A Hard Rain Falls: Professional Services in 2009
Wednesday 26 November 2008 at 12:00 The term ‘credit crunch’ no longer quite covers what history will see as a major sectoral and global correction. A contact of ours, Edward Craig has, with some wit, suggested that we call the crisis the ‘Great Capitalist Deconstruction’.
Literary deconstruction exposes ‘unquestioned metaphysical assumptions and internal contradictions' [OED]. This seems to be what is going on in the economy as we write – the unraveling of assumptions about value and the exposure of internal contradictions within finance capitalism.
The first stage of the crisis showed us that the banking system was built on what were in effect lies (let’s be honest about this).
The second stage (which we are entering) is the unfolding of what happens when the lies are exposed – in effect, the undermining of whole sectors that either benefited from complex financial engineering or depended on easy consumer credit.
The crisis in the banks and amongst insurers is well known. The troubles in the property sector, amongst small businesses, in the auto industry and in consumer services such as retail, present the second stage. These are only now working their way through the system.
But what of those who provide professional and business services not only to banks and insurers but to what is rapidly becoming an ‘old economy’ that offered fashionable disposable ‘things’ to people who had easy access to credit?
Why We Need To Understand What Is Happening
We have been making our own enquiries. Half of our business derives from this sector. We are not going to survive unless we understand what is going on and can come up with products and services for new times.
The collapse in the system has been so fast that professional services sector adjustment has had to be rapid, against a back-drop of often inadequate information and analysis.
We were lucky in a manner of speaking. Our own connections advised us successively of the sub-prime crisis, the collapse of Lehman Brothers and the assault on the UK banks before rather than after they had happened.
There are always some who can see a crisis coming. The art is to know who they are and to listen to them critically but with care. Even this foreknowledge doesn’t mean that we will survive, only that our chances of survival are much better than that of many others.
Our approach was to put in a three-part strategy for survival. The first stage was implemented from April (and involved shifting our product portfolio, of which more next week). The second stage is being implemented from this month (and involves rethinking the structure of the business).
The third is slated for April next year and is our little secret. Most other service firms seem to be entering their first stage thinking with big overdrafts (which we do not have) and much higher proportional head counts.
Cutting Head Count By Stealth
So, what are professional service firms (lawyers, accountants and management consultants) doing, now that it is clear that this is not going to be merely a re-run of the 1990s but something far more interesting?
Well, premium is being put on experience. Anyone over 50 is being dusted off for a view on what things were like when they were running their first serious unit or company in their 30s. This in itself is helping to guide action but with not always fortunate consequences.
Headcount freezes have been one of the first acts of most firms. Support service budgets have also been frozen, sometimes cut.
In the vulnerable mid-sized sector, squeezed between big brand name firms and small niche specialists, the slaughter has already started as any regular reader of, say, The Lawyer since mid-October will have noticed.
Many firms are deeply reluctant to indicate that they are having difficulties maintaining staff levels. Transparency is an issue. Many partners and lower level staff will leave silently with pay-offs which may not be large but are larger than a worker might expect at a manufacturing plant.
Since they think costs of entry into the market are low, they think they can set up again as freelance low-overhead experts and independent consultants ‘with a better quality of life’.
As those of us who have done it know, costs of administration and marketing without an adequate infrastructure are considerable. Business does not automatically shift to an executive because he is popular and cheap.
This mutual conspiracy of silence over job losses in the professional services sector to avoid ‘shame’ seems like the best way to get overheads cut without (apparently) affecting client trust in the brand - but it has its costs.
The ‘Missing’
One senior executive pointed out to us that this strategy had a very unfortunate effect on the morale of those remaining. A desk would become empty without any prior communication to clients or colleagues. The direct telephone number would go unanswered or be transferred to a colleague.
He likened it to the ‘missing’ in the Latin America of the 1970s or the Soviet Union of the 1930s. The whole business becomes the unfolding of a paranoid fantasy to those who remain. The difference, of course, is that (fortunately) these people have not been murdered or enslaved but simply sent home.
The Web 2.0 culture means, however, that the ‘disappeared’ are soon debriefing their remaining colleagues. Those colleagues are free with their doubts and concerns in turn.
In other words, the senior management of many firms seem to be running scared with no conception of how the new media are undermining their authority.
There is another disturbing aspect of the lack of management decisiveness. Cuts in both staff and external services mean that those remaining have to work harder with less access to expertise under conditions of anxiety if not fear.
Especially in the legal community, significant head-count cuts have been partly re-invested in marketing but in an entirely panic-stricken and counter-productive way. Let us explain. Senior partners with no sales and marketing experience have not understood yet what a shrinking market means.
For most firms, to get significant business, they will need to undercut rivals competitively on price or skill or to start moving down stream and eat the food of the smaller fish.
The alternative is Linklaters’ new model which is slashing its client base to concentrate solely on those providing a certain level of fees, implying though not stating the jettisoning of low-earning staff but also feeding the smaller fish beneath them.
The Predator Model
Either firms have to become aggressive predators to grab what cash is in the market and then try and ensure profitability through efficiency or, like Linklaters, they try and put profitability first, if necessary shrinking in scale (though they may not admit this) but in a managed way.
The former emphasises sales and tough internal financial management, the latter emphasises rethinking the business model and marketing for growth on a much firmer base later. We are doing a mix-and-match but we expect to shrink a little in 2009 and are not afraid to admit it.
What seems to be happening on the ground is that managements are pouring what little cash they have into telemarketing and direct mail in an environment where the customer is not interested in listening to me-too pitches on the phone and bins the superfluity of printed paper
In fact, the customer wants to hear a very specific proposition that gives him the same for less or better for the same.
We also know from our own sources that in-house counsel are no longer allowing themselves to be seduced by the mystique of the ‘magic circle’. They are demanding price cuts now because their senior managers are demanding better value for money.
This has not come out of the blue – complaints about fees have been building up for some time. The failure of the professions to respond to this before the crash means that there is little good will left now. A degree of deflation is in-built into the legal sector at least.
There is another way but it involves a steady nerve. It requires the ability to retain the best talent and make it work harder, use the price mechanism to outsource more effectively and target resources very precisely on the most likely sources of business for that firm in this environment.
(In the next few weeks, we will be announcing an initiative directed precisely at targeted sales and designed to adapt firms to these new conditions.)
Lemmings Off A Cliff Or Cattle Heading Home?
Numbers that will be offered up by the professional services firms this year will be no guide to the real state of the market. The first half of 2008 was exceptional for many firms precisely because the crisis affected only the banking and other specialised sectors at that time.
Few took the crisis as seriously as we did initially. Business was very good indeed at the top end of the market, tolerable in the middle.
The problem now for professional services managements is to assess whether this will be a miserable but manageable recession where everyone slides down together and then moves up with recovery for 2010 and onwards.
In other words, will good old capitalism will be back on track for another boom in due course? The alternative is very scary indeed – like falling off a cliff, with the very real threat that a major law firm or accounting firm that is less well managed than its peers could go the way of Lehmans.
The problem is that, as of today, no-one knows. No-one knows either whether the cod-Keynesian ambitions of Government or the first Hundred Days of an Obama administration will make a blind bit of difference. The fear in the system is still underpinned by a desperate hope.
The problem within the system, the one underlying sub-prime mortgages, lack of full information, has not changed. The typical British professional service firm is reading UK or perhaps American material about a situation that has to factor in sovereign crises overseas and a serious slow-down in China.
But there is a lighter side which is implicit in the model of this crisis as one of necessary and massive correction rather than of true deflation and depression. Some professional service firms and consultancies continue to do remarkably well, all things considered.
And what is their common denominator? They are niche or specialist with highly developed expertise that directly impacts on the ability of corporations to deal with new conditions.
One mid-tier management consultancy brand has managed to insert itself into major projects as a manager between the ultimate client and a top ten consultancy firm, with a brief to enforce value for money and timetable.
The big consultancy has been turned into an army of ‘grunts’ on contract, while the management specialist gets the higher added value fees by squeezing the grunts more tightly. This position of outsourced intermediary is a position we have been in, and like to be in, ourselves.
So Where Are We Heading?
Let us admit that none of us know where this is leading. Based on the last major recession, there will be casualties.
In the legal profession alone, The Lawyer reports significant number of small to medium-sized firms in or about to enter the Intensive Care Units of the major banks. It has also reported law firms going into administration.
It may be a little more complex this time around, not only because of the global scale of the crisis (a fact which has still not been entirely registered by many firms) but because trends that existed before the crash and which were pushed aside at the time as inconvenient facts are now manifestly important.
The first is the corporate resentment at high, often greedy, pricing by service firms of all types (including public relations). The second is that the pressures for sector consolidation at small to mid-level were already in place.
There are too many small to medium-sized law firms, management consultancies, public relations firms and accountancy firms charging too much money for variable levels of service.
This crisis is not the death of law, auditing, consulting or reputation management – these cannot be sent overseas like manufacturing.
But this Great Correction (our preferred term for what is happening) is likely to result, eventually, in more specialised, larger, better managed firms offering best of breed niche services or efficient low price commodity services. In terms of survival, quality of management is obviously central.
What this means in practice is effectiveness in terms of financial systems, a greater sense of participation in a market rather than just relying on acceptance as a profession and a preparedness for scaling up.
Those who hold their nerve and survive what may be a three-year struggle that only starts in the New Year could become dominant in the next cycle.
[A version of this Posting originally appeared as a Pendry White client and contact Crisis Point. To subscribe to Pendry White Crisis Points, see this Friday's As It Happens Posting.]