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a firm cannot remain profitable if all its projects are priced to cover only its
variable or marginal costs, but in the short term, squeezing in a project that
covers only its marginal labor and direct out-of-pocket costs may help in-
crease the firm™s overall profitability. In the very short term, even projects
that do not cover their direct labor costs may still be profitable for the firm if
it could not have avoided those labor costs otherwise because the staff that
worked on the project was able to squeeze it into their normal schedule.

Client Compensation Contract Negotiations
Compensation contract negotiations with the firm™s clients are one of the
most critical factors in determining the firm™s profitability. At the outset of a
relationship, these negotiations form the foundation from which the firm will
live, possibly for many years to come. Because of the long-term precedent-
setting nature of these discussions, it is important that the firm negotiate the
best terms possible. Often this may mean taking several months to negotiate
in the case of a long-term relationship, but that upfront investment of time
will, if done well, pay dividends for many years to come.
Most contracts include two main types of issues: financial and nonfinan-
cial terms and conditions, including the scope of work. Getting the most fa-
vorable financial terms may not be best for the firm if it does not negotiate
reasonable nonfinancial terms and conditions as well.
378 The Back Office: Efficient Firm Operations

SETTING THE PRICE. Establishing the rate of compensation and the
methodology to be used is the most basic and yet critical point in the negoti-
ations. Regardless of compensation methodology used, the firm would be
well advised to understand its projected costs by estimating the total number
of hours by each type of staff required to complete the project. This analysis
allows management to determine, a priori, the break point at which the firm
will walk away from the negotiations. Compensation methodologies can take
many forms and include:

• Time and materials: Under this type of agreement, the client agrees to
pay the firm for its actual time and all out-of-pocket expenses. Normally,
this type of arrangement is applicable to situations where the client rec-
ognizes that the scope of work is difficult to determine and thus it would
not be fair to force the firm to commit to performance of a project that
cannot be well defined. Sometimes the firm is able to negotiate prices to
be at its “standard” hourly rates. Alternatively, rates for each level of
staff may be negotiated separately. In some instances, the rate may be a
simple f lat rate irrespective of the level of staff (e.g., $250 per hour no
matter who works on the project).
• Fixed price: In situations where the scope of work can be fairly well de-
fined, it may be appropriate to negotiate a fixed price arrangement.
This gives the client the comfort to know that the firm cannot exceed
its budget without prior approval (assuming such a provision is negoti-
ated), and it gives the firm a virtual guarantee of revenue. To negotiate
this type of deal, the firm should first confirm the scope of work; then
it can estimate the total number of hours required to complete the proj-
ect and multiply those hours by standard hourly rates for each person or
class of staff to participate in the project. It is important for the firm to
recognize that it will be obligated to deliver the project in its totality
even if it takes more time to complete than estimated originally, so it
should ensure that it can in fact deliver within the time allotted; other-
wise, it could face a significant financial liability.
• Commissions: Depending on the nature of the services to be rendered, it
may be appropriate for the client to pay the firm as a percentage of the
project™s total costs. This method has been used for decades in the con-
struction management and advertising industries. Depending on the
volatility of a client™s spending level, this method may provide potential
for significantly increased or decreased revenues as compared to a labor-
related cost-based approach.
• Hybrids: Depending on the specific circumstances of the client and the
work assigned to the firm, some combination of the basic compensation
plans mentioned earlier may be appropriate. For example, a time and
materials contract may include a provision that the fees will not exceed
a certain dollar level. A commission arrangement may guarantee the
firm a certain minimum compensation level to ensure that it can provide
Finance, Accounting, and Human Resources

the staff necessary to support the client™s assignment. Also, the client
may agree to add in a bonus component to the base compensation struc-
ture to incent the firm to achieve certain performance standards. In
some cases, these standards may be objective and quantifiable whereas
in other situations, criteria for payment may be more subjective.
• When to reject a client™s “ best offer” for compensation: In many cases, a
client™s budget will not be sufficient to cover the firm™s initial cost esti-
mate and the two sides must then negotiate a mutually beneficial fee.
At some point, the firm must walk away from the assignment if the fi-
nancial terms and conditions are not sufficient to meet its requirements
to properly service the account. Determining that point is very difficult
and involves both objective and subjective factors. Short-term projects
that can be squeezed into the firm™s normal schedule with its existing
staff can, and probably should, be accepted if the revenue is any where
near its direct labor cost, irrespective of its overhead component.
Longer term or large-scale projects should be accepted as long as all of
its direct and indirect costs, including overhead and a minimally accept-
able profit margin, are covered. In some circumstances, there may be
valid strategic reasons to accept an assignment that does not provide
sufficient net income to the owners and may not even cover all fixed
overhead allocations. Senior management should sign off on any client
contract that is below the firm™s guidelines for profitability. Acceptable
profit margins vary by industry, but it is not unusual for professional ser-
vices firm targets to exceed 15 percent to 20 percent of gross revenue.

NONFINANCIAL TERMS AND CONDITIONS. As noted earlier, financial
terms are only part of the equation in negotiating a mutually beneficial con-
tract. Certain clients demand that the firm adhere to its “standard vendor
agreement,” ignoring the fact that most of those agreements are written to
cover the procurement of materials, not services. Accordingly, the firm that
recognizes that everything is negotiable will insist on the negotiation of a
contract that is applicable to the type of work being performed. In many sit-
uations, the client™s procurement team will try to accommodate that request,
generally to a lesser rather than a greater extent. Whenever these types of
contracts are being negotiated, the firm should employ legal counsel to en-
sure all terms and conditions are acceptable and understood. At a minimum,
the firm™s negotiations should address the following issues:

• Liability and indemnification: Terms of the contract should identify
the circumstances under which each party will indemnify and defend
the other party in the event a claim is made against it, often in the form
of a lawsuit. The firm should be careful to insist that, in cases where the
client will indemnify the firm, it will also defend it against any claim as
well as indemnify a judgment or settlement. The difference here is that,
without such a provision, legal costs to defend the firm against the
380 The Back Office: Efficient Firm Operations

claim remain with the firm and only the judgment, or settlement, is
paid by the client. In many cases, legal costs to defend may be signifi-
cant and may even exceed the amount being sought by the plaintiffs. By
including the words “and defend” in the terms of the agreement, the
firm can minimize its exposure against potential claims.
• Timing of payment and billing frequency: As noted earlier, the timing
of payment from the client should be actively negotiated. Payment of
fees ideally should coincide with the firm™s payroll cycle (e.g., two times
per month) and, when appropriate, include a provision that allows the
firm to prebill certain types of approved estimated costs.
• Notice period: Every contract, by definition, has a termination date.
The extent that the firm can negotiate a longer termination period
while fees continue to accrue can provide a significant contribution to
the firm™s profits. For example, if the client is willing to initially offer
the firm only 30 days™ notice (which should always be required to be in
writing) and the firm is able to extend that termination period to 90
days, it may have been able to improve its revenue and profit position by
simply asking for and justifying a longer termination period. Many pro-
fessionals are reluctant to ask for such terms, but many clients are will-
ing to agree to them in exchange for other contract provisions.
• Scope creep”getting paid for everything you do: One of the most vul-
nerable areas of professional firm management is the definition of
scope. Invariably, clients expect the firm to produce much more than
the firm ever envisioned when originally accepting the assignment.
Professionals, always eager to please their clients, may be reluctant to
ask for additional funding if their actual work borders on a gray area not
well defined in the original agreement. The key here is to ensure that
the original agreement defines fully, and in objective terms to the ex-
tent possible, all the work that will (and in some cases won™t) be per-
formed. If well conceptualized and well written, it will be reasonably
clear when the client has asked for something that is out of scope and
thus entitles the firm to additional remuneration.

Administrative Efficiency
Administrative functions in professional services firms normally are not the
focal point of executive management attention, nor should they be. Finance,
accounting, human resources, IT, and facility management, the so-called
“back office” functions when well managed, require little executive manage-
ment attention. However, when back office functions receive little oversight,
they may become suspect if their accomplishments are not well publicized.
To ensure that such functions are productive and their results easily under-
stood by executive management, tasks should be quantifiable and results
measurable. If every staff person™s position were organized in such a way
Finance, Accounting, and Human Resources

that at least one major function is quantifiable, workload and results could be
charted and graphed to portray an accurate picture of the relative efficiency
of each department over time. Examples of quantifiable functions include:

• Accounts receivable: Total dollars past due by month
• Billing: Number of bills issued each month and on-time payment statistics
• Cash collection: Total cash collected
• Accounts payable: Number of invoices processed (also percentage
processed without error); cash discounts achieved
• Financial planning: Percentage variance of actuals versus forecasts by
• Human resources: Number of candidates interviewed versus positions
accepted; number of separations processed; annual staff turnover rate
• IT: Number of help desk calls taken; average time to resolve a call
• Facilities management: Electricity consumption per headcount; main-
tenance costs per square foot and per headcount

By monitoring these key activities and rewarding excellent results with
spot bonuses or other types of recognition, the firm can secure better than
average productivity. However, in spite of these measures, as the firm grows,
at some point additional administrative staff will be required. When to add
that staff is a key question.
As a rule of thumb, a new position should be added once existing staff rou-
tinely is required to work more than 50 hours per week. With respect to finan-
cial staff, they normally may work 50-hour weeks during the monthly close and
fall back to an average at or just slightly above 40 hours in other weeks. How-
ever, if existing staff are unable to close the books in five or fewer working
days, either they are understaffed or their procedures are insufficient. If it is
determined that their procedures are adequate (which the graphs noted ear-
lier may help illustrate), additional staff may in fact be needed.

Mergers and Acquisition: Time to Revisit
Policies and Procedures
When a firm acquires another firm or it is acquired itself, this action pro-
vides management with an excellent opportunity to take a fresh look at poli-
cies and procedures at both firms and, when appropriate, take the best from
each or simply upgrade them to meet identified needs. For example, if cash
f low is insufficient to meet the combined firm™s objectives, it may use the
announcement of the merger as an opportunity to implement a semimonthly
billing process. Similarly, treasury functions can be merged, including the
implementation of credit limits for each client. Human resource functions
can be consolidated and redundancies eliminated. Merger transition plans
382 The Back Office: Efficient Firm Operations

should also set forth the goals for the IT team and plans for integrating net-
works and eliminate unnecessary redundancies. As difficult as it may be to
integrate two firms, if done well, clients from both firms may benefit from
reduced administrative costs and improved systems.

In this chapter, we have discussed a wide range of issues that professional
firm executives need to understand in order to provide their firm with sound
fiscal leadership. HR functions are an integral component of the firm™s
financial management as the majority of costs are tied to compensation and
related perquisites. Because so many of those HR issues involve interpreta-
tion of complex legal issues, HR professionals should be capable of recogniz-
ing when to utilize competent legal counsel and have the budgetary support
to tap those resources as needed throughout the year. Employee perfor-
mance should be evaluated in writing at least once per year and excellent re-
sults rewarded within an equitable market-based compensation system.
Executive management of the firm must ensure that GAAP are enforced,
particularly by being conservative in its revenue and expense recognition
policies. Long-range planning should be well documented and form the foun-
dation for the annual budgeting process. Annual revenue, expense, and capital
budgets that are developed from the bottom up by line managers within a set
of high-level targets established in the long-range planning process are more
likely to be effective than those set from the top down. Monthly updating of
all budgets and forecasts helps to keep executive management well informed
as to the fiscal health of the firm. A monthly briefing book, or executive re-
porting package, that includes historical financial statements, forecasts, and
trend reports can expedite the review process and highlight key managerial
issues. Finally, contract negotiations with both clients and vendors should
focus on key terms and conditions as well as pricing. The masterful execution
of these component principles is critical to a well-managed professional ser-
vices organization.
Purchasing, Procurement,
Vendor, and
Asset Management

People who work together will win, whether it be against complex football defenses or the
problems of modern society.
”Vince Lombardi1

If, after the first twenty minutes, you don™t know who the sucker at the table is, it™s you.

This chapter outlines management practices for ensuring that the profes-
sional services firm selects and manages outside vendors in a manner that de-
livers the most value to the company in exchange for consideration paid to
the vendors, all the while working in a partnership with the vendor to fur-
ther the aims of both the company and the vendor.
In this chapter, we emphasize the importance of properly managing ven-
dors and provide techniques for monitoring and assessing vendor perfor-
mance. We cover the typical vendor types found in a professional services
organization, how to set thresholds for prioritizing vendors that need scrutiny,
and how to establish and assign the vendor management role within the firm.
We also discuss how to take control of vendor relationships, particularly in-
herited ones, how and when to recompete vendor contracts, and provide
guidance to the vendor manager on working with vendors in turmoil or finan-


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