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Hiring outside expertise has long been a perilous exercise, but clients are gaining the upper hand.
Russ Banham, CFO Magazine
June 1, 2010
Over the course of his finance career, Jeff Henderson, CFO of Cardinal Health Inc., has hired consulting firms to offer insight on strategy, outsourcing initiatives, expense-reduction tactics, and large IT projects. While he believes strongly that consultants are an important management resource, he, like many other finance chiefs, is wary of their downsides, from high cost to inferior advice. "I've learned the hard way," he confides. "You can spend too much, not get the service you thought you were getting, and end up with the second-tier team [rather than] the 'stars' you were told you'd get."
Such complaints about consulting engagements are commonplace. As David Bean, vice president of finance at Vertex Pharmaceuticals, a Cambridge, Massachusetts-based biotech company, sees it, "There is a tendency among consultants to get hired merely for the purpose of getting more work." In CFO's recent survey of 400 finance executives, the majority — 55% — said they were only somewhat confident that their consulting spending was producing an acceptable return on investment, while 16% said they were not confident or didn't know: not exactly a stunning endorsement of the consulting universe.
But the situation may be about to improve. Thanks to a spate of mergers and acquisitions, along with the emergence of newly energized firms, a very different consulting industry is rising from the ashes of the recession, one in which competitive pressures are driving prices down for buyers.
In addition, new pricing structures, in which consultancies are willing to take it on the chin financially if their promises fail to materialize, are emerging. All told, prices for consulting services have dropped anywhere from 5% to 20% in the past year. "It's a buyer's market out there," says Lynne Schneider, senior analyst at Kennedy Consulting Research & Advisory.
To be sure, the U.S. consulting industry, remains a financial powerhouse. Last year, it generated $397 billion in revenue ($240 billion for IT consulting alone), according to Jenny Sutton, co-author of Extract Value from Consultants (Greenleaf Book Group, 2010). That's a mere 2% decline from 2008, suggesting that, despite client misgivings, consulting remains virtually recession-proof. Sutton projects that total consulting revenue will resume an upward trend this year.
The industry tumult has several causes. For one, the Big Four accounting firms have returned to consulting with a vengeance now that Sarbanes-Oxley-related compliance work is drying up. In addition, a wave of megamergers has created more-comprehensive "soup-to-nuts" consultancies, particularly in IT. In the past 18 months, hardware providers Dell, Xerox, and Hewlett-Packard have acquired Perot Systems, ACS, and EDS, respectively. Now, "the acquirers are looking to leverage their existing distribution channels to sell more of everything, and they are more willing to cut their rates if asked" says Susan Tan, research director of IT services at Gartner.
But this metamorphosis also poses a risk: in their rush to compete, consultancies may be more prone than ever to overpromise and underdeliver. "Clients hire a multiservice consulting firm to do strategy, and then are pressured to hire the same firm to implement that strategy even though this may not be its core expertise," says Sutton. "Too many buyers end up using consultants in areas that are not their power alleys."
Of course, clients also bear some responsibility for engagements that come unglued. One of their main peccadilloes, some experts say, is driving too hard a bargain. "We've seen buyers press the consulting firm to discount services so far that they ended up with the 'B' team on their projects," Kennedy's Schneider says, resulting in "bargain basement" advice.
Clients also suffer for not being well prepared. A "major trap," says Sutton, is allowing the consultant to define the scope of the engagement. "It's up to the buyer to know what problems it has to solve. And it should do that by spending more time upfront defining its needs," she says.
On the bright side, new pricing options may help firms avoid some disappointment with their consulting engagement. Contingent pricing contracts (also known as gain-sharing pricing), in which clients and providers share financially in a project's outcome, are becoming more common, with an estimated 5% of all engagements using this type of structure, according to Gartner. Its appeal is intuitive: if a consultancy says it can wring $500,000 in cost redundancies from the buyer's supply chain, for example, the contract can be structured to provide half that amount as a fee to the consultancy, but only if the savings are achieved. "It puts the emphasis on results rather than projects," says Erick Burchfield, director of research at Kennedy Consulting.
Henderson says he has priced some of his engagements on a contingency basis, both for easily measured projects like cost-reduction initiatives and for more-difficult-to-quantify engagements involving strategy. "We like to make an element of the fee contingent upon meeting specific goals or milestones," he says. Otherwise, "the contract is structured to hold some of the fee back" until the company can assess its satisfaction with the result.
While the concept puts more of the provider's skin in the game, it may not be the right move, depending on the nature of the project. Gartner's Tan notes that it is difficult to measure softer outcomes like productivity gains, an increase in client loyalty, or improved employee morale. "Gain-sharing became quite popular during the recession and is a good thing for cost-reduction engagements, which are quick and easy to measure," she says. "But measuring revenue as related to client loyalty is very hard, and could lead to a contentious engagement."
Slice and Dice
For those reasons and others, some CFOs, including Don Lofe at mortgage insurer The PMI Group, tend to avoid contingency-fee arrangements. "We prefer flat-fee arrangements based on the scope of the service and a specific timetable for deliverables," he says.
That can mean slicing projects into parts, each with a specific deliverable and fee. Some 40% of finance chiefs responding to CFO's recent survey said they plan to take this approach this year. Peter Iannone, former CFO of software firm Envenergy and now managing director at national accounting provider CBIZ MHM, advises his clients to do the same. "Explain what your problems are and what you need fixed, then insist on discrete milestones or project phases, each one measurable in terms of services and cost," he says. "An invoice is not the place to control the engagement."
Lofe, for one, is a proponent of the slice-and-dice concept. "We set upfront expectations for deliverables in a certain timetable, and require the provider to give specific reasons why a deliverable isn't met by the established date," he says. The practice further permits the company to delay, change course, or cancel subsequent phases if the earlier phases fail to show the promised results. "Otherwise," he adds, "we run the risk of the consultancy being here forever."
As Lofe suggests, a major part of keeping control over a consulting engagement is figuring out how to end it well. That works two ways: making sure the consultants don't hang on too long, but also that they don't leave too soon. "I've been in situations where we've had to repeatedly ask a consultant to return because there was no knowledge transfer. Never again," says Jeff Burchill, senior vice president and CFO of global property insurer FM Global. Now, the company assigns an internal project manager to each consulting project in order to fully digest the project and then end it. The project manager's job is to "import the skill sets of the provider and then transfer this knowledge to others through training," he says.
Cardinal Health has similar practices in place to keep a tight rein on its engagements. "If we engage Deloitte or McKinsey, we designate a very senior executive as its sponsor, to understand and monitor any and all projects being done by that firm," says Henderson, who himself is an executive sponsor for "a number" of large consultancies.
That approach ensures that Cardinal Health doesn't unknowingly retain the same consulting firm for the same project in different business units. The company thus achieves greater consistency in project design and fee structure. Using one consultancy to provide coordinated service wherever feasible may also offer the chance to negotiate a volume discount, notes Tan.
However, perhaps the best lesson CFOs can offer about handling consultants is to not get too comfortable with them. Henderson says his biggest goal is to avoid relying exclusively on the services provided by a single consultancy — no matter how good the price or the result. "Even if the firm provides top-notch service," he says, "you need to shake things up with other perspectives now and then — recommendations and observations you never thought of. We're learning all the time."
Russ Banham is a contributing editor of CFO.