The Enemy Within

Blair addresses the internal struggle for margin that happens in many firms between delivery teams and business development teams due to their lack of distinction between cost and price.

Links

Profit First by Mike Michalowicz

Pay Yourself First by Jesse B. Brown

Transcript

David C. Baker: Blair, before we talk about the enemy within, what made me think that getting a new puppy made sense at this era in my life?

Blair Enns: Oh, yes. A puppy the size of a pony, how's that going?

David: Oh, it's going terribly. It's worse than a young child because this thing runs all around the house and shits everywhere, and it has really sharp teeth and that neither of those things are true of young children. This was a bad idea.

Blair: It's a Great Dane. Right?

David: It's a Great Dane, yes.

Blair: They are weighing in at what?

David: Well, it's going to be 175 pounds, we're told. It's three months old and weighs almost 40 pounds already. It's just a matter of time before I'm living in a tent out in the front yard and the Great Dane is inside at the dining room table and my bed and the couch and everything.

Blair: Picking up turds the size of human turds.

David: All right. The enemy within, if I could just summarize what I think you're going to talk about and then you can spend the next 20 minutes correcting me, it's this idea that in your training practice you are trying to help salespeople effectively, honestly earn margin for the firm and then poof it can disappear because there's an enemy within. Just explain that a little bit further to start with.

Blair: Yes, it occurs to me that agency owners, you tend to think of yourself in this margin battle, and the enemy is the client because we all know that the client would be wheeling if they had visibility into your margins, your profit, they would push you to spend all of that. They try that through scope creep. just as contracts are new year over year, they ask for more for the same amount of money. You do see yourself in a battle with your clients to protect whatever margin is built into your pricing? It's really become clear to me recently that there's an even bigger battle that gets fought, and that is the internal battle for margin, because there are small number of people in the firm, senior people, finance people and certainly, the business development people on the front lines who are either setting price or delivering or negotiating price, who are charged with increasing margin, making sure that their firm is-- There's enough gap between the costs and the price. We'll come back and talk about that.

There's a small number of people charged with increasing the margin or going out and getting as much margin as they can but almost everybody else in the firm, whose remit does not include increasing margin, their incentives are aligned to decrease margin. You find yourself in this battle with your delivery team on one side, and then a small army of people on the other side, maybe it's just the business development person, maybe it's business development and finance in the struggle for margin. The small team is trying to create margin and the big team ends up giving a few different ways for a couple of different reasons.

David: Thus, the term enemy within or the phrase enemy within, that sometimes we can be our own worst enemy. EOS comes up a lot, I hear about it from a lot of my clients, I'm sure you do too, a book that I've been hearing more and more about recently, I don't know why, it's called Profit First. We need to weave that into this discussion at some point because profit isn't what's left over if you do everything right. It's what you protect as you do everything once the project has been accepted and that fits a little bit with what you're talking about. Right?

Blair: That's exactly, and there was a book, I forget who it was, it's called Pay Yourself First. That's a principle that my father had tried to beat into me when I had my first jobs. His point was take your savings off the top and put it away. I was never very good at that, but now as a business owner for the last 20 years, that's something that we try to live by. That's something that, I think, very few creative firms actually live by. This idea that you take your profit off the top or off the table first. I use this term pot stash that was coined by a client of mine years ago, pot you can spell it with one T or two, but it's profit off the table.

This idea that we need to properly understand the distinction between cost and price, and we'll come back to that, and the difference between those two is profit. You should identify that profit first and take it off the table, take it away from the delivery people and do everything you can to make sure that they don't give it back through over-delivering.

David: Well, so many thoughts are running through my mind. One of them is just an anecdotal story that I've actually run seven or eight times in the past, just putting a description of a job in front of three different groups of people and seeing how they approach what we should charge for this. One of them is project management minded people, account management minded people and then principals.

Invariably, principals were the ones who were pricing things the least maybe because they had a payroll in mind and they were afraid that they wouldn't be able to cover that or whatever. Before we get into some of the key points here, are you suggesting that in a well-run firm, the biggest advocate for profit is the salesperson or is it a team?

Blair: It's not necessarily the salesperson, it really depends on are they trained to close at a high margin and are they incentivized to close at a high margin? That second one is a bit of a touchy topic, so I think we'll come back to that. There's always a force for an increasing price within the firm. Sometimes it's the principle although I want to come back to that. I'm not surprised that when you survey people by function, it's the principles who would price things lowest. That should surprise me but it doesn't surprise me.

We've talked a little bit before about centralizing the pricing function and there are various levels of centralization. That's a whole can of worms, but generally speaking, I'm a fan of moving towards centralized pricing, if not totally centralized. Centralized means there's usually a small team. The worst is fully distributed pricing authority where everybody on the front lines has authority to set price, you don't want that.

You want some level of centralization. It doesn't have to be fully centralized. Generally speaking, there's a small team, sometimes in a small firm, it's a team of one. That person has pricing authority, so they're setting margin. Then the big mistake, I'll jump ahead a little bit here. The big mistake that they make or that the organization, the firm makes structurally that allows the delivery team to give away that margin is they make that margin visible to the delivery team. I think that's a mistake.

David: Let's start this with some key points and then we can move to-- I want people to understand exactly what you're talking about and see to what degree they can relate to it. Then we can talk about some solutions to these things. What are the key points? Just lay those out for us.

Blair: I'll reinforce the premise here. I'll tell you a story about-- This is 20 years old now, I went to work in a business development role at an agency and was essentially building an office from the ground up in terms of a client base. The first piece of business I landed was a really high margin, we were just going into a recession and the client was saying to us, "You're twice as expensive as our last firm." I was really proud we positioned ourselves the right way in the sale, we had the inside track. We closed at a higher price, unseated the incumbent in this AOR advertising relationship.

I was really proud at the-- It was the first piece of business I'd closed. I was setting the bar high for how much margin I intended to bring the jobs in at. Then at some point later, somebody more senior to me made the observation, “Yes, that account of yours, it's not profitable.” I almost lost it. It drove me crazy that I'd easily set a record for the amount of margin built into an account. What happened is because everybody sees the price and everybody is free to a certain extent to build time against that account, and we were heading into a recession and business across the firm was slow, people just spent more time on my sugar daddy account. In the end, somebody had the temerity to say to me, "Yes, Blair, your account isn't profitable.

David: As if you were responsible for that?

Blair: Yes, and so that was an example of me, the salesperson doing everything right. I probably made some mistakes, but largely doing everything right to bring in a piece of business with us positioned as the expert at high margin. You just imagine, "Okay, do that two, three, four times a year and that's a really lucrative business, but in this case, it didn't translate to being a lucrative business at all. It translated to all of the margin being frittered away to the point where somebody said, "Well, from an accounting point of view, it's actually not profitable. My response was, "Oh, then I guess I should resign the account." No, no, no don't do that.

David: Well, and looking back on it, was it not profitable because the individual crafts people or creatives just felt like the margin wasn't important or was it how the work was managed or maybe that's getting into it too much but.

Blair: No. There's a few issues there and I think the biggest one is the first key point I want to talk about is this conflation of cost and price. I close it at a certain price, and I forget how I arrived at the price, but then everybody else in the firm looks at that price. The people who are in charge of like resource allocation who's going to work on this, they take the dollar amount and they divided up into hours and then they assign certain hours to certain people. This idea that let's say it was a million dollars in fees, the idea should be I've sold a piece of business at a million dollars in fees.

We're going to take 20% off the top. That's our pot stash, profit off the table. Now there's $800,000 in time that we can assign to our people. That's how we should be thinking about this. There's two problems there. One is making the price not just the price but the margin visible to the delivery team, and essentially, putting it on the table for them to carve up however they wanted. The other problem is just conflating cost and price.

Your delivery team, and almost everybody in the agency, maybe even the principal you see $100,000 as a price that's delivered to a client and you think blended hourly rate of $200 an hour, divide that by 50 hours, 500 hours whatever the math is, we've established I'm horrible at math and that's how many hours we have to spend. We should not be thinking about this. We get into this trouble because we use an hourly rate as to delineate both costs and price. That's the mistake.

I think it's perfectly appropriate to use your hourly rate as cost. I think it's also appropriate to actually build in some expectation of profit into that hourly rate. If your firm has a blended hourly rate of $200 an hour, you're thinking of that is, “Well, that's the rate I have to charge in our effective hourly rate that we deliver it. As long as it's at that number we're going to be at a certain level of profitability.” The way I think you should think about it you could adjust that number down but I don't think you should.

I think you should just simply, in your own minds and in the minds of your people, adjust your thinking of that $200 an hour rate to understand it as cost and not price. You use that rate to calculate what your cost is with the understanding that at a certain utilization rate, that cost actually has some profit built in but you just throw that second part out. You should see your hourly rate as cost. When you're scoping if you're scoping up from a cost plus basis, you say well it's going to take us X number of hours at Y.

Hourly rate that comes to say $100,000. $100,000 is the cost. It's not the price. Then you add the margin on top of that. If you want 20% margin, you would add 20%. Now your price is $120,000. The scoping people in this example, and this is an example of cost plus and we can talk about it coming from the other way, look value-based pricing. But the scoping people would understand that there's $100,000 in time to spend that $20,000 that the person on the front line is adding.

Maybe they're adding 50 maybe they're adding 5, maybe they're adding 200, whatever, it's their call based on whatever voodoo math that they're doing, what the market will bear or the value that they're creating for the client. Whatever that add on is that the business development person or the pricing people would add on that should not be up for grabs for the delivery people to fritter away.

David: Even if it's not listed the firm is going to make it clear what their profit expectation is because they'll report on it and they'll say hey we missed our target and so on. Even if they don't see it, they're going to guess what it is, but our employees are really motivated by this idea of creating profit for the firm. You and I talk a lot about misaligned incentives and both you and I really enjoy listening to economists think through markets and so on.

They're always talking about that too, but there really aren't that many incentives that would align an employee with thinking about profit. When I think about how an employee would react when they see a $100,000 job versus a $30,000 job, they're not excited about at all about the fact that one represents more profit. They're excited about the fact that this is a bigger canvas we can paint on. We can do even bigger, better more effective things. Seldom does profit even enter the picture.

Are they really looking at that profit saying, “Oh, I can spend more.” I'm not even sure they're thinking about that.

Blair: Are you talking about the business development people or are you talking about the delivery people the delivery people?

David: The delivery people, yes.

Blair: I'm not sure this is as black and white as I'm going to lay it out. I'll say it first, then we'll back up. The delivery people don't really care about profit so much. Your point is they're interested in the size of the canvas, the number of hours, the amount of money they can spend on something so that they can do better work.

They're not so interested in how much money is left over at the end of the year for the owners of the business.

David: Except for bonus time.

Blair: We should talk about incentives in a few minutes. Now having said that generalization, I don't actually believe that's entirely true. The reason I don't believe it's true is way back in the day, even before I closed the piece of business that I talked about earlier, at another agency, I had inherited an account and it was quite a famous, highly visible account. The terms of the relationship were negotiated before I got there.

I show up, I inherited this account and I looked at what we weren't getting paid. It was really striking. The principal of the firm had decided that he wanted this account for the visibility. He had a relationship with the business owner. It was a professional sports team, and thought it would be a good high visibility and fun account for people to work on, but it was low money and no margin. I, over the short time I was there, ended up developing a pretty good relationship with the business owner.

At some point, he said to me, “I feel like your people aren't taking this account seriously.” He was sensing some bad energy from us. He asked me a very direct question. I forget exactly how he phrased it but I found myself speaking a truth at the same time I was realizing it. I said to him, “You know what, if you would have told me this was the case beforehand, I would have said there's no way. What I'm seeing is our people do not enjoy working on an account that is not profitable. There is a lot of pressure for them and there's a little bit of resentment about how little we're being paid for this.”

I said to him, “That's just me speaking. If you would have made this assertion to me a while ago, I would have said there's no way, they're not feeling that but I saw it and I believe it's there even more broadly.” I want to agree with you generally that the delivery people aren't really interested in a profit, but I've also seen it firsthand beyond that case where people don't like working on unprofitable accounts. It's not a comfortable feeling to be working on something that is costing the firm money.

David: This is an overstatement but it feels like they're wasting their lives and not having due respect for all the effort and experience and so on. In the past it was actually fairly common to look inside a firm and discover that the only person who saw the pricing was the principal and the project manager. It was just simply obscure anybody else. In fact, there were firms back in the day where nobody knew what the hourly rate was, nobody saw the proposals. What drove that was paranoid principals who said, “I don't want them to know how much money I'm making,” and/or, “I don't want them to spend more time than I think we have for this.” It was motivated by this really strange set of reasons.

You got to look a long time to find a firm that's like that nowadays. It's pretty much open book. I mean totally open book in many cases. It's not like we're going to be able to hide this stash. Isn't it more about education and expectations around it?

Blair: I'm not sure. I actually think we can hide it. As you're talking about the good, old days, I'm getting a little bit nostalgic. I recognize that things have changed. When I think of these advertising agency of record accounts where there would be this like negotiation every year or so and then that's it, that's all the financial stuff taken care of for the year. Now, there are very few of those relationships, even if you have a client who's spending millions with you, you're writing all of these different proposals, all of these different statements of work. You're costing the individual jobs and projects a lot more than you used to back in those good, old days and there's typically a number of people involved in that so there's a lot of visibility into that.

Now, I don't think there needs to be visibility into price just because, let's say, you the business development person, or the person on the front lines, you've got a price a project and you're going to do it cost plus, you go to your delivery team to get them to scope it, you arrive at a cost, and then you mark that cost up and you make the margin, you make it invisible to the delivery team. I think in some firms, some systems would have to change to support that idea, but I really think that's what needs to happen. I think we need to make this distinction between cost and price and understand that this hourly rate is cost and we add margin on top of it and the margin is not there to be used by the delivery team.

I was in a conversation with a principal the other day where it was like I made the point, "Don't let your finance person take that margin and atomize it by saying, well, with this extra, let's say it's 50,000 in margin, what we're doing is we're raising the effective hourly rate charged.” You can't do that, because as soon as you translate that chunk of profit into any type of unit like hourly rate, it's going to be seen as fair game for people. Don't let margin affect any calculation you have about effective hourly rate. I think it can be kept from the delivery person. If it can't be kept from the delivery person, that leads us to the subject of incentives that you brought up earlier.

David: Right.

Blair: If you're going to have incentives for your team, some profit-sharing incentives, I think it might be a wise idea to pull all of the incentives out of this pot stash, have the margin that gets added on after scoping, create this idea of this stash, this slush fund is called profit and then have any distribution of profits come out of that stash. Now, in a well-run firm, where you doing what I suggested in treating your hourly rate as cost and not price, and you're hitting a certain utilization rate, there's profit, I don't want to say built in, but you're going to have profit even before the pot stash. This is your domain more than mine, but I think it might make sense to actually view that as different buckets of profit.

David: I just wonder if we want the delivery team obsessing about not wanting a new hire because now we are reducing in effect this profit pot, because now our costs are greater or something that you've talked quite a bit about, the idea of innovation being wasteful and some of that innovation is going to be tied to client work, how do we balance all that stuff out? Right? If we align the incentives too closely, then we have the delivery team watching everything like a hawk and not wanting to spend a dime extra. It feels like we could go in the opposite direction too much as well.

Blair: Yes, I think that comes down to scoping things properly. I'm really getting into your domain here. Am I setting off any alarm bells for you?

David: No, not at all. I've often thought about this in a much more simplistic way so simplistic, I'm embarrassed to even say it. I haven't read Profit First, but I imagine they talked about this in there. It's this notion that we're going to give somebody a 15% discount, well, that's 100% of our profit. Then you step back and say, “Now remind me again, why we're doing this job if all we're doing is keeping people employed.” I know it's a really simplistic way to look at it, but I do think it's really important.

It's not just about incentives to me, it's also about culture, it's understanding that profit is not evil at all. I feel like profit’s getting a bad name in some ways and it shouldn't, it's fine, it's good, it's healthy. If I want to entrust extra money to people, I'd rather entrust it to principals of these firms that generally have really good hearts and do the right things with money and they invested in people and in their community. We're tying people's arms behind their backs by constantly giving it away. I think what you're talking about here is a really important component of our expectation that firms should be making money and we shouldn't apologize for that at all.

This idea of an internal enemy, it just makes so much sense to me. Maybe this is a little bit of an over statement, but it feels like running a firm well sometimes is like building a house of cards and you get one thing wrong and six things go wrong because of that, it just takes a real balancing act. You build this house of cards, and you're proud of it, you step back, and then some fool turns the fan on behind you, right? That's what it feels like. Where the salespersons gone to your training, they've worked on positioning, they poured their hearts out in lead generation and now they've got it in the bag. Then somebody wants to give away the profit and it just gets discouraging after a while, right?

Blair: It does, and the journey that that business development person has gone on to go from this place of viewing profit is not a bad thing. It's not me taking money from the client, we're worth this, I'm going to demand that we get paid this. They go on this journey of learning to value themselves in the work of the firm and they achieved this win of getting the client to pay them more than they thought they could have got the client to pay them previously. That's the journey that my people are taking our clients on. You have this win that's just one of the best wins in business from my point of view.

David: Right.

Blair: Then just like I experienced 20 years ago, your win is given back by other people who are trying to overserve, delight the client, invest in the relationship, all of these things that we get beaten into our heads about. These things are more important than running a profitable firm. You should be able to do both, you should be able to charge enough so that you're making really good money, and the client feels valued and taken care of. Those two things actually go hand in hand quite easily.

The idea that somebody would, here's my real beef, spent all of this money on their win without pitching and pricing, creativity training to win the battles on the front line, I'm starting to see now that's just the first battle, then there's the internal battle. We have to stop the delivery people from giving this margin away, giving away the hard fought victory in the name of relationship building.

David: It sounds like you want to take over my business. Sounds like this is the beginnings of a coup, I'm looking out the door to see who's knocking out here.

Blair: Well, I have this problem that I don't actually do real math so I have a vivid limitation. I am way out at the edge of beyond the edge of my domain here and it's clear to me that I'm encroaching into yours. I'm looking for you to beat me back. What I really want, David, is I want you to solve my problem. We'll keep teaching people how to go gain the margin, you go in and teach them how to protect it.

David: Well, this end, I think, maybe on an up note, this is just prompted by something you just said. Here, we are charged with doing really good work, keeping people happy, building a great culture and making money. It's pretty amazing that principles that people you and I serve are able to do that year after year and not go crazy, and some of them do, but most of them don't. That's pretty amazing to balance all those things, isn't it?

Blair: Yes, it really is. These battles, what other battles would you rather be fighting in life? They're fun. The fact that the sales people are increasing margin, then it's being frittered away by others, that's a battle I'd like to take on in terms of the battle that I want to fight my business because the margins there, you just have to institute some policies, some systems to protect it.

David: This has been a great discussion. Thank you, Blair.

Blair: Thanks, David.