Let’s consider a numerical example (Figure 2) to see how the forces at work in a consulting firm interrelate. Guru Associates, which engages in a variety of projects, nevertheless has a “typical” project that requires 50 percent of a senior’s time, 100 percent of a middle-level person’s time, and the full-time efforts of three juniors. In order for the firm to meet its economic goals, it requires that seniors and managers be engaged in billable work for 75 percent of their time, and juniors 90 percent.
Guru Associates currently has four seniors. If it is to meet its target of 75 percent billed senior time, its available senior time will be four multiplied by 75 percent, or the equivalent of three seniors working full-time. This implies six projects if the typical project requires 50 percent of a senior’s time.
With six projects, the firm needs the equivalent of six full-time middle-level staff according to the project team structure. (Each project requires 100 percent of a middle-level person’s time.) At 75 percent target utilization (billed hours divided by available hours), this means that the firm must have eight middle-level staff (6 × 0.75). Similarly, at three juniors per project, the firm needs 18 full-time juniors (at 90 percent billability, that means 20 juniors).
Simple calculations such as these show that, with eight seniors, the firm would need 16 managers and 40 juniors. The proportions remain constant: one senior to every two managers and every five juniors. Unless there is a change in either the project team structure (e.g., the types of projects the firm undertakes) or the target utilization (matters that will be discussed below), the firm must keep these ratios constant as it grows.
This seemingly simple-minded calculation relating the staffing mix requirements of the work to the staffing levels existing in the firm is in fact of extreme importance.
If we know the salaries of the staff members and their billing rates, we can construct the pro forma income statement of this firm at full utilization. (Figure 3)
The role of leverage is amply illustrated by Guru Associates. The four seniors (partners) personally bill a total of $1,200,000, or $300,000 each. At per-professional overhead costs of $40,000 (including the costs of all secretaries, administrative staff, space, supplies, etc.), this would result in a per-partner profit of $260,000 if these seniors were totally unleveraged.
With a healthy seven staff members per senior, partner profits now total $420,000 each. About 60 percent of each partner’s profit comes not from what he or she bills but from the profit generated by the nonpartner group. Thus the benefits of leverage!
It should be immediately stressed that high leverage is not always good. As we have already observed, having high leverage is completely inappropriate if the firm has a high level of Brain Surgery or Psychotherapy work. What we can say is that leverage should be as high as the requirements of the work allow.
We now turn to Guru Associates’ position in the market for staff. Guru Associates has the following promotion policies: It considers that it requires four years for a junior to acquire the expertise and experience to perform the middle-level function, and it expects to promote 80 percent of its candidates to this position. A lower percentage would be insufficient to attract new juniors, and a higher percentage would imply that insufficient screening was taking place (i.e., that there was no room for hiring mistakes). From middle level to senior is also expected to take four years, but because fewer candidates develop the critical client relations skills that Guru Associates requires, on average only 50 percent of the candidates make it.
We shall now trace the evolution of Guru Associates over time. Among the eight middle-level staff, we may assume that, since it takes four years to make senior, in any given year there are one-quarter (i.e., two) of these managers in their final year as middle-level staff. If Guru Associates is to abide by its promotion policies, then it can expect to promote 50 percent, (i.e., one candidate) in that year. Whether by firm policy or by the personal decision of the individual, the nonpromoted candidate will leave the firm. (Note that this result tends to happen in most consulting firms regardless of whether the firm has an up-or-out policy. Middle-level staff may, if allowed, hang on for another year or two, but most eventually leave if not promoted. As we shall see, there is a strong incentive for the firm to encourage them to leave, since they are occupying a slot eagerly being sought by the juniors coming up behind them.)
Counting both those promoted and those leaving, we have reduced the number of middle-level staff by two and increased the number of seniors by one. Since we now have five seniors, we require ten middle-level staff (unless the mix of project types changes), and have six remaining. We must seek out four new middle-level staff from among our juniors. Of the 20 in the firm, we assume one-quarter (five) will be in their final year as juniors. Since our expectation (or policy) is to promote 80 percent at this level, we will indeed promote four out of the five to fill our four available slots. (The fact that these figures match is not, of course, fortuitous. The percentage that can be promoted at a lower level is determined by the shape of the professional pyramid.) Like the “passed over” middle-level staff person, the fifth junior may reasonably be assumed to leave the firm.
We now have 15 juniors left. However, with five seniors and ten managers, the firm requires 25 juniors: it must hire ten. These changes are summarized in Figure 1-7, which follows the same logic for years one through nine.
In year five, the first batch of middle-level staff that were promoted from junior in year one will be ready to be considered for promotion to senior. It will be recalled that there are four of them. If promotion opportunities are to be maintained, then 50 percent will be promoted (i.e., two) and two will leave. This creates a total of ten seniors. With a total of ten seniors in year five, 20 middle-level staff are required. Of the 16 in the firm the previous year, four have been promoted or have left, meaning that a total of eight juniors must be promoted. Fortunately (but not fortuitously) there are 10 juniors who were hired in year 1, and are to be considered for promotion. The expected 80 percent target may be maintained!
What must be stressed at this point is that we have arrived at these staffing levels solely by considering the interaction of the firm’s leverage structure with the promotion incentives (career opportunities) that the firm promises. What we have discovered by performing these calculations is that the interaction of these two forces determines a target (or required) growth rate for the firm. As Figure 1-7 shows, Guru Associates must double in size every four years solely to preserve its promotion incentives. If it grows at a lower rate than this, then either it will remove much of the incentive in the firm or will end up with an “unbalanced factory” (too many seniors and not enough juniors) with a consequent deleterious effect upon the firm’s economics.
If the firm attempts to grow faster than this target rate, it will be placed in the position of either having to promote a higher proportion of juniors or to promote them in a shorter period of time. Without corresponding adjustments, this could have a significant impact on the quality of services that the firm provides.
We have seen that the leverage structure and the promotion policies together determine a target (required) growth rate. It should be acknowledged, however, that there is another way of looking at the relationship between these variables. An equivalent way of stating the relationship would be to observe that, if given a growth rate and a leverage structure, the promotion incentives that result can be specified. We may see this by examining Figure 8 once more. Suppose that we had constructed this by specifying the growth rate and the project team structure. We would then have discovered that we could afford to promote only four out of five juniors and one out of two managers. We would also have discovered that we would have a built-in, or target, turnover rate averaging over 4 percent (two resignations per year for the first four years, while the average number of nonsenior staff was 45.5).
In this example, Guru Associates can achieve what would be considered an extremely low target turnover rate if it achieves its optimal growth. However, the norm in many consulting firms is a much higher rate than this, often reaching as high as 20 to 25 percent or even 30 percent. The key point to note here is that, given a growth rate and an organizational structure, the target turnover rate of the firm can be specified. (This does not, of course, tell us what the actual turnover experience of the firm will be. We are considering here the turnover that the firm requires to keep itself in balance. While it may be able, through its promotion system, to ensure that the actual rate does not get too low, it may have to use other devices to ensure that the actual turnover rate does not get too high through too many people quitting.)
In most professions, one or more firms can be identified that have clearly chosen a high target rate of turnover. Under this scenario partners (or shareholders) can routinely earn a surplus value from the juniors without having to “repay” them in the form of promotion. This high turnover rate also allows a significant degree of screening so that only the best stay in the organization. Not surprisingly, firms following this strategy tend to be among the most prestigious in their industry.
This last comment gives us the clue as to why such firms are able to maintain this strategy over time. Individuals continue to join these organizations, knowing that the odds of “making it” are very low. In the eyes of many potential recruits, the experience, training and association with the prestigious firms in the industry make the poor promotion opportunities at such firms worthwhile.
Young professionals view a short period of time at such firms as a form of “post-post-graduate” degree, and often leave for prime positions they could not have achieved (as quickly) by another route. Indeed, most of the prestige firms following this strategy not only encourage this but provide active “outplacement” assistance. Apart from the beneficial effects that such activities provide in recruiting the next generation of juniors, such alumni/ae are often the source of future business for the firm when they recommend to their corporate employers hiring their old firm (which they know and understand) over other competitors.
The ability to place ex-staff in prestigious positions is thus one of the prerequisites of a successful churning strategy. (An exception might be provided by those professions where legal requirements such as professional certification necessitate that juniors spend time in a firm. However, even here the prestige firms provide active outplacement assistance.)
