Photo credit - Samuel Zeller
September 20, 2017 15:45
In 2015 I published an article (What are the 'hurdle rates' for management consulting projects?) that asked what rate of return managers were expecting when they invested in a management consultant engagement. One reaction to the question from some organisations was puzzlement - they manage external professional services as 'spend' rather than 'investment' and, to the degree that they have performance objectives, these are typically based in cost control i.e. set a budget for annual consultant spend and make sure it is not exceeded.
This is a bad way to manage consulting expenditure. Every dollar of consulting 'spend' should be managed as an investment and be subject to the same disciplines as capital and other investments.
A company should buy (what are typically costly) consulting services when they face internal capability bottlenecks – where the consultants can provide specialised expertise not available within the client organisation.
These bottlenecks are unlikely to be stable or predictable, so an annual budget for this type of activity will lead to either overspend or underspend: in the scenario that the consultants are not actually required, budgets will still tend to be spent (remembering that next year’s budget will almost certainly be reduced if this year’s is not fully consumed), while attractive investment returns will not be captured if the budget cannot accommodate engagement of the assistance required.
A better approach is to treat each consulting engagement as an investment. If the incremental value created by the consulting engagement (relative to the 'no-consultant' scenario) exceeds the organisation’s investment hurdle then the engagement should be funded; if not, make the best of the situation without consultant’s assistance.
Discussions with several managers who were managing consulting investment in this way led me to estimate that investment in consultant engagements was 'induced' when the expected return was in the order of 2.5-3 times the cost of the engagement.
However, managers were not expecting to achieve these returns; they recognise that they will have a series of 'hits' and 'misses' across their portfolio of consulting investments leading to a net return across all projects slightly above 2 times, implying a hurdle rate of about 50%.
I came across some data the other day which broadly supports this view, although it seems that my estimate of the net returns on consulting investment may have been optimistic.
Source Global Research, a research house specialising in the management consulting industry, "carry out large-scale surveys of CXOs and their direct reports, asking for their views of consulting firms". As part of their demonstration of their Client Perception System they reported on the perceptions of value by almost 1000 clients who had completed engagements in the United States with the major consultancies.
The data, which I have summarised in Figure 1 below, shows that these clients reported an actual return of about 1.7 times the project fees from their consulting engagements.
Figure 1 - Return on Fees
What was most striking for me about the data was the degree of variation in returns generated, with some engagements generating returns that were more than 10 times the consulting fees, while almost 10% of all projects failed to even cover their costs. What’s more, this pattern of varied performance was exhibited by almost every consulting company (all of whom are in the top 30 consulting companies in the WhoKnowsAbout global competency ranking).
To me, this highlights the importance of the Client Requirement/Consultants Capability fit. All consulting companies have their areas of general strengths and weaknesses, and have varying capabilities across their consultants. Where a company engages consultants with deep competency in the issue at hand, high rates of return can be achieved. However, if the fit between client need and consultant capabilities is weak, either at the firm level or within the engagement team, then results can be disappointing. This is not to suggest that other factors can also influence a project’s success e.g. consultant-client trust, client consultant collaboration, top management support, etc. However, as we will outline in part B of this post several studies have demonstrated that consultant capability in relation to the problem at hand is the key determinant of project success.
These findings support the logic that led us to establish WhoKnowsAbout. By enabling clients to efficiently identify the consulting companies and the individual consultants who have the specific skills required for the task at hand the overall returns on consulting investment can be improved. In our next post, we will outline why we have focused, at least in the first instance, on experience and expertise and why we believe that this is the most critical factor in consultant selection.