The Anatomy of a Consulting Firm 10 - Growth and Profitability

By David Maister

Before we leave the topic of growth, we should take a quick peek back at Guru Associates. How did its growth contribute to its profitability? Let us perform our analysis on the basis of constant (year zero) dollars, to remove the effect of inflation. By implication, this means that the salaries and billing rates at each staff level remain the same. What does the firm’s P&L now look like? Figure 1-8 repeats the analysis of Figure 1-6 using year-five staffing levels instead of year zero.

The result? Per-partner profits have not increased! In fact, they have remained precisely the same!

What this simple example shows is that there is no necessary relationship between growth and profits. As we have seen, growth in a professional firm is driven primarily by the need to attract and retain staff, and is critical for that reason, but it is not a guarantee of higher per-partner profits.

Why is this so? We shall explore the reasoning in greater detail in subsequent chapters, but the basic fact is this. If a firm grows subject to two conditions, as Guru Associates has, whereby (a) the mix of client projects (and hence fee levels) remains the same; and (b) the project staffing (or leverage) is such that the same proportion of senior or partner time is required to handle each project, then the number of seniors or partners that the firm requires will correspond exactly to the growth rate. In consequence of this, the profit pool may increase because of the higher volume, but it must be shared among a correspondingly increased number of partners.

If per-partner profits are to increase, then one of the two conditions must be broken. Either the firm must bring in a different mix of business commanding higher billing rates (i.e., find higher-value work for its people to do) or it must find ways to serve the same kinds of work with an ever-increasing proportion of junior time and a declining proportion of senior time.

It is an interesting observation to note that few prominent consulting firms act as if growth were profit-neutral. Indeed, rapid growth is often listed as a primary goal of the firm, and advances in top-line growth are used as a primary internal and external measure of success. If justified in the name of providing career opportunities for staff, this indeed makes sense. However, if desired on profitability grounds, it looks like many consulting firms are fooling themselves!