And how understanding the business model of your employer will help you get one
Brace yourself, promotion season is coming. The yearly event where every tired and overworked accountant, lawyer, consultant, [insert white-collar professional] eagerly awaits that meeting with their superiors to discuss one thing.
When I was an accountant in a public practice accounting firm, I would wet myself with nervous anticipation about what my pay-rise would be.
I mean, the obligatory 2-3% indexation adjustment was a given. What I cared about was the meaningful increases to my salary package. The 10%, 15% even 20% jump!
The meeting itself inevitably begins with small talk. How’s your day been? What plans do you have for the weekend?
Then, the conversation abruptly turns to the firm’s budget, your performance, and where you sit in the elusive ‘salary-band’.
WTF is a salary-band?
Salary-bands have forever been a tool for HR managers and Partners to put their employees into a box. A framework to help them decide, without bias, where their employees fit into the overall hierarchy of the firm.
It’s an easy mechanism to fit cogs into their machine
The thing that I never seemed to understand was that managers always spoke in ‘bands’, but rarely explained to you what they were – in dollar terms that is.
I always questioned how they came up with these bands. How were they derived? How were they calculated? Do they actually exist or was the whole thing just made up?
Despite my probing, managers always had the same generic response. That the salary-bands are based on an ‘independent benchmark assessment’ of comparative firms and market conditions. Of course they never disclosed the source of this apparent ‘data’.
I could never get a straight answer.
Over time, I accepted that that’s the way the world worked.
That if I was placed into the band, then that’s what my salary is.
Afterall, who was I, the humble employee, to decide what I was ‘worth’ to the firm.
A Different Perspective
That all changed on the 4th of September 2015.
It was the day I turned the tables of my professional life.
It was the day I decided to quit my job.
It was the day I started my own business.
Rather than being an employee of a professional services firm, I suddenly became the employer.
I started to see things in a different light.
As an employer and financial advisor to other professional services businesses, I wrote this blog to help employees think about how they should think about pay-rises.
Why? Because I wish somebody explained this to me when I was an employee.
Here we go.
Understanding the economics of a professional service business model
Here’s how a professional services business model works.
Every services business has 3 primary business functions. Colloquially, these functions are referred to as;
Finders, Minders and Grinders.
Let’s start from the top.
Finders – these are the folks that are responsible for ‘finding’ new sales. They spend most of their time in business development, bringing new accounts to the firm and upselling to existing clients.
Minders – Minders are responsible for managing the ship. They are responsible for quality assurance, workflow and maintenance of existing client relationships.
Grinders – These are the technicians. The often overworked, underpaid grinders pumping out the billable hours that drive the economic engine of the entire firm.
We can decode these functions into your typical job titles, as follows:
Now that we have the three primary functions sorted, let’s deep dive into the economics.
How to build financial value as an employee
I’m going to invite some controversy with this statement. It is this:
There is no financial value in a typical professional services business.
The ‘financial value’ is with the Partners of the firm. Their relationships, their network, their knowledge and personal reputation in the market.
It’s a reason why it’s not uncommon for Partnership buy-ins to be structured on a ‘no goodwill’ model, where Partners entering and exiting don’t buy or sell Goodwill. The financial contribution they make to the partnership is for ‘’working capital’ to fund day-to-day operations.
Accordingly, Partners of such firms are not actually business owners in the traditional sense. Rather than owning a part of a business with value, they are simply buying a right to income.
Income, in the form of their annual profit distribution.
Accordingly, your financially motivated boss (aka Partner) is focused on one thing and one thing only. That is, to maximise their annual profit distribution.
As an employee, you should try to understand how you can help them do that as it will put you in a better position to negotiate a pay rise.
How to Maximise a Firm’s Profitability
You can help your Partners maximise their profit distribution in 3 main ways. They are:
- Improving the top line (sales) – by bringing new accounts into the firm and upselling existing clients
- Improving the bottom line (profit) – by effectively maximising productivity and efficiency of client work
- Improving the bottom line (profit) – by maximising billable hours, over and above your budget.
Let’s break it down.
1) Improving the top line (sales)
by bringing new accounts into the firm and upselling existing clients
Business Function: Finders
It is rare to find any firms have KPIs on winning new business. Professional services firms don’t traditionally have business development engines. They rely on word of mouth and referrals. If you have a knack for business development (and can execute on it), you will immediately be favoured by Partners.
If this is you, the KPIs you need to track and manage are:
- $ value of new revenue brought to the firm in the form of new clients
- $ value of new revenue brought to the firm in the form of upselling services to existing clients.
- # of strategic partnerships generated (partnerships with complementary service or product providers that may eventuate into sales/referrals).
If your firm doesn’t have the tools to track and measure these KPIs (highly likely), then it’s up to you to do it. Just keep them in a simple spreadsheet.
2) Improving the bottom line (profit)
Focus on efficiency by effectively managing and maximising the productivity of the technicians doing the billable work charged to clients
Business Function: Minders
The professional service business model is built on a system of leverage.
That is, the head-honchos at the top need to push all the technical work down to the minders, who then delegate the work to the grinders to get it done. The Partners need to generate a profit on all of the work done by the managers and technicians.
Accordingly, the ‘Minders’ in traditional firms play 2 roles.
Primary Role of the Minder – to ensure work is completed on time and on budget
The primary role of the Minder is to ensure:
- workflow is allocated effectively to the grinders;
- the work is getting done on spec and on budget;
- their clients/customers are happy
If you are in this category, the KPIs for you to track and manage:
- $ revenue (billables) per Minder/Manager
- Number of Grinders managed per Minder
- Client Net Promoter Score
- % of Jobs completed on spec and on budget
The more $ Revenue and number of Grinders managed under you, the more ‘leveraged’ the firm is. A back of the envelope metric to understand the financial leverage can be calculated as total Revenue / Headcount. This is an indicator of how efficiently run your firm is, which directly correlates to profit.
Of course, you can have a highly financially leveraged team, with lots of revenue and minimal staff. But, if it comes at the expense not getting through all the work or poor quality, then it will impact customer satisfaction and will result in churned clients and revenue. The last 2 KPIs are therefore operationally focused.
The secondary role of the Minder is to also do billable work.
Minders are in a challenging position because not only do they have to train, manage and nurture the Grinders, but they also have the expectation to grind themselves! They also have crazy targets of billable hours to bring to the firm.
It’s a reason why most Minders quit ‘Public Practice’ at this stage of their career.
It is hell.
The final way an employee can help Partners improve their profit distribution is by grinding. This is you, Grinders.
3) Improving the bottom line (profit)
as a technician by working and charging billable hours, over and above your target financial contribution.
Business Function: Grinders
If you are in this category, the KPI for you to track and manage:
- $ revenue (billables)
- Number of review points per file (this trend line should decrease over time ideally!)
Accordingly, the only lever you have is to maximise your billable hours to the firm, in the form of utilisation rates, and reducing write-offs (by reducing time spent on re-work due to mistakes).
If your firm charges via hourly rates, then the financial value you can bring to the firm is limited to the number of chargeable hours you do on a day-to-day basis. Assuming you are meeting your target utilisation or ‘productivity’ rate (typically 85%), you are meeting the minimum level of financial contribution to the firm.
How charge-out rates are established
There is actually a science behind how our hourly charge-out rate is established. It is derived on your salary and function in the business.
Professional service business models work on a ‘rule of thumb’ financial metric of ‘the rule of thirds’.
That is, of total revenue, ⅓ are wages costs, ⅓ are overhead costs (rent, insurance etc.) and ⅓ is profit.
Practically what this means is that your Partner needs to be earning at least 3x – 4x of financial ROI on your salary cost. This means the firm is making, at a minimum, a ~65-70% profit margin on the work you produce for the firm.
This target margin is actually already built into your hourly-rate. It’s broken down in this calculator:
In the example above, a Grinder on a $70,000 base salary with an 85% productivity rate needs to generate net revenue of $322,000, assuming a ROI multiplier of 4x.
Factoring a target 85% utilisation rate and an average write-off of 20%, the ballpark hourly rate for this employee is $275 per hour.
Now do you understand why your managers are always busting your balls on productivity rate. A higher productivity rate = more fees = more profit!
As employees are promoted, their target productivity rates reduces, as more time is expected to be spent on non-billable work, like managing staff, workflow, business development etc. At the same time the salary package will increase as there’s more responsibility.
In order to maintain the Partner’s target profit margin, the Hourly Rate has to increase to compensate for the lost hours of productivity, as well as the additional costs associated with your pay rise.
I hope you’re beginning to understand how the leveraged business model works in practice.
Varying Inputs to the calculator
The inputs to the calculator, like the salary multiplier for example, will vary depending on the firm. The main factors are; the branding of the firm and the profit expectations of the Partner group.
Big-4 firms, for example have charge-out rates up to $1,000 per hour. It is so because they can demand it in the market via brand reputation and specialisation.
In addition, they need it in order to sustain the circa $1M of profit distributions their Partners receive annually, plus, the 20% of profits that are paid out Retired Partners’’…(*cough PWC cough*)
Contrast this to smaller, boutique firms that operate on a fraction of those rates.
Overall, the inputs will differ, but how it’s derived is the same.
If you’re curious to understand the economics of your charge-out rate and expected ROI generated for the firm, you can download a free copy of this calculator at the end of this blog.
What you should you bring to your salary negotiation
In addition to your confidence and bravado, I’ve outlined below the data you should bring to your salary review to inform the conversation.
Ultimately, the ‘salary band’ is, like every management concept, is fabricated. An invented framework to guide salary conversations. I’ll assure you that it is a tool only – and one that is flexible.
My recommendation is to get really specific about the Financial ROI you should targeting to contribute to the firm.
If you can prove that you are generating over and above financial ROI on your contribution to the company based on the above 3 functions, then you are in a strong position to negotiate a pay rise – because you have generated more money for them!
In other words, if you build a case to justify that you are a revenue-producing asset to the firm, your boss will pay a premium to invest in you to grow and retain you!
And what if you don’t have the direct ability to quantify your impact to your organisation?
What if your role isn’t directly correlated to ‘billable hours’?
Here’s the thing.
Your value doesn’t decrease based on someone’s inability to see your worth.
Understand the box they are trying to put you in.
And if you struggle to fit into that box, find a different one.
Or, create a new one altogether.
One final note:
Reflecting on my experiences both as an employee and employer, my view is that employers should communicate to their employees differently about their role in the business and associated remuneration.
Rather than talk in brands, brackets and hierarchy, which I gather is derived on an Industrial Age business model, I think employers should first explain the business model their employees are signing up to.
Questions I would be asking as an employee:
- What is the business model?
- Where do I fit in that model?
- What does success look like in that function of the model?
- What’s the roadmap and how can I perform beyond the expectations of the model?
I invite anyone with expertise in this area to engage in a discussion as I myself have not fully fleshed this out. Consider this an open invitation. I’d love to hear from you.