The Unscalable Business Model

The faster you work, the less you earn. The more productive you become through investments in technology and training, the less you can charge. The expertise, intellectual capital and intellectual property you accumulate can never be directly monetized. Welcome to the world of professional service firms that bill by the hour. Meet the unscalable business model.?

The billable hour places a self-imposed limit on how much professional firms can earn, and therefore how much they can pay their employees. This explains why advertising agencies in particular are losing the current talent war. The most gifted agency professionals are being lured away by client organizations with the promise of twice the salary. The tech giants can easily outbid agencies because they have a business model that generates revenue in ways that nothing to do with what gets recorded on timesheets.

Linear versus exponential growth

Professional service firms actually don’t have a revenue model; only a cost structure.??A schedule of hourly rates is a manifestation of the firm’s internal costs.??Meanwhile, the firm’s clients have revenue models comprised of innovative pricing approaches designed to capture the value to the customer, not just the cost to the company.??Modern businesses have led a global pricing revolution that has spawned such resourceful methodologies as dynamic pricing, two-part pricing, buy-now-pay-later, partitioned pricing, and subscriptions. Pricing professionals attach the price to the product or service itself, not the person delivering it.??They price the output, not the input.??This allows the modern enterprise to achieve exponential growth.?

The hours-based professional service firm is constricted to linear growth.??The only way to increase revenue is to increase head count.??Increases in staffing expenses grow at the same rate as increases in revenue. This direct relationship between income and expenses means that economies of scale are practically non-existent in professional service firms.??

In the advertising business, the holding companies that have been purchasing agencies since the 1980s have discovered this the hard way.??Beyond the opportunity to consolidate basic operational expenses, these enterprises have not been able to achieve the kinds of economies of scale available to other types of industries, and as long as they continue to base their income streams on billable time, they never will.

Nothing left to sell

Professional service firms imagine that their inventory is a warehouse full of hours, and when the hours are gone, they’re gone -- there’s nothing left to sell, no more revenue to earn, no more profit to be had.??To make matters worse, when the firm invests in an expensive new software system to help speed up internal workflow, they lose on two counts.??First, they incur the cost of the software.??And then their improved project velocity results in less revenue, not more.??Fewer hours are billed and the invoice amounts to clients are reduced accordingly.

More broadly, as the professionals in the firm develop and cultivate expertise, they get better and faster at solving client problems.??Who benefits from that???In the world of hourly billing, only the client benefits, never the firm.??

When a project is delivered early – in half the time originally envisioned – the client is charged a lower fee even though the actual value is higher.??A problem solved faster is worth more, not less.??Speed to market is a vital competitive advantage.

FTE versus ROI

One of the simplest ways to judge the effectiveness of a revenue model is to calculate revenue per employee.??In the advertising agency business, this figure currently averages somewhere around $150,000.??At Apple, it’s $2.6 million. This stark discrepancy is explained by the difference between a revenue model based on a bottom-up calculation that starts with costs (firms that bill for time) and one determined by a top-down assessment based on value (most of the rest of the business world).?

When advertising agencies look at an employee, they see “FTE” (billable hours) whereas other businesses see “ROI” (ways to leverage intellectual capital).??Enlightened professional firms understand that what they have to sell is not a finite amount of employee time, but rather their employees’ intellectual capital, and there is almost an unlimited supply of that.??

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Tim Williams?leads?Ignition Consulting Group, an international consultancy that advises?agencies and other professional service firms in the areas of business strategy and revenue models.?Tim is the author of several books, including "Positioning for Professionals: How Professional Service Firms Can Differentiate Their Way to Success." Tim also writes a monthly blog,?Propulsion, and shares insights on Twitter?@TimWilliamsICG.