I spoke with a mid-level consultant at a medium-large American consulting firm. His project had an overrun. Question was, how to handle it.
Me: How big an overrun?
Him: $80K—a 50% overrun.
Me: A big percent, but not a big dollar number. Tell me about the client.
Him: Medium sized for us; decent relationship; we do 5-6 projects a year with them.
Me: What do you each say?
Him: They agree they signed a contract saying they were responsible for the disputed work. We thought their interpretation was wrong. We ended up doing the work, but disagree about who’s responsible.
Me: Of the $80K, how much would they agree is their fault?
Him: Maybe $20K of the $80K.
Me: And you?
Him: We think $70K of the $80K.
Me: That is a mere $50K issue. You’re a big company, this is a good client relationship—$50K is chump change.
Why don’t you go to them and say, ‘Look, we value this relationship. There is an $80K overrun here; why don’t you pick the number between $0 and $80K that you think is most fair, and we will pay it.’ Give them total choice. Let their choice reveal their character and their intent, and show good faith on your part. Work the relationship, not the negotiation.
Him: Well, they might take advantage of us.
Me: Of course they could. And if they do, you’ll know if these are people worth trusting in the long haul, or whether henceforth you get tighter controls and/or give this client over to a competitor. Do you want a relationship, or a petty quarrel? How much do you think they would offer?
Him: I’d guess they’d offer us maybe $40K. And I think what you say is the right thing to do. But my [service offering] leadership team won’t go for it.
Me: Why not?
Him: They think we deserve more, and they can get most of it by holding out.
Me: For how much?
Him: They think they can get $70K.
Me: You realize, that is only $30K of difference between the two of you.
Him: Yes, but they are really under pressure to make their profit bogeys. There’s really nothing I can do.
If you’re not sickened by this dialogue, let me break it down.
It sounds like a bad divorce settlement. Two large firms wasting time and creating bad blood—over $30K. A true imbalance.
But it’s worse.
This was probably a good relationship. Let’s assume it might have generated five projects a year for 8 years going forward. Further, that benefits to the client would have increased as the consultants gained more familiarity and expertise over the years.
Suppose that amounts to a present value of, say, $10M in fees.
Assume that the bad blood generated results in lower trust—more haggling over fees, lower fees, more competitive bidding, more audits, more skepticism over advice—all resulting in, say, 30% reduction in the present value of expected fees.
That’s $3M reduction in present value. For $30K on a quarterly P&L.
Many think it doesn’t matter because it doesn’t hit the P&L. It’s true that FASB rules don’t book present value, at least not through the income statement.
But it is real. The eagle eyes on Wall Street know very well how to discount future streams. Private equity firms know the value of customer retention rates.
In other words, the financial metrics that matter most—those of the market, not of the accounting books—do know the cost of this firm’s decision.
You may think the young manager is at fault for not standing up for what he knew was right. Or, you may think his bosses are to blame.
I think the real culprit is endemic bad business thinking. Business thinking that mindlessly focuses on short-term metrics of short-term behavior, linking the two by short-term incentives. The solution doesn’t lie in more short-term thinking ("I know, let’s analyze imputed market discounts and allocate them across quarterly bonus pools for each decision!").
The resulting behavior is value destruction by any sensible definition. Bad business. They call it financial management. It is anything but.
Yet this way of thinking, as anyone in the corporate world knows, is the rule, not the exception. Anyone who believes in perfect market theory need only look at daily management behaviors to find their disproof; everywhere managers behaving in ways that destroy value. Believing that they’re creating it.