It’s January 2017 (hard to believe). Many mid-market firms are finalizing their numbers for 2016 and it appears to be shaping up to be a pretty good year with organic growth averaging at 4 percent to 6 percent and equity partner compensation seeing a modest increase principally through technology enhancements, more and more work being shifted to India, and intense expense control.
This is also the time of year when many firms begin to lock down their 2017 operating budgets, evaluate partner performance, reward partner compensation adjustments for 2016, and set partner goals for 2017.
All good things that very well managed mid-market firms do around this time of the year. We continue to find, however, that very few firms perform annual appraisals on the quality of their client base. This is a missed opportunity, and over the years (particularly post the financial crisis, when organic growth has been very difficult to come by), a good number of firms have slowly attracted lots of clients that are referred to as low-hanging fruit that does little, if anything, to build the firm’s brand, intellectual capital, profitability and client credentials.
In fact, we have found that this so called low-hanging fruit has become a curse or a drug, if you will, and once firms go down this path, it is very hard for them to turn away. Clients that are viewed as low-hanging fruit are generally looked upon by partners and staff as lose/lose propositions!
This low-hanging fruit that we are referring to includes employee benefit plans (unless you have a dedicated group that can perform this work, it generally is low reward and high risk because of the Department of Labor oversight and regulations), condominium associations (we haven’t yet met one mid-market firm that makes a decent margin doing this work and the clients are very tough to work with), and other nonprofits (except for the seasonality of this work, there isn’t any compelling reason to be doing it; auditor rotation occurs every three or four years, margins are terrible, risk is high and unless your partners are getting access to prominent board members who might be a source of business, it doesn’t make much sense to pursue). Low-hanging fruit also includes Sarbanes-Oxley compliance work that bears very low margin these days and, if President-elect Trump’s administration is successful, SOX requirements will be substantially, if not completely, eliminated to help invigorate small and midsized company IPOs in the United States.
One more very popular type of low-hanging fruit that is a curse is client work that comes out of a small practice acquisition, which usually consists of clients with small compliance fees that haven’t received high-quality services over the years. We have found that clients and staff picked up through small practice acquisitions are here today and gone tomorrow. Again, very unrewarding.
The worst part about all this low-hanging fruit, however, is the negative effect it has on the professional staff, and that’s the principal reason why we refer to it as a curse. Staff quickly realize that these pieces of business are taken by the partners just to keep the staff busy and because a dollar of revenue is better than no revenue at all. This is a turn-off to staff, particularly the younger ones, who are looking for professional challenges and opportunities for growth. If they see too much of this low-hanging fruit in the practice, they question if your firm is right for them. At a minimum, this usually results in poor morale and, more often than not, defections of some of the firm’s best people.
In my opinion, as mid-market firms are turning away from 2016 and start looking towards to 2017, they should consider performing client appraisals for new client wins (at least for the major wins) to assess the quality of the firm’s year. It is a very simple exercise, not time-consuming but very effective in determining if your partners are selling work simply to meet their new business bogeys or if they are they selling work that is challenging, rewarding and has the potential to help perpetuate the firm.
A new client appraisal tool usually asks if the prospective client will:
- Allow the firm to build new skills and service capabilities?
- Add to the firm’s list of marquee clients?
- Allow the firm to train younger professional staff?
- Provide staff an enjoyable and meaningful experience?
- Build the firm’s industry credentials?
- Create access to C suite executives and board members?
- Value the firm’s services or view the services as a commodity or necessary evil?
If you find that this assessment demonstrates that your firm is attracting too much of the low hanging fruit as new clients, goal setting sessions with the partners should probably include discussions about the type of work that the firm wants to attract as opposed to what it is attracting. Partner compensation time is a very powerful tool for behavior modification.
Too much low-hanging fruit creates the risk that short-term profitability and partner compensation (a firm’s income statement) trumps building the brand, intellectual capital and client credentials (a firm’s balance sheet). We encourage you to be a little less hungry for top-line growth at almost any cost in 2017 and a little more hungry for retaining your all-stars by demonstrating that you are striving to perpetuate the firm for the next generation by attracting quality clients. This is easier said than done at many firms, but in the long run, it’s a win/win for those firms that want to build a sustainable mid-market brand!
Dom Esposito, CPA, is the CEO of Esposito CEO2CEO, LLC, a boutique advisory firm consulting with small and midsized CPA firms on strategy, practice management, mergers and acquisitions.