rethink the PKF to escape these constraints. Is there a way to “productize” and package it in a way that makes it infinitely more scalable (Turbo-tax and QuickBooks seem to point to yes).
I would love to have your input as to what the numbers are telling you and how you would then go about moving and addressing the questions that inevitably arise.
Thanks in advance for any time and knowledge share.
The Firm of the Past
As my colleague Tim Williams says—with a little exaggeration, but you get the point—if you sell time, and want to make a million more dollars, you have to charge a million more hours––a self imposed ceiling and not a very effective lever for creating wealth.
This mindset is what we call The Firm of the Past, and its theory is as follows:
Revenue = People Power x Efficiency x Hourly Rate
All of the firms in the IPA report have, in effect, the above theory as their talisman. I detail the problems with this theory in my November 2008 Journal of Accountancy article.
This is why we believe a new model is needed among Professional Knowledge Firms (PKFs) that leverages the real source of wealth in our knowledge economy: Intellectual Capital (IC).
The Firm of the Future
Hence, our New Practice Equation, or what we call The Firm of the Future:
Profitability = Intellectual Capital x Effectiveness x Value Price
This enables a PKF to leverage its IC in a myriad of ways––rather than relying on the head count of billable hours––so firms can generate what we call “sleep revenue"—money you earn while in bed. You can’t do that if you’re selling hours.
We have seen some innovative advertising agencies doing exactly this. They are creating their own portfolios of IC, thereby escaping the constraints of selling time.
Looking at these revenue per employee numbers also teaches that there are no economies of scale in a PKF. So firms that are merging as a source of growth are not getting any great gains in that area.
PKFs are incredibly labor intensive, and until the business model changes from selling time to selling IC, I don’t think you will see great movement in these numbers.
Value Pricing will, inevitably, help push up the revenue per employee numbers, while allowing the firms to do so with fewer customers.
This is a change from economies of scale to economies of scope. Fewer customers equates to more profitability. This is why I would love to see revenue per customer calculated for these firms, which would shed some light on their value propositions.
After all, Value Pricing is limited to the value firms create. If all they want to do is play financial historians by offering attest and low-level compliance work, then unless they innovate new products and services to climb up the value curve, they are going to struggle to break the $300K barrier, let alone any higher.
How long it takes for the New Practice Equation to diffuse throughout the profession, let alone impact on these calculations, is anyone’s guess. Mine is past my lifetime.
As always, I welcome any and all comments from our readers on this very thought-provoking analysis from Jonathan, and the questions he raises.