Today we discuss architecture firm management for maximum profit. 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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Enoch: Hello, Architect Nation. I am your host Enoch Bartlett Sears. Now, just a quick note: Remember to get on the early notification list for the Business of Architecture Conference. You need to be on the list to access the early bird discounted tickets. This is going to be the event this year for solo and small firm architects that want to run a more flexible, profitable firm and have fun doing it.
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Today, is the second part of my interview with Herbert Cannon. Herb Cannon is the President of the consulting firm AEC Management Solutions. He’s held senior positions at some of the nation’s most prestigious firms including Robert A.M. Stern Architects.
He’s a business powerhouse with a wealth of information on what works to create a business that is flexible, fun, and profitable which, as you know, I love talking about here on the show.
In addition, Herb also conducts seminars across the U.S. including one of his most popular seminars “The Pathway to Profit: Discover the Secrets to Earning 20%+ Profit.”
So, without further ado, here’s the show.
Enoch: What are the top project management mistakes you generally see architecture firms making?
Herbert: Well, I still can’t believe that people are not sharing, owners are not sharing, project information with their project managers on the business side. They may not be sharing the fee. They may not be sharing- just not sharing the contract whatsoever. There is some sort of voice in their head that says that the world is going to fall apart if they share financial information with their employees. So, that’s a big thing.
We can talk a little bit more about that psychology. That’s a big problem.
Enoch: Herbert, can we talk about that right now, the psychology of that?
Herbert: Yeah, we could talk about that. I mean, they’re so afraid that the employees are going to think that they’re making so much money that they’re going to ask for a raise. I really think that’s part of it.
Herbert: But, what I tell them is there’s such a lack of understanding on the business side by many of these people, really, more than you would believe. They really just don’t understand the business side whatsoever.
I’ll give you an example of what they think:
Let’s say that, okay, I’m being paid $20 an hour. That’s about $40,000. I’m being paid $20. They’re billing me out at $75 an hour. What do you think a junior person like that thinks?
They think, “Well, they’re paying me $20…”
Enoch: They’re pocketing $50
Herbert: $5 to $10 covers everything else, right? So, $30. So, you know what? That hurt. “He’s putting $45 an hour right in his pocket for every hour that I work.” Clearly, we know that’s not the case. But, if you ask them, they will come up with something similar to that – I guarantee it. So, there’s not even any education on that part.
So, I tell the owners, “You know what? No matter what you show them, they think you’re making a thousand times that.”
The reality is generally they show them when times are really, really bad. All of a sudden, there’s a willingness to share the information with them. You know, “We’re all in this together,” sort of thing. So, that’s interesting psychologically.
When I first started out, I did ABCD and E, and I don’t understand why they’re not doing this. Number one, if they were doing all those things, they would have their own firm, they wouldn’t be working for you. So, a lot of what I do is really talking owners down off the ledge from unrealistic expectations of their employees.
If you have a hundred-person firm, you’re probably lucky if you can find two people that have all the attributes that the owner has when he was young.
Herbert: So, the psychology behind it, I find it difficult to accept because I have never seen any harm done by sharing more information – sharing billing rates. I always say, “Share everything except the salaries.” They already know what everyone else is making anyway, so it would be redundant, right? They all share the salary information.
So, share everything. Share the contracts with them. Have them right the proposals. Have them do the budgets. Have them decide. Get them more involved and engaged because, when you do, it creates much more of a team spirit. It creates that much more responsibility and accountability for making it happen. If they help negotiate the fee, if they put together the team, if they put together the scope of work, if they have the access to the contract and the schedule, and they get to meet the client, you know, these things can only help – nothing bad can come from that.
Enoch: So, number one is: Be open about the contracts. I’m guessing that’s so they can have a benchmark. There’s no way to measure a progress unless you know what you have to work with.
Herbert: Absolutely. I’ve had people tell me, “You know, I finished a project.” Then, the first thing I hear is, “Well, you know, you’re 20% over budget,” and they go, “What budget?” They were never told what target they were supposed to hit.
You know what? One thing about the younger people coming out of school, I think they’re really smart just like many of us were when we came in. They’re just as eager to build their careers.
I have three daughters. I noticed their education through, certainly, high school and college, everything seem to be much more team oriented. When I went to school, you did one thing: You did your project, you did your homework, you took your test, and then you were judged individually. There seem to be a lot more teamwork involved like team projects and so forth with, certainly, my three daughters.
I think they, kind of, expect it. They enjoy being part of a team. So, I think the more that we share with them, the more they feel like they’re part of a team, and the more they will help the owners, the managers of the firm, accomplish their goals and succeed because they know where they’re trying to go.
One of the things that I do is what I call a “management audit” or sometimes a “human resources audit.” It’s really just talking to the employees, interviewing the employees, doing an online survey with multiple choice from something that’s a huge problem to it’s no problem whatsoever. Within each section, there’s a chance for them to say anything that they want.
“Give me at least two ideas to help us improve our marketing.” That’s their opportunity. “Give me two more ideas to help us improve our financial performance,” or “our project management,” or “our design,” or “our quality.” So, again, each section is a chance for them to do that. It can be, “What do you think the biggest problem here is?”
Interestingly enough, almost, without a doubt, the thing that they’re most dissatisfied with is communication. I used to think that… I’ll be honest with you. When I first got out of school, when I trained as an accountant, you know, communication… I come to work, I do what I’m told, and I get my paycheck. It doesn’t work anymore. That doesn’t work and that’s certainly not the mindset of the more creative people. They want communication.
As I slice and dice that information, you will find that the Principals, or partners, or owners of the firm, they think there’s great communication. Because they know everything that’s going on – they think. The further you go down on the food chain, the worse they think the communication is. It’s such a simple problem to solve. I don’t know why everyone doesn’t do it. Part of it is the sharing of the information.
Herbert: Part of it is the sharing of the information of the current work.
How difficult is it to, for once a month- if you have a large firm, you could do it over a webinar sort of thing and talk to everyone, spend the half hour. If you’re a small firm, you get together and you talk. “Hey, these are the marketing proposals we put out.” “We’re hopeful for this one.” “These are the two jobs we got in last month.” “This is the team…” Just give them an update and have a little open forum for them to ask questions. It creates a huge difference. It creates a huge difference for them and makes them much less likely to leave your firm, which is another problem we’re facing now as the economy gets better because they feel like they’re part of their team.
That’s the one other thing that I like to talk about. We need to be careful when we’re communicating what we say to the employees. If you’re an owner and you’re fifty years old, and your two other partners are fifty years old, and you come up to your thirty-person firm and you tell them, “You know? I’m working till I’m eighty-five.” “We have thirty employees now. We’re never going to be more than thirty-five.”
What are the employees really hearing? The employees are really hearing, “There’s no place for me to go.” Number one, “I’m never going to be an owner because there are three owners already. They’re going to work for the next thirty-five years.” Number two, “We’re thirty people. They’re only going to grow by five people, there’s nowhere for me to go.”
Herbert: “So, in order for me to grow my career, I have to leave the firm.” So, we need to be careful about what we say.
That’s another thing.
Owners always say, “My ambition isn’t to grow the firm. I never wanted it to be…” I remember Bob Stern, Robert Stern Architects, telling me… He goes, “You know, Herb, I never thought we’ll be a hundred and forty person firm.” “Herb, I never thought we’d be a two hundred-person firm.” “Herb, I never thought we’d be a three hundred-person firm.” “I don’t want to be, but I don’t want to be, but I don’t see anybody turning down work either [Inaudible]
Herbert: So, it’s, kind of, that inner conflict within them that they don’t want to turn down work. They don’t necessarily want to get bigger, but, you know… So, they’re conflicted. They’re conflicted in that way.
It’s interesting because I think growth is good. I think it creates opportunities for people. You can accomplish more design-wise. Who’s in a better position to create better design? A firm that’s scraping by trying to cover payroll or a firm that’s comfortably making a 20%+ profit, reinvesting it back in the company, being able to hire the best people, the best facilities, rewarding your people, just creating the best websites, the best marketing materials to track even more and better clients? Clearly the person with the money is in a much better position to do that.
Herbert: I don’t believe that the creativity is stifled by the money side. I think that the money side and the creativity side go hand in hand – they complement each other.
Enoch: Herb, earlier you talked about firm valuation.
Enoch: You infer that there was a disjuncture between the reality of the situation. Generally, before people are informed, there’s, sort of, a mismatch there of expectations. Is that what you see in that space? I’d like to talk about that a little bit.
Herbert: Yeah, I do. There are two different things of ownership transition and valuation. It’s one thing if I’m the 100% owner and I want to bring in some other people to help me, reward them, and help grow the company. So, I’m a 100%, I’m willing to give up 25% and spread that amongst a couple of people without any real intention to ultimate the transition the full ownership to them. I want to keep them under my umbrella. That’s one valuation. The valuation under that scenario tends to be relatively low because it’s not profit motivated in the short term.
The other scenario is that: I’m retiring. I started this company from nothing, but I want to get full value. The real conflict is that the value that I can get for selling it to the outside VS the value that I can get transitioning it internally – there’s a big gap there.
Enoch: In which direction?
Herbert: Selling to the outside, you’ll generally always get more because, number one, the employees that have been with you, all they’ve ever gotten was a salary. Where are they going to get money to buy a market value company design firm that’s well run? It’s just difficult. Of course, it’s been done, but it’s just much, much more difficult.
On the other hand, some owners are willing to transfer ownership even on retirement as a lowest book value, you know, the net equity in the firm. “I’ll be happy to transfer that” because they’re provided for the retirement outside of the value they’ve created in the company.
On the other hand, if they haven’t provided for their retirement, you know, taking the money out, provided outside of their – the stock market or real estate – whatever their investments are and their business is the biggest investment, then they [Inaudible 00:14:36] They are almost forced to sell to the outside. So, there are a lot of conflicts that they’ve got on there.
The internal transition – I easily talk for three hours about this at my seminar. I could probably talk for six. There are so many things that go in to it:
Owners tend to have an unrealistic expectation about the timeframe. If you’re going to transition internally, you need to do it over maybe seven to ten years for the employees to be able to buy you out just because of cash flow issues. If you’re selling externally, they’re unrealistic even then about what they could expect to receive in value for their company.
I’ve ran across, recently, some people who are in a disadvantaged business enterprises, or either at a WB or a minority status. It makes even that much difficult to transfer because your contracts may not necessarily be transferrable.
Working with one firm that does work for a school district… Even if you sell 100% of your company to another individual, the contract isn’t even transferrable. The practicality of that, I don’t know. They would probably transfer it anyway, but you have all of these other issues that just come up.
One firm that I was working with here in New Jersey probably about eight years ago, it started out as an internal transition. Part of the process I go to is education. We’re educating the owners. We’re educating the new staff that’s coming in to be partners.
There were three people that this individual wanted to transfer ownership to and he didn’t want to retire. As I sat down with the individual interviews, one person said, “Well, you know, Herb, I’m going through a divorce, I just can’t do it. It’s just not practical financially for me to be able to do it, and mentally, and all these other…” Okay. Understood. “We still love you and we want you to stay here.”
Talked to the other person, he goes, “Herb, no one else knows this, but I never really had to work. I have a really big trust fund. I’m thinking of about going and doing some fulfilling and non-profit work anyway.” Ultimately, from there it becomes an external sale which happens, you know, maybe 20% of the time.
We try to go through that internal transition. For whatever reason, people don’t want to take on the risk. They don’t understand the business side. They haven’t been trained on that.
We show them a balance sheet. So, we see a balance sheet and we see, okay, actually we have $250,000 accounts receivable. We have $700,000, so we have $950,000 – almost $1 million of current assets. They look at the liability side and they say, “Oh, there’s consultants payable $250,000. Other trade things that are $100,000 – $350,000.
This firm owes $350,000. This owner wants me to come in and buy this company with $350,000 worth of debt. Coming from their background and experience, that’s exactly what they see. They can’t put it together in the short term anyway. But, gee, there’s a $1 million here. Yeah, we owe $350,000, the net is $650,000 to $700,000, so that’s a challenge too. So, you never really know until you go through it.
Some employees are so offended that they would be asked to pay anything.
Herbert: Absolutely. “I’ve been here for eighteen years. Why should I have to pay money to be a partner?” Because it has a value and we’re not giving it away. For the last eighteen years, the company has provided you with a salary, benefits, and all these other things that go with them. The reward for that service is being asked to be a partner. The reward isn’t to give it to someone. So, you know, there’s a lot of education in that. On the other hand, some people are just really ready and eager to do it.
While we’re on that subject, how do choose the owners of a company? Big thing. The smaller the firm, the more the number of criteria there generally is for being an owner. If you have a ten/twelve-person firm and I want a part in it, well, you better be technically good, have good design skills, you better be able to bring in business, you better be able to manage people, you know, just go down the list.
If you’re a larger firm, if you have a150 people, you can afford to have someone as a smaller partner who is a specialist. “Yeah. You know what, Herb? They’ve never to market. They really can’t manage people, but they’re really great designer.” Okay. Well, you know, we can afford to have that person. So, the criteria is different.
Herbert: What’s the checklist of the ten things we need to look for before you can become an owner? I say, well, there may be a checklist, but the last thing that you want to do is publish that checklist. You don’t want to put it out there and say, “If you’re an employee and you can do these ten things, then you’re going to be an owner.” Because I guarantee you, the person that you least want to be an owner in your firm will accomplish that list and he will come to you with a check. You can hardly bear being with him as an employee, so you don’t want to publish it. You have mental list of what it is, but don’t publish it, whatever you do.
Enoch: Excellent. A large part of our audience, we do have people from different firm sizes listening in to the show.
Herbert: Yeah, sure.
Enoch: A lot of the audience, they do belong to smaller firms or they own smaller firms, we have a lot of sole practitioners who are practicing now. What tips do you have for being successful as a sole practitioner? Maybe the top two or three things that you think, generally, sole practitioners need to be focusing on to be competitive and have the good kind of life they are wanting to have?
Herbert: Yeah. I think you need to have a really good work process. If you have a small firm, you need to hire good people. There is no room for dead wood in a small firm. If you have a larger firm people can fly under the radar. But, if you have a ten-person firm, everybody better be pulling their weight plus. So, I think it’s really important. If there are personnel issues, you need to deal with them and deal with them quickly because a cancer in a small firm can spread very, very quickly.
Understand the business fundamentals. What are the key drivers of the business. Understand the net multiplier, the overhead rate, the utilization rate are the three big things there. Share those concepts with your employees on a regular basis. Set benchmarks for them.
When we talk about ratios and benchmarks like that, that’s a way of sharing high-level information without sharing the actual dollars that are involved with profit and so forth. So, I think that’s important.
Make everyone in your firm a business person and aware of what those key things are, what their expectations are, and utilization, what a net multiplier means.
Most of your success comes from the basics. There’s no question about it. A lot of firms they don’t take the really very, very short time it takes to master those basics. If you master those basics, you’re 80% of the way there easily. Master the basics, everything else is an incremental 20% that’s much more difficult to do.
Master the basics, which you can get a basic understanding of those by spending a day at a seminar (Mine!) where you really get to understand those basics. It takes a little bit longer to put them in to place and really understand how to optimize them, but it’s an investment that really does pay dividends.
Enoch: How can people connect with you, Herb, and find more about what you do?
Herbert: They can connect with me at my website: http://www.ABCmanagementsolutions.com. They can send me an email at firstname.lastname@example.org. Notice how I have a nice short website URL for people to go to. Pick up the phone and give me a call 732-705-5098. My business number. I’d be happy to your call, answer some questions.
I found this immensely enjoyable. Are we wrapping this up now, Enoch?
Enoch: Yeah. I wanted to ask you if you had anything else that you felt like you wanted to talk about or mention before we cut it off.
Herbert: No. I just wanted to really thank you for this opportunity. I think that it’s a great thing that you’re doing here. I’ve had the opportunity to see some of the videos that you’re producing. Good work. I enjoy it, and I’m honored that you asked me to participate in this. If I have the opportunity again, I would love to do it.