• Live Our Values, Demonstrate Our Behaviors, Support Our Strategy…

    By • Nov 5th, 2009 • Category: Latest, Pure Content, The Big 4 And Consulting


    The Train Paradox: Time Dilation and Length Contraction

    “One-firm” firms, and those that aspire to this goal, share the following characteristics:

    • Loyalty – Great emphasis is placed on firm-wide coordination of decision making, group identity, cooperative teamwork and institutional commitment.
    • Downplaying stardom – Leaders and members of the firm view themselves as belonging to an institution that has an identity and existence above and beyond the individuals that belong to it. There’s a great emphasis on institutional history, broadly held values, and a reputation all actively work to preserve.
    • Teamwork and conformity – An emphasis on teamwork and “fitting in” creates an identity not only for the firm but also for the individual members of the firm. This identity, for better or worse, is readily identifiable to the outside world.
    • Long hours and hard work – The way an individual illustrates his or her high involvement and commitment to the firm is through hard work and long hours.
    • Sense of mission – All professional services firms typically have the standard “3 Ss” as their mission statement: client service, financial success, and professional satisfaction. In a “one-firm” firm the client comes first, the firm second and the individual last. This does not guarantee superior client service only that the ideology is strongly emphasized.
    • Client service – The emphasis is clearly one of significant attention to managing client relations. It’s a far-ranging attentiveness to client needs and quality of interaction between the firm and its client.

    Maister, the author in 1985 of the original points summarized above, updated his article in 2006 with his colleague Jack Walker.  Much had changed since then, including the self-immolation of Arthur Andersen, one of the firms held up as a shining example of this concept.

    In our view, many professional service firms are currently engaging in activities that undermine loyalty and create fault lines, including:
    • Growing for growth’s sake, by incoherently adding laterals and merging;
    • Expanding into unconnected practice areas and markets;
    • Hiring primarily semi-experienced lateral associates rather than hiring and training entry-level applicants;
    • Eliminating social and partner/officer meetings as a cost-cutting measure;
    • “Pulling up the ladder” to partner or owner status and establishing complex membership hierarchies, including nonequity levels, not to serve clients but rather to relieve inside pain; and
    • Obsessing about the short-term bottom line: treating financial success as the goal rather than as a byproduct of a well-run firm.
    I think about  the “one-firm firm” concept frequently. It’s an ideal that I can safely say all the Big 4 aspire to.  And David Maister was the guru when I started in consulting in 1993 at KPMG Consulting.  Later my mentor gave me the book, Managing Professional Services Firms, and I was hooked on the theory of professional services as well as the practice.
    What’s currently threatening this “one-firm firm” ideal, in my opinion?
    • The re-emphasis by the audit firms on their consulting business and, subsequently, the increase in acquisitions and lateral hires in spite of the lessons of Enron.
    • The economic downturn and slowing of growth in audit revenues from Sarbanes-Oxley work with no clear substitute, perhaps foreshadowing a return to audit services as a commodity.
    • The globalization of the firms and the problems they’ve run into both in the US and abroad by trying to market a global network concept while at the same time protect each local firm from liability for other’s mistakes. Their legal and business model is threatened.
    • The “layoffs” and breakdown in culture and loyalty that’s resulted from the overwhelming focus on growth and profits in the short term for the leadership at that time.
    We can certainly see examples of all of these ailments in the Big 4 and I have written about them extensively.  However, for today, I’d like to focus on the 1st of Maister’s concerns, “Growth for growth’s sake,” and the 5th, “Pulling up the ladder.”

    Some of you may recognize the title of this blog post as the PricewaterhouseCoopers LLP mantra.  So much has changed even in my professional life, which only goes back to the early 80’s. Front and center are the threats to the global network of all the firms (which isn’t mentioned above) and the focus on aggressive growth while diluting the partnership culture of the firms by perverting their compensation structure.  These systemic problems with the audit firm model are found in all the Big 4 firms, but I’m going to use PwC as an example.

    Partner performance assessment has become a short-term, self-serving tool to throw disproportionate wealth to a small group of senior leadership.  This top heavy, both in pay and influence, structure is due to the loss of a true consensus leadership model. A decreasing percentage of active partners, estimated by insiders at PwC for example to be 10%, are actually true “equity” partners. The firms are nowadays run more and more like major global corporations than closely-knit partnerships.  Maybe that’s inevitable.  Huge, global firms with hundreds of thousands of employees, billions in revenues, and far-ranging lists of services don’t lend themselves to having thousands taking a vote every time there’s a decision to be made.

    But they do try to maintain the illusion.

    (Ok, I concede, what’s the point of requiring a partner to sign an audit report in their own name when they can’t be held personally liable? They’re essentially “at-will” employees acting as an agents of the firms.)

    Regardless of the language used and the ongoing illusion of fraternity, the current Big 4 partner compensation plans, using PwC as an example,  are generally based on a salary component (responsibility income), a share of profits (equity income),  and a corporate-like bonus for a few (exemplary award).  In PwC’s case, what’s funny is that even though the firm purports to have as their primary FY10 goals growth of the business, enhancement of the brand, success of business model changes, and dominance of their network over competitors, they have an “all the children are high performing” performance appraisal methodology that contradicts these goals. Notice that none of these stated goals for FY10 have anything to do with client (shareholder) service, audit quality, technical competence, or a restoration of faith and trust in the profession.  They have everything to do with their “burning platform for growth.”

    I’ve written quite often about the performance appraisal process for staff and the concept of forced ranking. “Jim’s better than Bob but not as good as Mike.” In a nutshell, that’s forced ranking.  In the partner world it has a different name, relative performance.  When it comes to performance rankings, this means you may be judged to have met your objectives or exceeded them, but your peers may have “met them more.” Therefore, you are relatively not as good as them and must significantly improve your performance, not against a set of clear objectives that lead to firm success, but against the performance of an ever changing, subjective, out of your control, set of peers.

    So what does it mean to be rated “High Performing” as a partner at PwC?  Not much since you’re part of a band of brothers that includes 89% of your partners in FY09 – the same percentage as in FY08.  What has changed is percentage on the right and left side of the “bell curve.”  In FY09, 4% of partners are considered “Exemplary” and 7% are considered “Under-performing.”  Interestingly enough it was just the opposite in FY08, 7% at the top of the heap and only 4% in the slush pile.

    How convenient. That’s not a bell curve. That curve has a different shape…

    Even though “only” 7% were rated as Under-performers, it’s clear to leadership that this is not going to cut it. Given that PwC Global revenues declined 7.1 % and North America also declined, “we have a greater number of partners who may have met their plan but are contributing below their peers.” That’s the bad kind of relative performance.

    What happened?  Were plans at an individualal level not set to add up to the total result that was needed to exceed last year?  Did the wrong people meet or exceed plan and the ones with biggest bang for the buck completely blow it? Rest assured, the 7% under-performers will have responsibility levels reduced (salaries) and shares reduced (equity income.) You’ve started down the relatively short slide out the door.

    The concept of relative contribution goes hand in hand with relative performance. Relative contribution means that in order to meet overall firm growth targets, the relative contribution of each partner must increase if he/she is to maintain his/her responsibility and share level.  But the firm reserves the right to decrease your responsibility and shares, even if you were rated high performing in FY09, if leadership doesn’t anticipate you will keep pace with your peers.  If that doesn’t sound like “the house always wins” I don’t know what does.

    Let’s go back to the 4% this year who were rated “Exemplary.”  Now, and in the future, the message is that the “Exemplary” rating and the bonuses that go along with it will be allocated based on “going above and beyond to reach strategic priorities.” Those strategic priorities, which we mentioned earlier, are focused on the “burning platform for growth.” These awards do not have an upper limit, have a floor of $50,000, and averaged ~100k to the 90 or so partners who received them.  Good thing that a large number of those partners are in the two lowest responsibility levels because when I look at what they earn on average and the median total compensation for these partners, let’s just say the others don’t really need the bucks. Relatively speaking.

    That’s not to say that the highest paid partners in a firm like PwC US really make that much either.  Relative to their clients, the top 25 client service partners, the top four US leadership partners, and the rest of the Leadership team are making pocket change.  Even the highest paid client service partners, on average, are making chump change when you consider that their audit clients in the US include some of the largest financial services survivors of the crisis.

    Caterpillar is an interesting company since one of their former Chairmen and CEOs, William H. Franklin who passed away in 1995, was actually a PwC alum.  Just goes to show you what you can accomplish if you get out soon enough. Suffice to say no PwC partner is making anywhere near even the lowest paid of these six CEOS. But the top four at PwC are making several million dollars a year and Nally almost 8x his partners’ median partner income.

    Let’s look at their colleagues in the UK and the UK Chairman Ian Powell.  In the UK, the firm issues audited financial statements, on an IFRS basis, complete with executive compensation and retirement plan disclosures and plenty of operating metrics. Here in the US, the firms fight transparency.

    “The toll of the recession on the big accountancy firms is illustrated again today with PwC revealing the firm has seen growth, but by only half of one percent.

    Results from the firm, released alongside its annual report, show UK revenues have gone up by around £10m to £2.25bn for the year ending in June.

    PwC’s advisory business grew by 5% to £737m (fm note: This the US$100m Lehman bankruptcy advisory effect which was not shared hardly at all with anyone else), while assurance saw a drop in turnover of 1%, to £861m, as did tax but by the slightly larger margin of 4% to £650m.

    Profits per partner fell to £777,000 (US1.3m), down 3%, a and Powell earned £3.3m (US $5.5m) for the year, against £5.2m ($US8.8m) for Deloitte’s chief executive John Connolly…”

    I can tell you that Dennis Nally, as the US Senior Partner prior to his ascendancy to the Global Chairman role, did not make as much last year as even his UK counterpart but that’s maybe just an exchange rate difference. For some reason, the PwC Global Annual Report likes to provide comparisons in constant dollars, as if the impact of the fluctuation in the US dollar last year was just a rounding error. The UK/US cross currency rate alone went from .502 on June 30th of 2008 to .607 on June 30th of 2009 and is at .602 today.

    Then again, Mr. Powell had a slightly better year than Mr. Nally.

    The Lehman UK bankruptcy administration put an enormous sum in the UK coffers and made their Advisory practice look like heroes. It’s expected to be a gravy train for them for a while.

    In the report, PwC revealed that in their first year working on the case they have charged £154m (€168m) in fees for work on the company’s winding up.

    The report notes that there has been a “general downward” trend in the average hourly charge-out rates for PwC partners and staff.

    The average hourly rate has dropped from £329 to £309 over the past six months, say the administrators.

    The profit per partner in the UK is substantially higher than profit per partner average in the US of $810k (a decrease from 2008) and the average or median income payout to US partners who are not on the leadership team or not in the group of highest paid 25 partners ($100k lower.)  The highest paid 25 client service partners at PwC are the ones who manage the audits of clients like AIG, JPMorganChase, Bank of America, etc.  And yet, their total payout for all that work is equivalent to a Wall Street guy’s custom tailoring allowance. Ok, throw in the Starbucks and dry cleaning budget and call it a couple mil.

    So what has this done to the goal of being a “one-firm firm” at PricewaterhouseCoopers?  Well, in addition to the overwhelming focus on growth, aggressive growth, “address the burning platform” growth that is contrary to Maister’s model, we see a deterioration of the partner compact based on a compensation scheme that pits partner against partner in a never ending game of trying to top each other.  They’ve reduced the “partners” to essentially “hired hands.” What does it do to partner morale when they realize the obstacle for getting paid a market wage for hard work, long hours, and significant effort is not losing the engagement to the competition but having your peer partners arbitrarily deemed harder working, more successful and bigger team players than you?

    Maybe I’m giving the average partner too much credit.  Are the 90 % of the partners who aren’t leading the largest engagements and on the leadership team really working that hard?  How often do you see them at your client or at your office if you’re a client? Hey PCAOB: How many hours do they charge to engagements on average?  1%, 5% , certainly not 10%.  And how many subordinates do they have, on average? With the way they manage the staff performance appraisal process you can see that the connection to staff is tenuous at best and true mentorship and ongoing supervision is an exception.  I saw quite a few partners who had no team, or had a team in name only, as staff was pooled and no one higher than a Manager ever coached, trained, or mentored them on a day-to-day basis.

    And what’s the incentive to stay in client service when you can make so much more in an administrative job on the leadership team?  No client complaints, no risk and quality paperwork, no PCAOB inspections, no revenue pressures, no liability, no hassles. Just endless meetings and conference calls.  Why not aspire to get out of the rat race of client service if it’s never going to pay more than a few million at the very most?

    It also means that we shouldn’t be shocked that the audit partners for these large public companies don’t act or feel like equals to their clients’ CEOs, don’t sit across the table from these leaders regularly, aren’t called into the huddle during crisis weekends when the fate of Wells Fargo, Merrill Lynch, Lehman Brothers and Bear Stearns are decided.  Money is the ultimate scorecard and Wall Street, in particular, is operating in a different league than the audit firms, especially in the US.

    At least in the UK, Mr. Powell, Mr. Connolly and their counterparts at EY, KPMG, even BDO are routinely sought after by the FT, the Guardian and the Times of London for their opinions on the economy, the markets, the future of capitalism, and general economic trends. Here in the US, if it’s not about an accounting related topic on their lobbying agenda or a new pet initiative such as “green” or “sustainability” you just don’t hear from them.

    Maybe “you get what you pay for” here in the US.

    Main page photo credit

    Inside video credit: The train paradox is a famous example of the strangeness of relativity. Demonstrates just how non-intuitive reality can be. “Whenever you get a paradox of relativity almost invariably what you are intuitively assuming is that things that seem simultaneous are really simultaneous when really the concept of which came first depends on your frame of reference.” Professor Richard Muller of the University California, Berkeley.

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    15 Responses »

    1. As former Big 4 tax partner who is now enjoying having my own firm, I think you have accurately summarized what I don’t miss about Big 4.

    2. Fran, you’re on fire!

    3. Iam pridem, ex quo suffragia nulli uendimus, effudit curas; nam qui dabat olim imperium, fasces, legiones, omnia, nunc se continet atque duas tantum res anxius optat, panem et circenses.

    4. Honestly, I have not met a single person who has left the Big 4 and misses it. In fact, if anyone goes back to the Big 4 from industry will admit that their primary motivation was money. Now that the Big 4 has no money, who would ever go back? It is a good thing that the Big 4 can still prey on the innocent new grads and convince them that Big 4 is the only way to go, by throwing a few lavish recruiting events and inviting them to a few meals (with alcohol, if still allowed by the schools). The Big 4 is melting down, and its leadership does not know what to do. Which Fortune 10 company would hire a Big 4 partner as a CEO? Get out early while you can.

    5. For those of you who do not read Latin, @3 is quoting Juvenal, the patron poet/philosopher of this blog.

      … Already long ago, from when we sold our vote to no man, the People have abdicated our duties; for the People who once upon a time handed out military command, high civil office, legions — everything, now restrains itself and anxiously hopes for just two things: bread and circuses…

      http://en.wikipedia.org/wiki/Bread_and_circuses

      Francine

    6. Couldn’t be any more accurate. Now if only the Big 4 leadership could figure it out.

    7. What’s the average or median figure anyway, I am curious

    8. I have a question inspired by a comment on Going Concern for partner pay. At GC, a KPMGer mentioned that there was a lot of talk of partners making 20-30% less in 2009, however, revenue was not down nearly that much, and it turns out partners may have made near their full payouts (compared with 2008).

      At D&T, we’re told global firms saw a 4.9% drop in revenue (and part of it is exchange rates), while audit remained virtually flat. Now I’ve heard rumors of the same 20-30% drop in partner pay here at D&T. If we had similar revenues, coupled with aggressive cost-cutting and fewer partners, wouldn’t the bottom line have been (mostly) preserved? For the partners lucky enough to survive the cutbacks – and I know they’ve felt the pain too – life isn’t that bad during our historic crisis.

      I might be missing something, but nothing a little transparency would not clear up.

    9. @Tony Rezko

      Two answers:

      1) Partners who are talking are the ones who saw significant drop so partners at top (who aren’t talking) can maintain payouts at near recent levels.
      2) Litigation, litigation, litigation. Lots of settlements, bigger amounts. Maybe more reserves.

      Francine

    10. From my perception, the client service is suffering. In the last 18 months, I’ve seen numerous (more than 12) client deliverables that had errors and insufficient data because PwC does not value, or bring in, the subject matter experts. One deliverable was so poor and inaccurate that I’d be surprised if the client ever asks us back again. We gave another client “recommendations” that were “googled” and elementary. Yet another team provided a CBA that missed 75% of the real costs because the team didn’t know any better. Because the “U” word is like a whip with chain (utilization), everyone seeks ANY engagement they can find, and they take whatever they can get…without asking the right teams for help. As a result, directors without the proper skills are trying to find engagements and provide clients with incorrect deliverables. RFPs often go to the wrong group. While this has happened in all groups, internal audit appears to be the worse culprits. They think they have the skills to “fix” whatever they find from their audits. Rather than bringing in others, they deliver less than average, and sometimes incorrect, reports. Until the firm pays for team performance, and encourages use of the right skill for the right engagement, the quality will suffer.

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