Risk Management in Management Consulting Firms

Abstract This paper will deal with the risk management issues in a management consulting firm. After an outline of the strategic and operational issues in a typical management consulting firm I focus on a particular sales stage to show which implications it has not to take the time dimension into consideration in the forecasting process. It is all wrapped up in the conclusion, which also includes a few recommendations for management consulting firms Introduction

This article will deal with the risk management issues in a management consulting firm. Like most other businesses it is about balancing effectiveness and efficiency and I will later return to the relevant strategic and operational issues. Two facts distinguish a consulting firm from i.e. a production company: You cannot produce for stock and when an employee leaves the company he or she takes a large portion of the company's intellectual capital with him/her. If it is a fast growing consulting firm you have "resource utilisation"/"growth"/"profitability" dilemma on top of it that can be very hard to manage and certainly involves a lot of risk management issues.

In this paper I am not going to deal with all of them, but I will bring all the major risk issues to the readers attention for the sake of comprehension.

I have been in the management consulting business for 15+ years and I have had the opportunity to participate in the development of both small and very large consulting practices. Despite that I have been working for some of the leading consulting firms I have never been introduced to methodologies or processes that underpinned the strategic and operational targets. And I have never seen a systematically risk evaluation in the forecasting process or in the process of selecting which opportunities to pursue. What is risk? Risk is about management. There are many different definitions of Risk and some of them are very specialised and only makes sense in a specific context. The definition used in this paper is: "Risk is the variation from the expected outcome over time" - a definition made by Prof. James Kallman

Strategic and operational issues As we saw in the definition of risk, dealing with risks only gives meaning if the goals and objectives are clarified. So lets assume we in the following are dealing with a smaller management consulting firm with these goals and objectives:

Grow 60% per year with an average resource utilisation of 70% with a client satisfaction not lower than 80%. Growth is measured by invoiced revenue and resource utilisation is measured by how the number of hours invoiced to customers compared to total hours worked in a period of time, e.g. a month.

To achieve these goals you need to be aware of and have a plan for dealing with risk in several dimensions, where the most obvious are outlined below. How do you grow a consulting practice fast and maintain a high resource utilisation? If you want to grow a consulting business you need estimate the future cash flows from the pipeline of opportunities. A more detailed description of this process is found later in this paper. Based on the predicted revenue over time you can plan for how many people you need. If you are good at estimating the future cash flow you can build a very profitable business, because the resources (people) you have available fits the requirement at a given point in time. This ideal situation is rare. In practice you will make some rough business planning and then hire consultants as the business development process goes on, so that they can start delivering to the clients as soon as the contracts are signed.

The risks are several: What if you don't get the large contracts you were hoping for? What if you have an unfit portfolio of opportunities, which will increase your opportunity-cost dramatically e.g. not having the right mix of small and large opportunities? What if you get more contracts than you can fulfil and you can't get enough qualified resources? Then your client satisfaction will decrease and you don't grow as fast as it was possible. What if the sales process suddenly takes much longer than earlier? Then you charge ability and profitability will decrease.

How do you make reliable forecasts based on previous experiences and the current pipeline? The forecasting process in a consulting practice is essential. It is particular important in this type of business because you cannot produce for stock and the cost of the consultants is sunk if they are not chargeable. To minimise the risk of having sunk costs you need to analyse the past carefully - if possible. The reason for that is that it can give you a good indication of realistic sales cycles, feasible sales methods and a realistic profitability ratio per client. Being too optimistic about opportunities you are working on is the primary reason for poor profitability in the consulting business. But on the other hand, you need to be optimistic and ambitious to meet the requirements for growth. It is therefore very important to analyse both the opportunities you win and loose with the purpose to draw out lessons and experiences that can help you making your forecasting process more and more reliable. How do you make sure that the intellectual capital remains within the firm when an employee leaves? In management consulting firms you provide knowledge, confidence and experience to your clients. To some extend you can encapsulate the knowledge in methodologies and systems, but confidence and experience are closely linked to the individual consultant. It is therefore often a great loss for a consulting firm when it losses one of its good consultants. This means that the clients he or she have been working with will often follow the consultant rather than staying with the company. So the company not only looses a consultant but may also loose one or more clients partly or entirely. You can't prevent it from happening but as a manager you can reduce the impact of such a loss by following a few simple steps:

Don't let the same consultant work with the same client for too long. He or she might be very successful, but over time they may move their confidentiality from the consulting firm to the client. Never let a consultant work alone with a client over a long period of time. By being more consultants, you will as a company have more relations and more lines of confidence with the client. This will improve client retention. Make it hard for your consultants to leave by offering them financial and non-financial benefits of great value to them. Integrate with their families by offering services that underpin the consulting firm as a nice place to be.

Lets take a closer look at the forecasting process. As mentioned before a key success factor for a consulting firm is the ability to manage the scarce resources: People, time and money in the best possible way. The table below shows the typical sales stages with the percentage of likelihood of winning and the average time from a particular stage to the start of delivery.

Sales stage Likelihood (%) Time to delivery (days) Initial identification 10 100 Need for solution acknowledged 20 90 Draft solution 40 75 Presentation of proposal 50 60 Positive feedback 70 40 Contract negotiation 90 30 Won 98 10 Delivery started 100 0

As time passes it is important to all the necessary information from the opportunities you are working with in order to adjust the mean values shown in table above. If for instance you only win 30% of the opportunities in the "Presentation of proposal" stage it has a significant impact of your forecasted cash flow. We have similar concerns with the lead-time. It may change over time due to e.g. changes in the industry, recession and legal changes. It is also worth noting, that the values in the table above are very cultural dependent. The lead-time is usually much longer in Asia than in the US and you might need to add or remove stages depending on the culture you are operating in. The "Presentation of proposal" stage Appendix A shows a history of 21 opportunities in this sales stage and the time passed from that stage till start of delivery. The mean time is 60 days and the standard deviation is 46. This means that roughly 68% of the opportunities in this stage will reach the start delivery state in between 14 and 106 days. Lets assume we have a portfolio of opportunities worth 200000¬. The likelihood of winning the deal in this stage is 50%, so we have reason to believe that we will get orders at a value of 100000¬. Most forecasting systems in the consulting business stops here. But a very crucial part in the equation is left out - the timing. It is quite likely that we will get 100000¬, but we don't know when. In 68% of the cases we will get it in between 14 and 106 days, which is a very wide span in time. It will have a huge impact on our cash flow if we don't get the money close to the average time to delivery. The size of the standard deviation indicates that this is rarely the case. How can we manage and reduce the risk? Unfortunately there are no simple solutions. If we estimate with a 100 day lead-time in order to reduce the risk of a bad cash-flow we create a risk of not having the necessary resources available because we have a more modest revenue forecast. My experience tells me that the best and most sustainable solution is to reduce the standard deviation, so that we achieve a larger degree of predictability in the forecasting process. The predictability can be increased through the following initiatives: o Make sure that there is a constant progress in each and every opportunity you are working on. If it takes too long it has a reason. In that case it might be a good idea to remove it from the pipeline, as it doesn't follow the general pattern. o Be realistic about the size of the opportunity. Don't be afraid to ask the client about their budgets and expectations. o If you have a diverse group of clients it may be a good idea to cluster them in groups with similar business development patterns. Conclusion As consulting practices are so extremely sensitive to fluxions in resource availability, cash flows and timing it is crucial to work on increasing the predictability. This is done by creating the desired level of risk at the desired time, so that the organisation can achieve its goals and objectives. Every consulting firm should appoint a risk manager, who has the responsibility of planning, organising and writing a risk management program. He or she shall also make sure that all account managers are aware of the basic risk analysis processes (Identify, measure and evaluate), so that the predictability will be improved. I have been in the management consulting business for quite many years and I have never seen good tools for managing this business in an intelligent way bridging opportunities and risks. Most often the forecasts have been based on wishful thinking. I have seen a lot of forecasting systems, but no systems is better than the policies around it and I have never seen a system where the opportunities were directly linked with the risk issues except for the very large opportunities where the risks were obvious. So the management consulting business has a great opportunity to take its own medicine by implementing and using systems and policies that link opportunities, resource utilisation and risks.

by Finn Drouet Majlergaard, Gugin