Fee Innovation in Consulting
The business model of consulting has changed quite a bit since the industry’s founding roughly 100 year ago. But one thing has certainly stayed the same—consultants like to get paid in cash.
But cash isn’t always king. In fact, the billable hour may not even be royalty anymore, specifically when dealing with smaller, growth-oriented clients. The cash for service model has four inherent flaws.
1. If a problem is hard enough to require an outside advisor, it’s hard enough to make scoping the work messy.
2. The billable hour model rewards consultants for selling work, not for solving problems.
3. Repeat business only comes from happy clients, and keeping clients happy and solving difficult business problems are not always the same thing.
4. Billable hours accrue today, and benefits accrue tomorrow. For companies in a cash crunch, consulting work accelerates the cash burn at precisely the wrong time. For smaller enterprises entering a new market, cash is scarce just at the time when foundational advice is most needed.
Truth be told, none of these issues are fatal enough to kill the fee for service model outright. Given the right mix of people, careful contract writing, and minor innovations such as the “success fee”, all four issues can be dealt with. However, there may be a more optimal way.
A new model involves companies putting equity at stake, and in return, receiving massively discounted consulting services. Call it the SEM, “sweat equity model”. The varieties of the arrangement are infinite, but the basic model goes like this.
1. Scope the work as though the client would pay by the billable hour. The amount of work being done is worth X dollars.
2. Value the business based on comparable and earnings multiples. The business is worth Y dollars.
3. Determine the right-mix of cash and equity for both the client and the advisor.
4. The client awards the consultants in equity in lieu of cash for the given work. In some cases the consultants get the entire value of his/her work (X) in equity, or some fraction thereof.
5. Execute the work as partners
How might this work in practice? Consider a small to medium sized enterprise entering a new market. They probably don’t have excess cash to employ expensive consultants, but the likelihood of success goes up with an improved team or temporary additional resources that have done it before. Employing a SEM reduces the cash outflow, allows a company to bring on the right resources, properly incentives the “partner”, and increases the possibility of a big upside several years down the road. One can imagine a similar model working for a heavily distressed company facing bankruptcy, tricky litigation, or another high stakes event….but as you can imagine, the consulting entity needs to determine the risk associated with ownership.
Despite its flaws, the fee for consulting model is likely here to stay. But innovative clients and their advisors will continue to challenge the normal pathways in search of better-trusted advisor relationships.
Jesse Koltes is a senior consultant with Blossom Growth Partners. To learn more about Blossom and how it’s using the “sweat equity” model, please visit us at www.blossomgrowth.com