Professional Services: what are we paying for, exactly?
Dec 17, 2014 5:51:00 AM
As supply management evolves into a strategic business function, one of the key roles procurement teams often play is to challenge stakeholders to justify what they are paying for. In “traditional” cases this is relatively easy: you can count the number of laptops you need to buy, you can benchmark the wholesale price of utilities, you can understand the need to use a recruitment agency to find new or replacement staff.
Professional services, however - that’s just people coming in and telling you how to do things better, right? How can you tell whether their fees are worth it? And how can you be sure you wouldn’t get the same service, but cheaper, elsewhere?
Part of the problem is that large professional services firms – such as lawyers, financial services firms and advertising agencies – are unlike manufacturers. They often seem to operate on reverse economies of scale: the bigger they get, the more they seem to be able to charge.
That’s why procurement has to be really smart about hiring professionals if it’s to have any credibility with colleagues who work with those firms. And the first step is to understand why professional services firms’ fees are the way they are.
- Limited supply. Look at how they’re described: The Magic Circle of law firms, The Big 4 accountancy firms – at the top level of professional services, there is often an oligopoly. The message these firms send out is “if you want to access our talent, it’s going to cost you.”
- Uniqueness. Every professional services engagement will have some unique aspect. That’s why your organisation wants them: they are offering something you can’t get from within. A process or a system can’t replace a partner’s unique expertise, personality or experience. So clients are prepared to pay bespoke prices.
- Scale. Large companies often want to work alongside businesses with similar scale to ensure their demands can be met.
- Talent. Big firms often attract the top talent with lucrative financial packages. Clients can benefit from that depth of talent – but often at a price.
- Risk. Working with a large (or expensive) outfit can bring the perception that risk is being managed. More importantly, using firms from an elite group reassures senior executives and shareholders that management aren’t taking undue risks.
All of these elements made it easy for the larger professional services firms to justify high fees and created an ever-increasing spiral of rates that rose almost uncontrolled until the 2008 crash.
Even post 2008, though, understanding professional services fee rates is a complex business. Over-supply and a lack of client projects may have led to aggressive discounting but buyers still haven’t got much closer to fixing what the true cost or “market rate” for a particular service or individual should be. And now, as a result, we’re seeing headlines of fees starting to climb again.
Breaking down each service into its individual input costs isn’t helpful in this case. Professional services fees, like statutory audit, are a murky world that is difficult to understand and is not based upon factors that procurement guys are used to working with, like input costs, mark-ups on third party charges, straightforward margins and index-linked price rises.
The main costs for a services firm are its people, maybe some proprietary technology and some overheads. But in this business costs don’t have a linear relationship with charges. A quick glance at the Lawyer’s UK200 review of legal firms’ performance will show you that some firms can command margins of 40%+, while others “struggle along” at 10-12%. While you will always be able to find a cheaper lawyer, less sophisticated technology or a firm with offices in Letchworth rather than the City, will they really deliver against all of the points above?
Let’s come back to the example of statutory audit, on the surface it looks like a standardised service to validate an organisation’s financial reporting and the checks and balances it employs, often against a set of pre-determined rules and regulations. But the best (or worst) auditors can bring all manner of additional value (or risk) depending on how it’s procured and the provider is selected. When you’re buying widgets you can specify dimensions, tolerances, quantity and logistics. But audit relies on more nebulous factors such as capabilities, sector knowledge, personal chemistry and more.
And while any supplier failure can be disastrous, getting it wrong with professional services like audit can be terminal. The most famous example is Enron – where shareholders might have assumed prestige firm Arthur Andersen was a reliable auditor. The reality, of course, is that management was procuring dodgy advisory services from the firm – and the audit arm was signing off on them.
In the professional services realm, you’re going to have to live with the fact that most senior execs will want to use the “best” and most expensive guys in the market. The job of the buyer, then, is to get the most out of these guys and to keep some control over the relationship so that you are not continually ripped off by their obfuscation and obscure fee structures.
In my opinion, the evolution of sourcing professional services, coupled with increased regulatory and stakeholder/shareholder scrutiny, means that procurement teams need to think very carefully about how they approach this highly sensitive area of business – engaging in business conversations (not procurement ones), identifying the levers for enterprise value (not just cost), reputation management, risk, innovation etc. – to ensure they position themselves as credible advisors, able to bring some clarity around what exactly the business is getting for its money and whether these outputs really make a business case stack up.
If you would like to find out more about building better professional services relationships, download our five key recommendations for maximising your audit tender process here.
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