Herbert M. Cannon is one of the nations leading experts in the management of A/E firms. With over 25 years of “hands on” experience in the A/E Industry, Herb has held top management positions in a number of high profile firms.
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Interview Transcript and Members Only Resources:
Enoch: Welcome back, Architect Nation. This is Enoch Bartlett Sears, AIA. Today, we have an awesome presentation. I know everyone is going to get lots of good information.
You’re going to want to lock your door, take out your notepad, and put this one on replay because I’m sure you’re not going to be able to keep up with all the great information in this particular interview.
Herbert M. Cannon is one of the nation’s leading experts in the management of AE firms. Today, we’re going to discuss how to turn your firm in to an unstoppable force of nature. Mr. Cannon himself is an unstoppable force of nature.
So, Herbert, welcome to the show.
Herbert: Well, Enoch, thank you very much for inviting me to be here. It’s an honor. You know, me and my firm are dedicated to helping architecture and engineering firms earn the profits that they deserve for all their creative efforts.
Ever since I became involved with engineering and architecture firms, I find that they really create an extraordinary value, and often that value is not rewarded financially. Most of them are very professionally rewarded, however went a little bit short on the financial side. That’s what I try to help them out with.
Enoch: That is a perfect message for what this show is about. Like I said, I’m excited to have you on here. I hope you don’t mind the introduction – a little power-packed – but, I know you’re a guy with a sense of a humor based upon our conversations through email, so I thought you would enjoy that.
I just want to mention to our audience also that Herb has actually worked with a number of illustrious firms here in the U.S. So, it’s not just someone who has, kind of, come up with these solutions on his own. He’s done this through practical experience over the years. He gives seminars all around the country.
We really look forward to finding out your opinions and your thoughts on the state of architecture.
Herbert: Or the business of architecture anyway.
Enoch: Perfect. Now, Herb, in our email exchange, you did say you have plenty of opinions that you’re more than willing to share.
Herbert: I do have a lot of opinions. To get my opinion, all you have to do is ask and I will give you the opinion. It may not be the most politically correct opinion, but it’s not my job to make people feel good about what they’re already doing.
Most of the firms I’ve worked with, they’re already successful. They have eight, ten, twenty, fifty, a hundred, three hundred employees. Many of them are the founders, they’ve created it from nothing, so they’re already successful. I just want to help them really reap those financial rewards.
Enoch: You have worked with some of the nation’s most illustrious firms. I’m just curious, in terms of the state of architecture now, how do you see things sort of change over the past ten to fifteen years?
Herbert: Well, we’ve been over more than the last ten to fifteen years. I remember when I started with Ehrenkrantz Eckstut & Kuhn Architects back in 1995. At the time, there was still a lot of hand drafting going on. People were designing by hand drawing. We used a lot of drawing by hand in concepts and so forth, but really, the technology has not really taken over the profession.
I remember they had 386…
Enoch: Yeah. The Pentium… Yeah, the 386 computers.
Herbert: Yeah, 386 computers, monochrome monitors, doing AutoCAD whatever version, wondering if they should make a commitment to doing it all electronically. Of course, I nudged them to start doing it all electronically. So, that’s where we came from there.
The technology has really become a much more integral part of the design process, not only the AutoCAD, but SketchUp, and all these other things that are in there. I think what the architecture engineering profession has failed to do that a lot of other professions have done is leverage that for their own financial benefit.
I think that if we look at the quality of drawings and the quality of service that we’re giving now in the year 2014 compared to 1995, it’s just light-years ahead. The main beneficiary of that has been your architects’ clients.
If I compare that to CPA firms, for example, they have pushed all of the drudgery, all of the hard work back to the client. They just take that product, polish it up a little bit, but they don’t charge them any less. So, they’re actually doing less work and charging more. I think, us, in the design profession business, we’re doing more and not charging enough.
Enoch: What are your thoughts and recommendations about how to swap that around?
Herbert: Well, you know, somebody is always going to do it cheaper. Part of the challenge that we have, I think… People like myself and you, we deal with engineers, we deal with architects, most of them have post graduate degrees – some of the smartest people that I’ve ever met. That’s really why I enjoy working with them. They’re so smart. They have this little voice in their head that’s the other side of the argument. They’re afraid. They live in the depression mentality, perhaps, if you will.
Those of us who have been in the business for twenty-five to thirty years, we’ve seen at least three or four major downturns. I think when those downturns happen, they, kind of, push us back to that depression mentality and it takes us a long time to come out of that. Certainly when times are bad, certainly at the end of 2008-2009, we’re forced to take any job at any price. It takes a long time to turn that around even when the economy is getting better, which it has been over the last eighteen months or so.
Enoch: Yeah. Tell me a little bit more about what you mean by the “depression mentality.”
Herbert: Well, it means that you’re afraid where the job is going to come from. You’re afraid of how you’re going to pay your rent that you’ve committed to on that five-year lease or in the leasehold improvement loan that you’ve taken out, or how you’re going to pay your employees, cover payroll, cover payroll taxes.
Let’s face it, a lot of us we’re on a survival mode five/six years ago. I think the average firm that I knew, that I was aware of, we saw our clients here… You see management reduce their workforce by about 30%. Even firms that were profitable downsized just because of the lack of volume of work and it was something they had to do.
One thing that I’ve noticed over the years on the business side is that downsizing and the adjustments on the overhead that were made on the end of 2008-2009 were done much more quickly, much more severely than they had done previously. There wasn’t a lot of wishful thinking going on that we all get, you know, “The big jobs are coming in next week, next month, whatever.” “How am I ever going to get the work done if I lay off people, if I give up this office space?” We weren’t caught up with that so much at the end of 2008-2009, so the adjustments were swift, and severe, and probably necessary.
Enoch: Yeah. It definitely affected the profession pretty profoundly. So, technology was a change you’ve seen. Do you see any big waves or overall factors that are influencing the way we’re going to practice for the next ten years or so on the horizon here? Are there any big changes in the industry?
Herbert: They always talk about change. They talk about design-build is the new thing. There’s always the management fad du jour. I don’t see things changing all that much quite frankly. I think it’s going to be more of the same. I think people are still slow to take on the additional fixed, committed expenses on the business side – and that’s probably a good thing.
From the practice side, I see consolidation now. I see larger firms gobbling up some more firms. I see the people that were laid off in 2008 starting their own firms, restarting the cycle. So, it’s almost like continuous cycle where: Times are bad, lay people off, some firms get absorbed by others. The people that were laid off, a good portion of them, for sure, will get out of the industry. Other people, they start their own business.
Herbert: This is quite frankly why I’m a management consultant because I had a disagreement with one of my illustrious employers that you referred to back in ’95. I said, “You know, perhaps, consulting is best for me.” It’s been very good for me, personally. So, I’m a living example of how people when you’re job terminates and perhaps you think life is over, it’s really, perhaps a new opportunity. The fact that I parted ways with that company is, personally, one of the best things that has ever happened to me.
Enoch: That’s very inspiring and we can almost end right there. That’s a great life lessons.
Herbert: Well, you can cut this up and put that at the end.
Enoch: Herb, you do seminars across the nation right now. What are some of the most popular topics that people request and are talking about in response to your seminars?
Herbert: It’s funny, the things tend to go in cycles as to what people are interested in.
Herbert: In some points, right now, I am getting a lot of interest in the ownership transition valuation of your AE firm seminars that I’m doing. I have these seminars, I have more coming up, and it’s people my age, a little bit younger, a little bit older that have been through two or three of these tough times that I’m talking about. They’ve, kind of, managed to come through the last one, they don’t really want to go through it again and jeopardize everything. You, kind of, get a little bit tired of that fight.
So, there’s a great interest now on how am I going to extract the value that I’ve created on this firm either through transitioning internally or selling to the outside. What is the process for doing that? Who are the advisors that I need? I heard from so and so at a party that your firm is valued this way. You get a lot of the cocktail party management philosophy that comes back that I try to undo and paint it real well. Right now, there’s interest in that.
At one point, and I’m starting to see this pick up right now, is also incentive compensation where we reward people on the financial results that they’re producing rather than, at the end of the year, you know, the two or three owners sit in a room and they divvy up some arbitrary, subjective method of how we’re going to pay year-end bonuses. A bonus plan is not the same as an incentive compensation plan. Inherently, they’re very different.
So, I’ve done a lot of work with incentive compensation. I hear the same objections to incentive compensation, but I have never seen incentive compensation not work effectively if you’re already a well-run firm.
Part of the issues that I get in to, and it’s actually how I develop a good relationship with Axium Software, was that, “Herb, we’d like to put in an incentive compensation plan.” “Great.” When we come in, I talk, “Let me see your financial systems. How are you tracking project profits? How are you tracking it by project manager, by branch office, by discipline – however you divide it up?”
I would go in and they are not using the appropriate software to do that. If they do have the appropriate software, they’re not using it, they’re not tracking it. So, the first thing is it almost becomes a remedial assignment to help them get their financial systems and reporting up to speed because one thing is for sure, and particularly with… I’ve heard this with many architects years ago: “Herb, I really don’t care about the money. I’m not in this for the money.” Okay. Understood.
What they’re really saying is, “I don’t care about your money.” Okay, they don’t care about your money for your company. “I care about my paycheck,” “If I had the opportunity to make more, I will make more,” or “I don’t understand the numbers.” “Herb, I don’t understand the numbers.” “I don’t believe in the numbers.”
All of a sudden, when it becomes their money, when they have the opportunity to earn a significant incentive, these people become financial geniuses, they know the numbers upside down. They have new ways of analyzing profits that I never thought of.
All of a sudden, if you have a forty-person firm, you have forty financial experts, which is a good thing. So, the first thing that they’re going to do in an incentive plan is they’re going to challenge the numbers, so you better be on top of your numbers.
Anyway, I went a little bit off track, I know, but incentive compensation was a big thing. I see now as firms are starting to grow again, there’s hiring going on, there’s rebuilding going on. We do not necessarily want to go back to the same business model that we had before in 2007. Even though times are great and we’re making money… When times are great, it hides a lot of problems.
Enoch: Okay. So, when you said “the business model that we had before,” how would you characterize that?
Herbert: Well, the business model that we had before, as I recall 2005/2006/2007, you couldn’t hire enough people to get to work. Everybody was working at a 120% capacity. If you had fifty people, you needed sixty. If you had two hundred people, you needed two hundred and forty. That’s just the way it was.
Everyone was making a lot of money. The other firms that were very smart and well-managed made even more money and they didn’t spend it all. They squirreled it away for the rainy day.
My philosophy is that every firm borrowing some sort of government contractual regulation should be making a minimum of a 20% profit on their net revenues. Many of my clients back then, and have now actually returned to this, were actually making over a 40% profit on net revenues. It didn’t happen overnight, but as a way of just fine tuning and upping your billing rates, becoming more selective about your clients, and getting paid, really for all of the work that you do, that scope. That will help you do it.
Enoch: Yeah. Well, Herb, I had an interesting conversation on Twitter with someone – a couple of architects that I respect very highly. We were talking about this particular question. I had put out the tweet that an architect’s bare minimum should be expecting a 20% profit margin. That was reasonable to expect.
One architect replied with a very interesting comment that I think sort of typifies some psychological thinking about money and about profits. I want to get your feedback. He said a simple comment… I think it was something along the lines of “That sounds greedy to me.”
Herbert: You know, that’s okay. I really understand where they’re coming from. We can talk about the psychology behind that, but what I say to them is: Who is better off with this money? Are we better off leaving this money with the developer client, with the government, whatever your client type is? Is the money better spent there or is it better spent in your hands where you can reward your employees, perhaps, making a larger contribution to their 401k, provide better to their families, give raises, have nice events? Or if you don’t want to do that, maybe there’s some sort of local charity that you would like to do?
There was a firm that I worked with at Vermont that, kind of, had the same thing. They had a ceiling on what they felt as a reasonable profit. So, I said, “Well, you know, why don’t we do this? Why don’t we find an organization that we believe in and that we can help locally? We’ll help them and we’ll get some publicity from it too. Everybody will win.”
So, they found a battered woman shelter that needed some sort of rehab or expansion. They actually donated money to that plus their services on what they felt was the excess profit on this one particular project. So, I think that’s a way that I try to come back to people.
When I talk about making money, it’s not about being greedy. It’s not about these Wall Street movies or anything like that for people who don’t create any value. The architects and engineers are creating an extraordinary value. They deserve to be rewarded for it.
The money should go to them, their employees, and it should be shared with those charitable organizations. I think that’s a much better use than them not having it. I don’t know what those other people do with that money – they buy football teams.
Enoch: Yeah. Well, I definitely agree as well. It’s just my personal feeling that an equal exchange of value. The more you can equalize that between two parties, the owner and the architect, it seems like that’s a great way just to maximize the value all around.
Enoch: So, instead of compensation, what would it look like, from an employee’s perspective, to be in a firm that is employing a good incentive compensation plan? I’d like to, sort of, get in the details of how that works. I’d like to talk about incentive compensation trying to get an idea of what does that really look like. So, we talked about the high level – how is that implemented in a firm?
Herbert: Yeah. Well, incentive compensation is probably best explained through an example.
I worked with one firm where they had six partners who were managing projects. There were two other partners, one was a managing partner, and one was the marketing partner. The other six managed projects, sold projects.
We have one partner who was making over a $1 million a year in profit consistently thereabouts. Another partner was losing $600,000 a year consistently. Another one is making $200,000. Another one is losing $150,000. At the end of the year, they’re making a very small profit, maybe 2%-4% profit on their net revenues.
Now, that presents a real challenge because, number one, they’re all getting the same salary, they all have the same resources, the same employee pool, the same human resources, the same IT, the same design tools, the same name on the door that should bring people in. So, how do we motivate the person who was losing money to make money and to encourage the person who was making the profit not to leave the firm?
If I’m the person making a lot of money, and I’m looking around and my partner is getting all the same benefits. He’s drilling holes in the back of the boat while I’m rowing as fast as I can, I might want to throw him off the boat or I might jump off the boat – one or the other.
Herbert: So, what we try to do is give… Everyone has market salaries or better. We’re not punishing anyone, but what we’re going to do, Enoch, to the extent that you contribute more profit to the firm, you’re going to get a larger share of that. That only makes sense.
We try to start at the partner level or the highest up level to make sure that those people are highly motivated because they’re the ones that have the most influence. The level below that, project managers, we can have project management incentive, or divide up the company’s profits in to certain pools. One for the partners, one for the project managers, one for the non-titled employees, and anyone gets to participate.
So, we talked about non-titled employees including the administrative staff. We create a pool, for those employees, of money, and it gets divided based on the relative percentage of their salaries as it relates to the total salaries within that pool. You follow?
Herbert: So, that’s how we reward them because it’s hard to really directly relate their efforts to the financial results. They don’t have that much control over it. The higher up you go, the more that we want to tie you to the financial results.
Remember, we’re never punishing anyone. You’re still getting your salaries, you’re still getting your benefits, but you know what, Enoch? If I made a lot of money, maybe I’ll get a $10,000 distribution. You didn’t make any, you only get $2,000. So, it’s a little bit more than that.
When you talk about a bonus system – that’s highly subjective, the overachievers financially tend to be under-rewarded, underachievers tend to be over-rewarded. So, we, kind of, try to compress that down in to the middle. To me that’s unfair.
Enoch: What kind of systems are used to track performance and determine, for instance, partners, how much revenue are they responsible for?
Herbert: Well, there are two softwares that are used. One is the Axium Ajera Software. It tracks everything by project and project manager. The other one is Deltek Vision. Deltek just bought Axium. Those are the two softwares that I’m familiar with, that I support, and I have great familiarity with. It’s easy enough to set up. It’s easy enough to track.
The hardest thing that I’ve seen is convincing the people at the top that it’s going to work and promote the right behavior. What we never want to do is we never want to compromise design. We find that you’re compromising design, you’re going to do it over once, twice, three times, ten times, because we’re still going to give that level. I haven’t seen that. I haven’t seen that happen.
I’ve seen people be more focused in getting to the solution and not spending a lot of time wondering, doing designs that really are unrealistic or they know will never happen. So, it gets us much more focused and spending more time producing that quality product.
So, generally, with the incentive compensation,… Let’s say I’m a 100% owner of a company. Why would I want to share my profits with any of the employees on an incentive bases? I think that’s a fair question. Why would I?
Well, I would have to be convinced that by sharing 1/3 of my profits with my key people, my entire company, that in the end the 2/3 that I have left as a dollar value will be greater than the 100% that used to keep – if you follow that logic.
Herbert: So, you’re making a $100 thousand now and I’m going to put $30 thousand in to a profit pool, I need to be convinced that in a short amount of time, I’m still going to be making more than a $100 thousand, right? It’s not about dividing the pie up in to smaller pieces. It’s about growing the pie.
We see that people that are motivated by money – and most people are motivated by money even if they say they’re not – all of a sudden, become much better managers on the business side. All of a sudden, you know, it’s a $450 thousand. There’s an extra here that will probably be another $5,000 or $10,000, [Inaudible 00:25:55] and just let it go. That’s easy to say in the context of a company.
However, if you know that by getting that $10,000 change of scope, it’s completely legitimate and we should be paid for as design professionals, if I know I’m going to put $2,500 in my pocket out of that, I am much more motivated to get that.
So, what we find is that all the key indicators of the company escalate because we’re really getting paid for a lot of the out of scope work. That really is the key.