March 2012
Warren Riddell, ((qualifications)). http://au.linkedin.com/in/warrenriddell

2
Since the end of the GFC, many professional service firms, especially in the legal and consulting engineering professions, appear to be in a frenetic race to get bigger. This is a global phenomenon, but
Australia presents itself as a succulent opportunity for two key reasons. First is the attraction of the resource sector, and the related markets of capital and infrastructure, driven by an apparently insatiable appetite from north Asia and the Indian subcontinent.
Observers believe this demand will continue for a generation. Second is the push into Australia’s professional services markets, especially by foreign law and consulting engineering firms as they strive to become global firms and mirror the clients they seek to serve.
Until recently, half-a-dozen major local firms dominated the top end of the Australian legal market, with little effective international competition. Up to a third of the income of some Australian firms was referred by major US and UK firms that had no presence in Australia. But now, many of those referring firms are entering the market, merging or poaching top talent, turning off the tap of referred work and competing with the larger local firms for domestic clients. To make matters worse for the locals, all too often the local offices of international firms are trading margin for market share in an over-supplied and relatively flat market. So a “big crunch” is looming, which will cause pain for those law firms that don’t adapt. Meanwhile, the consulting engineers are basking in a booming market of some $30 billion and 9% annual growth, a veritable “big bang” in Australia that is replicated in some other overseas markets. Yes, bigger consulting engineers are getting bigger, going international and entering new sectors, and generally the smaller well-run firms are not (yet) being squeezed – because there seems to be more than enough work to go around. But for various different reasons, the mid-sized legal (defensive) and consulting engineering
(opportunistic) firms are asking the question, “should we get bigger too?”
In what appears to be a race to get bigger we are seeing the markets disrupted. Globalising law firms and engineering consultants, with brand power and scale, are targeting the large clients and top talent. Boutique firms with low overheads compete on price, relationships and often leading-edge specialisations
– the losers tend to be the mid-sized firms. Often they have high infrastructure costs to manage the broader spread, full service and multiple locations of their services, but they do not have either the reputation or the brand to command premium prices. They may be smarter than the globalised firms, they may have stronger local relationships, but as the buying of professional services becomes more objective and expertise is commoditised, price will rule. A recent case in point is a local law firm that was recognised as a leader in a certain type of financial transaction. It recently lost a specialist matter to the local office of an international firm lacking a local reputation in that field. It was lost because the international firm had won the client in an offshore market and was offering a global rebate on fees, and in the eyes of the client the specialisation had become commoditised! For a mid-tier consulting engineering firm, the issue was quite different. They could see growing opportunities in adjacent markets but their own specialisation was in decline. Their attempts to diversify were failing and their top talent was starting to leave.

Bigger, better or both. Dilemmas and strategies for mid-sized professional firms. Warren Riddell
The professional service business model is not complex. The economics of a professional service firm are driven by:
» ability to charge a premium price (a function of quality of execution, reputation, expertise and
IP)
» leverage ratios of business owners to employed professional staff
» utilisation of fee earners
» the cost of the back office and other overheads
» economies of scale.
The raison d’être of a professional service firm is to serve clients. But only the first point above, the ability to charge a premium, is related to serving the clients’ interest. The other points determine the return to the business owners. So the choices open to business owners are quite simple:
» What is the willingness and capacity to invest in
IP and the highest-quality resources?
» What is the interplay between the profit and professionalism motives?
Larger firms take advantage of scale to invest in IP and quality resources, and scale should mitigate the conflict of profit and professionalism. Boutiques, which are often first-generation firms, typically have embedded
IP and are usually formed by recognised professional experts. Mid-sized firms, however, will wrestle with the trade-off between taking profit today and reinvesting for the future, and with the inter-generational issues to which such choices give rise. But a firm takes its eyes off its clients at its peril.
3

4
Since the GFC, market dynamics have sharpened.
Maybe this is due to a refocusing on cost and value, maybe there is just more fear in the market that is reflected in the way individuals view their own future within that of their firm. So the decisions they take are more protective of themselves and their firm. Is there more cynicism in the market? Whatever the undercurrents driving changing behaviour, it can be characterised with the following traits in every professional services market:
» Clients’ purchasing is increasingly price-driven.
» There are fewer meaningful brand differences between advisers.
» There is little differentiation in perceived performance between advisers.
» Clients are substituting, off-shoring and unbundling services to reduce cost or increase value.
Typically, progressive professional service firms are on a continuous path to redefine their unique competitive advantage – what sets each one apart from its competition. Such differentiation enables firms to create an imperfect market in which they out-compete, allowing them to charge premium fees and dominate their chosen markets. In the old vernacular, they are
“price-makers” rather than “price-takers.” The larger firms have deeper resources to maintain this continuous search to create an imperfect market. The successful boutiques have a cost structure and flexibility that allows them to deliver services that the large firms overlook at a given point in time. But too many mid-sized firms find themselves as price-takers in a market under threat from both the larger firms and boutiques – they are, as one observer put it, “middle everything firms.” Or in Michael Porter’s language,
“stuck in the middle” – and often sinking ever so slowly. The conventional strategic options for a mid-sized firm are based around combinations of key client relationships, work type specialisations, geographic focus and/or being smart generalists.
But given the new competitive landscape, these options are no longer defensible:
» Relationships are giving way to price and delivery pressures.
» Work type specialisations are commoditising through unbundling and outsourcing.
» Geographic focus is under threat from new entrants.
» Smart generalists are under threat from smarter specialists.

Bigger, better or both. Dilemmas and strategies for mid-sized professional firms. Warren Riddell
The risk to mid-sized firms lies in their believing that size is the only answer. Bigger does not beget better, but better begets clients. Being able to attract more clients creates an option to scale. And scale creates a new set of opportunities and challenges.
The following diagram offers a choice of paths:
1
4
2
This path will probably reduce the profits to owners if premium pricing lags the investment. Increased performance draws clients that drive organic growth and provides a qualified base for equally qualified M&A opportunities that enhance performance as distinct from size (path 4).
The solution for mid-sized firms rests with how they service their clients and how their clients see them. It is this mantra that should dictate strategy. So the solution is to focus consciously on performance and increase the quality and value of client service. First and foremost, organic growth and M&A strategies should be designed to improve client service. Resist buying market share until you have truly addressed client service for your existing market. Resist moving into new markets until you understand how your clients truly see your business – what you are known for and capable of becoming in the quest to get better.
3
Now
Better
Bigger to be bigger (path 1) without an increase in performance will not improve client service and, as a sustainable long-term strategy, it has to be questioned. A controlled increase in size and performance (path 2) can be a goal, but as a practical strategy it is not achievable – how do you prioritise between the two? Path 3 is achievable by reinvesting profit into IP and increasing the quality of resources.
5

6
Many mid-sized firms are reinventing their business models to increase both their relevance and value to their clients – that is, become ever better at what they deliver. In short, these strategies are:
» Innovate the business model . Acknowledge which services are commoditised and which are specialist, and reconstruct the business in the way the clients see it. Do not wait for your client to unbundle your services and find alternative suppliers for each. For your core service offerings, improve and innovate their delivery ahead of competitors. Communicate and share these benefits with the client.
» Invest in IP and talent . Invest in knowledge and absolute expertise, but acknowledge the finite shelf-life of any expertise and the ultimate risk of commoditisation. Hire the best and allow them time to think. If acquiring new
IP, be aware of the limits of brand permission given to you by your clients. Choose adjacent specialisations that are a natural extension of what you are currently known for. A specialisation too far removed from your core is more likely to be rejected by clients.
» Create a strong balance sheet . Retained earnings provide a business with resources to be responsive. This can be done efficiently in partnerships, although few do so. Balance sheet strength is not a natural situation for many firms that typically distribute all profit and only retain a working capital facility. A pool of capital allows the leadership to have strategic effectiveness. Linked to this are governance and decision-making processes.
Firms that still require a partner majority to make investments or strategic decisions are usually at a disadvantage to those that have delegated power to an experienced and trusted executive team.
So how do firms decide what to do and how to prioritise? The most effective start is to undertake an honest and well-researched assessment of your chosen market and your position in that market. In a structured way, talk to your clients and ensure you understand where they are heading and what priorities they have. Challenge yourself – will your existing business model remain relevant to your clients and can you remain competitive? If not, what do you have to change? How do you change? Are you able to change?

Bigger, better or both. Dilemmas and strategies for mid-sized professional firms. Warren Riddell
Getting better rarely creates problems for a business.
But getting bigger does, and more often than not the problems usually relate to the cultural glue that binds an organisation. These are some of the issues that will need to be managed:
» Business diversity and cultural compatibility .
It all comes down to fit. Businesses are different for a reason; ignore this and an investment will become worthless. Consider a house of brands strategy as opposed to “our way or the highway” when acquiring or merging.
» Growth for size and loss of ownership . Where there is a sense of proprietorship that motivates the team, well-structured and disciplined ownership models are able to cope with growth.
» Long-term investments and short-term returns . This trade-off comes down to shared vision and values and how the ownership is constructed. Be disciplined about who joins the business and why.
» Profit of the business and individual wealth creation . This is an issue for a business of any size but it becomes more acute as a business grows. It is typically addressed by refreshing individual KPIs as the business expands to drive whole of business responsibility, accountability and reward.
» Creeping corporatisation and professional freedom . Probably the single most critical area is how to prevent creeping corporatisation and preserve professional freedom. Great leaders understand and manage this balancing act.
When in doubt, revert to asking how the business is serving its clients and whether this service can be improved.
7

It can be very tough in a mid-sized firm for leaders to be both “in” and “on” the business. Taking time out to rethink the business model, let alone change it, is anathema to many business owners. But the business landscape is changing very fast and professional service firms will need to adapt if they are to prosper.
Many mid-sized firms have already started on this process and are proving that new client service strategies are keeping them both competitive and profitable. Some combine this with getting bigger, others don’t, but they all focus on getting better.
This paper is based on a seminar presented by Beaton
Capital and Cast Consulting in December 2011 as part of the First Movers seminar series organised by Beaton
Research & Consulting.
Bigger, better or both. Dilemmas and strategies for mid-sized professional firms. Warren Riddell
8