Owner compensation ideas to reconsider at year-end

Anonymous. Partner's Report. New York: Oct 2003. Vol. 03, Iss. 10; pg. 1

Abstract (Summary)
PR agrees that the motivation "angle" is becoming increasingly important as a tactic to institute change within CPA firms. As [Joel Rose] notes, "Firm management will be unable to move the organization in a particular direction unless the compensation system points to that direction as well. Your compensation system's emphasis and its administration ultimately determine your firm's direction and culture.
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Copyright Institute of Management & Administration Oct 2003
[Headnote]
Increasing Margins



Now that year-end is approaching, it's a good idea for CPA firms to revisit the issue of owner compensation-especially this year, with all the shifts in CPA firm practices and priorities. Even if most of your partners are satisfied with the firm's current structure, it can't hurt to consider the range of options.
PR finds interesting several suggestions on new ways to view owner compensation from a consultant who regularly works with law firms, Joel Rose, a Certified Management Consultant and president of Joel A. Rose & Associates, Inc. (Cherry Hill, N.J.; 856-427-0050 or 800-381-1645; e-mail: JROSE63827@aol.com). Although the structure and billing practices of law firms are a bit different from CPA firms, these ideas are easily adaptable to a CPA firm setting.
Start with motivation. "Your partner compensation system must reward owners for their total contribution and serve as a management tool that motivates them to perform the fee-producing and nonbillable activities the firm needs to progress," Rose says. "But when you create, revise, and administer a compensation system or components of the system, you must think carefully about what it will motivate your partners to do."
PR agrees that the motivation "angle" is becoming increasingly important as a tactic to institute change within CPA firms. As Rose notes, "Firm management will be unable to move the organization in a particular direction unless the compensation system points to that direction as well. Your compensation system's emphasis and its administration ultimately determine your firm's direction and culture. You must determine how to make it encourage hours, delegation to others, management, and so forth."
When compensation criteria and firm goals don't mesh. Tensions develop among partners when the compensation criteria you've designed to establish the firm's direction and reinforce its culture fail to do the job. Conflict can result from competing values when compensating partners for:
* Delegation of work vs. revenue from personal working hours.
* Credit for joint business development vs. individual origination.
* Credit given for consequential nonbillable time vs. time devoted to producing client work, etc.
Issues to address. To make your partner compensation plan work for the firm as well as for individual partners, you must resolve issues in the following areas:
* Business origination from new clients. In today's climate, the firm that fails to recognize client origination won't prosper and may not survive. Nonetheless, the system must also reward partners for their efforts to retain clients and expand existing client relationships. Origination has always been a more contentious issue for law firms, but CPA firm partners are finding that the move to cross-selling in recent years has brought this issue to their own partnerships. Properly recognizing the origination of new business-even when a CPA doesn't perform the work-encourages CPAs to participate in business development activities and discourages them from hoarding work. Rose suggests that firms need a procedure to deal with the issue; in particular, you have to decide whether the origination credit will be permanent or for a defined duration.
* Permanent origination credit. This lasts as long as the client or the originating owner remains with the firm. If the originating partner retires or leaves, the client may be considered a "firm client" with no individual attribution or credit assigned to the CPA(s) most closely identified with the client, thereby providing no incentive to the CPA(S) responsible for the client relationship. This system will require adjustment for the winding down of a practice before a partner's retirement, as the partner hands off the primary client relationship to others.
If a subjective compensation system is in place, new business may be considered comparable to the retention of significant clients as long as the partner's efforts are apparent and consistent with the firm's goals and objectives.
* Origination credit for a defined period of time (i.e., five or seven years for total fees). This requires rainmakers to develop new clients. At some point, the new-business credit-but not the cross-selling credit-ceases for a given client and that client becomes a "firm" client.
* Shared-origination credit. This gives credit to partners for their marketing efforts, acknowledges the importance of their initial value to the client, or recognizes their immediate assumption of responsibility to retain and increase the volume of profitable business from that client. This credit is especially useful to ensure that partners don't ignore clients originated by others as they pursue new origination.
Other important issues involve the means for allocating origination credit and the relationship between new-business credit and cross-selling:
* Allocating business origination credit effectively. Your system must track the new business developed by each owner and should include information called for on the new file opening form. Also, to limit misunderstandings between and among partners, the firm should define what constitutes a new client. Problems can be averted by publishing client information in new-business files, thereby allowing all partners to review the list of clients for which new business credit is being given.
It is also important to give credit for and to track cross-selling credits when partners develop new work from existing clients, since this is probably the best source of additional business for the firm. Rose recommends that credit for cross-selling business be equal to that for new business. And, when administering the tracking system, use a broad definition of "new" business to keep the partners' level of interest in origination high.
* Tactics for allocating credit for new business/ cross-selling. These will depend upon whether your firm has a formula or a subjective compensation system. With a formula system, the percentage should be high enough to serve as an incentive to develop business, but not so high that there is no incentive for others to work on the engagements. With a subjective system, make it clear that the firm is giving significant credit for business development. In either case, your firm will have to reach a compromise between the client producers and the work producers.
Compensation systems must also address issues related to receivables, delegation, and credit for management:
* Billing and collections. Your compensation system must value these because the systems that reward hours billed and collected lead to more work being delegated. If origination credit and client satisfaction are measures of value for compensation, delegation is more likely to fulfill both criteria.
The collection of billed hours has proved to be a far more significant measure of productivity than billable hours alone at law firms, where billed hours are still the leading tender for work that is accomplished. While Rose says that hours billed and collected are a fair and significant basis for reward and are probably more likely to lead to delegation, it is important to consider how you will work value or set-fee-billed engagements into the formula so as not to neglect alternative ways to price engagements for the more traditional billed time.
* Partner delegation. Although partners in most firms recognize the importance of delegating work to others, such delegation will only take place under one or more of these conditions:
* The delegator has more than enough work to do.
* The delegator has more important/profitable work to do.
* The delegator has additional responsibilities that require others to do the work.
* For the economic efficiency of the client, it is appropriate for certain work to be done by others.
* The work in question falls within a defined area of concentration that necessitates its transfer.
Partners must establish guidelines to ensure that work is assigned within the appropriate area of the firm and that supervision is available for compliance. If origination credit is involved and is properly rewarded, the partner will be less likely to focus solely on the "eat-what-you-kill" principle.
* Credit for management. The system must award credit for practice areas, activities that relate to the firm, or other defined responsibilities (e.g., managing partner, partner in charge of a department) "so as to be able to identify quantitative and qualitative goals by which to measure management performance," Rose says. Results from management responsibilities must count as well, he stresses. "If the management task assigned and ultimately evaluated results in heightened efficiency, cultural betterment, and/or increased profitability, the firm should include this in the compensation of the responsible partner(s).
"Remembering that leadership of high quality is harder to replace than to retain, firms must reward it appropriately. If they don't, those in current management will be less motivated to continue their efforts, since meeting other criteria of the compensation plan will undoubtedly lead to more dollars for others."
Firms generally acknowledge devotion of time to management by:
1. Reducing the targeted billable hour goals for managers. Those with heavy management responsibilities should be given lower billable-hours goals without having to worry about taking a compensation hit.
2. Paying a fixed stipend for management roles. Rather than adjusting work goals, some firms assign a fixed sum for certain management work, such as $25,000 or $40,000 for service as the managing partner, member of the executive committee, and/or head of a practice area.