Tags: authorityearn more moneyfirm profit secret
Episode 181

Small Firm Profit Secrets

Ruth Danielle LuiskingJan 1, 2017

Our guest today is Karen Compton. Karen is the principal at A3K Consulting which is a firm that focuses on business consulting for small and medium sized AEC firms.

In today's power-packed show, you'll discover:

  • How to avoid the #1 small architecture firm profit killer
  • 3 profit metrics you must keep your eye on as a firm owner
  • 2 ‘profit fixes' to increase your bottom line

Go here to watch the second half of our interview on Build Your Dream Firm: Business Tips for Architects

Resources for today’s show:

A3K Consulting
ArchiOffice Online

Interview Transcript and Members Only Resources:

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Karen Compton: The hardest thing I think for microbusinesses is the idea that they're going to have to spend 20% of their time doing marketing and business development when they're actually still doing work.

Enoch Sears: Business of Architecture episode 181. Hello, I'm Enoch Sears and this is the podcast for architects where you'll discover tips, strategies and secrets for running a profitable and impactful architecture practice. I'd like to invite you to discover how to double your architecture firm income and create your dream practice of freedom and impact by downloading my free 4-Part Architecture Firm Profit Map. As a podcast listener, you can get instant access by going to FreeArchitectGift.com. Our guest today is Karen Compton. I'm glad to welcome Karen back to the Business of Architecture show. Karen is the principal at A3K Consulting which is a firm that focuses on business consulting for small and medium sized AEC firms. Without further adieu, here's today's show. Well, Karen, welcome to back to the Business of Architecture.

Karen Compton: My favorite place to be.

Enoch Sears: I love it. I love it.

Karen Compton: I've actually told several of my friends, “You need to come to the Business of Architecture.”

Enoch Sears: I love it. Yup. You have a way with words, Karen. You have a way with words.

Karen Compton: Thank you.

Enoch Sears: We're here today to talk about why small firm architects don't earn more money. This is a topic that both you and I are pretty passionate about. We were talking about it earlier when we chat on the phone and we're just saying, “Man, you know, there's just so many things that smaller firms could do to improve their processes, to improve their profit.” Let's talk about that. You sent me over some talking points. I'm just going to pull that up here and let's talk about why and perhaps you have a list, but why don't … Let's just start at the top. In your experience, why don't small firm architects make more money? The money they earn for their creative efforts.

Karen Compton: Let's really start at the beginning. The real beginning to this all is that I truly don't believe that most small firms, most small practices, truly know their numbers. They don't realize and don't understand what the key performance indicators are for their business. As a result, they kind of run blind. They can't truly make informed decisions. They can't really make business decisions. They assume they're actually profitable when oftentimes they're not. There's really no clear understanding of what are the metrics that actually drive architecture or any practice for that matter and then what do my numbers actually look like and where are my benchmarking relative to that. That's the biggest flaw that I've seen. I see it with firms that are unfortunately 20, 25 years in practice.

I sit down and say, “Okay. What's your multiplier? What's your overhead rate? What's your labor cost?” They just look at me with these kind of blank stares without really truly understanding what those numbers actually are and what they mean and why they should care.

Enoch Sears: Do you have some anecdotes that you can share with us? Some stories where you sit down with these clients, these principals, they're obviously smart businessmen and businesswomen that's why they're running an architecture firm. When you just began to take a look at these metrics, what does that do for a firm? Take me through that process.

Karen Compton: When I first sit down with a client and talk to them about their business, I really am trying to understand where have they truly struggled. Many of those struggles have really truly been around this particular area, metrics. How do I actually make money? Where do I make money? How do I lose money? Where am I losing money? Oftentimes the conversation begins with, “Okay. Can you at least show me your profit and loss statement or show me your balance sheet?” In most cases and in all honestly, a lot of firms can't show you that. What they can show you is a checkbook balance. Your check registry is not a place from which to run your business. It's a place from which to pay your taxes, pay your vendors, but you can't run a business that way.

You really need to move to a platform that at least allows you to aggregate expenses and income so that you can begin to run some of the metrics that we're talking about. Honestly, I can't tell you how many times I've walked in and somebody hands me a checkbook or hands me a box of receipts and says, “I don't know where I am.” I worked with a firm up until about a month or two ago and very well established, very reputable firm. They basically build prototypical retail franchises for a very large national food retailer. They didn't have a profit and loss statement. They didn't have a balance sheet. They're running a $2.5 million company out of a checkbook.

Enoch Sears: Come on, Karen. There's no way that that many firms out there are running companies based upon the bank account.

Karen Compton: Yes, they are. I have a client. I love her. I absolute love her. She's been in business 25 years, a national landscape architectural practice. When I first sat down with her some 15 years ago, I said, “Okay. What's your profit?” She said, “What's left in the bank.” I was like, “No. No. No. That's not it.” We had to have a real basic conversation around what is revenue, what's the difference between revenue and sales, what is the ratio between your expenses and your direct labor so that you have an understanding of your overhead, what does a balance sheet tell you versus what does a profit and loss sheet tell you.

I am by no means what I would consider the financial expert, but what I think I am is a real solid business strategist that really tries to give small firms a starting point to be able to say, “This is where we are to begin with today. Let's talk about where you want to go and grow and come up with that plan, but that plan has to be supported by numbers.”

Enoch Sears: What is the process when someone doesn't have these numbers? What process do they need to go through to get this information, to compile it so they can have then those numbers like the multiplier, like the utilization?

Karen Compton: This is not an endorsement by any stretch of the imagination. I think the simplest way to go honestly, QuickBooks actually makes a real simple product. There's one called QuickBooks for Professional Services. Deltek is a very complicated system, but nonetheless, they do have a platform for small business. That is put out by Intuit. These are more of what …

Enoch Sears: I have to mention ArchiOffice. They've been a strong supporter of the podcast. Definitely want to throw in the plug for them as well.

Karen Compton: I have used them as well. They all make very good, very intuitive software platforms that I believe small businesses can use to input at least their labor and expenses. From that, the reports themselves are really more or less a click of a button. If you want to run a report on a profit and loss statement, you click it. If you want to run a balance sheet, you run a balance sheet, but at least the numbers are there. It's really difficult to run, truly run a business out of a checkbook because all that is is an account of dollars in and account of dollars out. It's not telling you how effectively you're using those numbers. It's not telling you how much debt do you have relative to your assets. Could you actually get a line of credit or a U2 foreign debt?

It doesn't tell you anything about the multiplier which is the ratio of your expenses to your direct labor. It doesn't tell you anything about your job costing which is the second place that small businesses lose money. They don't have a clear understanding of what is the cost of an actual project, what is the profit that's built into it and where do they lose money. That's the second common area.

Enoch Sears: When you come in and you start to compile these numbers, what are some of the key things that you start to see? I'm sure they will reveal themselves. That's the whole purpose of doing the measurement. You'll start to see the problem areas. Are there any common problem areas that you see that are consistent or is it just kind of all across the board?

Karen Compton: Depending upon how small the business is and keep in mind, I kind of categorize small into microbusinesses which are one to five people and then emerging growth businesses which are five to 10 and then small is really 10 to maybe about 15 or 20. Each one of those categories behaves quite differently. If we're talking about a microbusiness or even an emerging business, what I often find is that I'm actually dealing with clients that are basically running a lot of expenses through their business. If their intent is to be able or if their intent is to do that … Are you there? Okay. Sorry. If the intent is to do that because it's what we call a lifestyle business, I have no issues with that. The challenge is however, if you come to me and say, “I want to be a corporate entity,” then you can only run corporate expenses through your business.

You can't run your personal expenses through your business. When I first sit down, the most common thing that I see, Enoch, is that there are a lot of personal expenses that need to either be taken out or removed or recategorized or redistributed. That's the most common problem. Once I take those out of the equation and we're really truly looking about businesses expenses, it's really truly understanding what are they. Do you have reproduction cost? If so, how are you managing them? Are you billing for them? What else? Labor costs usually are pretty straightforward. Most people do a very good job at least of tracking labor because they have to pay for it. It really kind of falls into those kind of two categories. That's where I start to see things kind of shake out.

Enoch Sears: Do you find that firm owners are pretty good about including their own salary and their own compensation in that direct labor number?

Karen Compton: No, they're absolutely horrible. They kind of lie to themselves actually and take their salary out of it. Really the only person they're hurting in doing that is themselves. Let me go back. About three or four months, I actually had one of my clients. I handed her a time sheet. I said to her, “You're going to fill out a time sheet for me for a month.” She said, “I haven't had to fill out a time sheet for anybody.” I said, “You're going to fill out a time sheet for me because I really want to see exactly what are you doing with your time.” About halfway through the second week, she stopped doing it. She called me in absolute frustration and she said, “I get the point.” I said, “What's the point that you finally got?” She said, “I spend a lot of time, nights, weekends, early mornings, and I do not aggregate what I'm doing on overhead.”

Ding ding. “Exactly what are you doing on overhead?” She's like, “Well, I'm trying to do my books. I'm trying to figure out my profit and loss. I'm trying to actually do my payroll.” What she figured out, Enoch, was that she was actually spending a lot of time trying to be a bookkeeper and she sucked. What she really is a really good civil engineer and the business decision was that we hired her a bookkeeper, so that she was actually using her time in the best ways. Owners do a horrible job in terms of booking their time for non-billable work and they really need to because it goes into your overhead calculation.

Enoch Sears: What are the effect someone has if they're running a business, they think they're making money, but they're not including all that overhead like you're talking about? At the end of the day, I mean why should that matter?

Karen Compton: Well, it matters because at the end of the day what they find is they have incorrect understanding of whether or not they are or are not making money. I can't tell you how many small firms say to me, “Well, I don't really take a salary.” “Okay, but why don't you take a salary? You're in business to make money so that you can earn a living. If you can't draw a salary, then maybe you should consider doing something completely different.” There has to be a means and a mechanism by which the business itself actually generates sufficient revenue to cover the owner's salary. Unfortunately, that ugly thing in architecture called insurance because it's extremely expensive and we have to have it.

There's no escaping the fact that we have costs associated with the intellectual capital that we generate. To be fair to ourselves, we must recover those costs in terms of our salaries. It makes a huge difference at the end of the day.

Enoch Sears: The first things we talked about, we talked about getting those personal expenses out. We talked about the second one was that … Actually it slipped my mind. Is the second one getting a bookkeeper? What was the second thing?

Karen Compton: The second one is be honest about what you're actually spending your time on as an owner. If you're spending 60% of your time as an owner on administration and that administration is not going to Staples or Office Depot or whatever it happens to be for you and buying books and pencils and pens or whatever, but truly in doing bookkeeping and things that are really truly not in your strong suit, then you need to do a trade-off analysis and understand is your time best spent in doing that or is it best served in design ?Is it best served in going out and getting more work and paying someone $30 an hour, $40 an hour to actually do books?

What you might really very well find is the answer is yes, I need to go and get somebody to finally handle some of these things either because you're not doing them correctly, that's very common, or it's just too much time on the part of an owner to be able to do especially in a microbusiness. In a microbusiness, every minute counts. We need to be as billable as we possibly can and we need to be looking for new work and new opportunities. It's hard to do that when you're just trying to write out checks. Very time consuming.

Enoch Sears: What kind of savings do you usually see? If you go in and you find out that after really taking into account all the time that they spend doing overhead, you try to figure maybe 60% on admin and only 40% is actually doing billable or chargeable work, where do you shoot to get them to in terms of those percentages? If someone's listening, where should they aim for in terms of administrative versus actual chargeable work?

Karen Compton: Again it's going to depend on the size of the firm, but in general, what I have found is that my owners who are very critical and take that kind of critical path or critical analysis towards looking at where they truly spend their time, they usually generate about 18% savings back to them by giving up things like bookkeeping or general administration. Now that doesn't seem like a lot, but when you look at that 18% at the end of the year, that's profit. Most of us at architecture would love to have 18% profit.

If you can generate that by simply looking at and redistributing tasks that you're using your billable time for at $150, $160 an hour to do and redistributing them to somebody who's making $30 an hour or $40 an hour, yes, there's a decline or a decrease between your 150 and their 35 or 40 that you're paying them, but you can be much more productive in terms of doing billable work, going out and marketing work, promoting your company. That's where I really need you to focus.

Enoch Sears: That is excellent. That sounds like a big win for our listeners. Hopefully they can take this strategy, they can go out there and implement it. Shoot to have more of their time spent on revenue generating things like business development and marketing which you mentioned. If a person is maybe a sole practitioner or a firm of about 10 people, what would you say is reasonable or what would you recommend in terms of time to spend on marketing and business development?

Karen Compton: These metrics kind of vary all over the map, but as a rule of thumb and I know none of your listeners are going to want to hear this, but about 20-25% of your time needs to be on marketing and business development. If you think about it, think about it as a glass. You have to constantly fill the glass in order to drink out of it. If you wait until it actually is completely depleted, then you have to offset all the more. Marketing and business development has to be an ongoing effort. It cannot be when you have time. The hardest thing I think for microbusinesses is the idea that they're going to have to spend 20% of their time doing marketing and business development when they're actually still doing work.

In a microbusiness, the typical model is, “Well, I'll wait until I don't have work and then I will go and market work again.” The run up meaning the marketing time, the sales cycle if you will, depending upon the size of the project is anywhere between three months and 12 months. If you wait until you're out of work, then you're not just out of work for a short period of time, you're out of work for that run up meaning the sales cycle to actually develop the client, develop the contract, secure the work, and then finally be able to start the work and then it's another 30 days before you can bill it. That's six to nine months. You have to constantly be marketing and I know people are going to hate to hear that, but I'm sorry.

Enoch Sears: Well, if we're talking 20-25%, that is one day of every week if you look at a five day work week. We're talking one day spent on marketing and business development. Well, Karen, this is a great place to end this episode. Let's jump in to our next segment and we'll discuss a little bit more about marketing and business development, where their focus should be and some of the other reasons why small architecture firm owners aren't earning the money that they truly deserve. That is a wrap. Thank you for listening today. If you're looking for more time, freedom, impact and income as an architect, get instant access to my free 4-Part Architect Profit Map by visiting FreeArchitectGift.com.

The sponsor for today's show is ArchReach, the client relationship management tool built specifically for architects. If you want to systematize your marketing and business development, ArchReach will help you through it. Visit ArchReach.com to learn more. The views expressed on this show by my guest do not represent those of the host and I make no representation, promise, guarantee, pledge, warranty, contract, bond or commitment except to help you conquer the world.

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ABOUT

ENOCH SEARS

Enoch Bartlett Sears is the founder of the Architect Business Institute, Business of Architecture and co-founder of the Architect Marketing Institute. He helps architects become category leaders in their market. Enoch hosts the #1 rated interview podcast for architects, the Business of Architecture Show where prominent guests like M. Arthur Gensler, Jr. and Thom Mayne share tips and strategies for success in architecture.

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