Destroying Shareholder Value: One Quarter, One Customer at a Time
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.
As usual, you’re spot-on. The company I work with is getting better about this, but we still spend a ton of time (and money) on meetings before we can finally decide that the multi-million dollar customer relationship is worth more than the few-thousand-dollar argument.
On the other hand, you do need to ensure that fairness is managed. Per your post of a few days ago, customer-servitude is very bad, too. If the customer finds that they can nit-pick a few points off of every deal, and that we always give it to them, then our giving-in can be damaging to the mutual trust, too.
There is a balance here – as always, finding that balance is based on mutual trust and respect.
Carl, you’re of course absolutely right about the need for balance. And the client needs to be part of the discussion about the definition of fairness. Here’s my best shot at how to have that conversation with the client.
"We would like this relationship to last and prosper. We hope you do too. To that end, we must each feel fairly treated, over the long haul.
"That means we can stand an imbalance of fairness at any point in time, but it must be redressed at some later time. To cut each other slack, we need to trust that we both agree on ‘slack’ and on how to balance it.
"We are willing to take the first step here so we can start defining our level of agreement. You pay us whatever you feel is right–and we’ll live by your choice. If we think it’s unfair, we’ll say so–but we’ll still pay it, at least this time.
"In the not-very-long run, of course, we will either agree on these cases, or not. If it turns out we consistently disagree on what’s fair, then this is a small price to pay to find out we differ. If we do agree, as I suspect we will, then this is a good first step toward cementing our agreement.
"Tell us what you think is fair. We’ll pay it. Over to you."
I agree – wholeheartedly. My intention was to add discussion, not to argue.
This reminds me of your friend David Maister’s policy: He provides his customer with an invoice, but encourages them to pay whatever they think his services are worth. Almost every time, his clients pay the full invoice.
If he was to find that client repeatedly disagreed with the value of his service, then it’s clear that they should re-evaluate their relationship.
My apologies if I conveyed in any way that you were being argumentative; I took your comments as purely constructive, and also intended that mine be "builds" on yours, not as arguments. If it came out otherwise, that’s my bad.