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Consultants shun pay-for-performance contracts

A business is in trouble. It needs to revamp this and restructure that, but cannot do it by itself. Only an outside expert’s practiced eye can diagnose the problems, develop a customized strategy and help implement it. The dilemma? The company cannot afford management consulting, which typically costs $50 to $150 per hour. Yet without such help, the business might be forgoing its only opportunity to turn the corner to profitability.
And even if it could scrape together the cash to cover consulting services, are there any guarantees the investment will pay off?
The good news is that some consultants these days are willing to share the risks, to get paid only if their work provides the desired results. As Eric Muller, a consultant with Arthur D. Little in Washington, D.C., wrote in a recent New York Times opinion piece: “The trouble lies in evaluating consultants’ services before they have had an effect. … Result-oriented pay gives consultants a powerful incentive to do well.”
The bad news is that performance-based, or contingency, fee arrangements–while often attractive at first glance and particularly suited to certain circumstances–can be fraught with pitfalls, for the consultant as well as the client. In Rochester, such deals appear to be rare.
Until 1981, members of the New York-based Association of Management Consulting Firms were forbidden to enter into performance-based contracts, on the grounds that they could “jeopardize the integrity, objectivity and independence of the consultant,” says Edward Hendricks, association president.
Though the group–which represents 55 firms and some 50,000 consultants worldwide–no longer can legally enforce that position, it still discourages contingency arrangements. Hendricks says performance-based contracts make up a very small percentage of its members’ work.
Hendricks’ association defines management consulting as services provided “at a management level, dealing with management issues using a diagnostic process and recommended solutions.”
Though it is impossible to measure the revenue generated by such activity, he says, industry experts typically estimate the nationwide market at $17 billion annually.
One drawback of a contingency contract, Hendricks says, is that it may “put some roadblocks in how the consultant structures his recommendations.”
For instance, a consultant’s best recommendation for a client might be to phase in a strategy over five years, with his or her fees paid as services are rendered. Under a contingency arrangement, however, the client would agree to phase in the recommendations over one year, tally the results and give the consultant his or her cut. The client will see a quick fix, Hendricks says, but is forsaking the five-year plan in the client’s best interests?
James Whelan, a partner in the management consulting division of the Rochester branch of Price Waterhouse LLP, concurs that ethical standards–particularly among the major accounting/consulting firms–long have shunned contingency contracts.
Pay-for-performance “puts you in the position of not rendering objective advice,” says Whelan, a 38-year consulting veteran. “You stand to personally gain or lose, based on what you tell the client.”
Pittsford consultant Kurt Grage of Grage and Associates says a consultant has to be leery of performance-based arrangements for several reasons.
An outside adviser has only so much influence on management, he says. He or she cannot force management to implement recommendations properly and completely.
And, Grage asks, on what measurement does one base the consultant’s effectiveness and, therefore, fee? While typical benchmarks might be return on net assets, gross margin or net profit, does one exclude the personal portion of the owner’s trip to a trade show? What about capital improvements?
No matter how the contract is written, Grage says, conflicts over such exclusions always are possible unless “a whole lot of trust between the company and consultant” exists.
Both Grage and Hendricks, however, look more kindly on including a performance bonus as one element in a traditional consulting contract. A consultant might receive 25 percent to 75 percent of a fixed fee when services are rendered, Grage says, with the remainder dependent on results.
Stephen Shannan, a partner in PDF Associates–which has offices in Rochester, Chicago and Toronto–is negotiating a deal with a Toronto advertising agency that would tie 20 percent of Shannan’s fee to producing promised results.
Among those results, he says, are the creation of a “self-generated team to address communication problems,” and “alignment around a vision for the organization’s future” that would add 25 percent to the agency’s billings and 6 percent to the bottom line over 12 months.
Key to achieving those results, Shannan says, is a willingness by those who must do the work to promise that they will succeed.
“We train people to self-generate,” he says. “Until they declare something is possible, it won’t happen.”
Skepticism about the possibility of success, at the executive level or among the rank and file, will doom the project every time. Critical to success is Shannan’s ability to give employees a new perspective on what they do, and the language tools to achieve the results.
With a dubious executive, Shannan would try to illustrate how his or her reluctance to take certain risks is part of what keeps the company where it is.
Taking on a contingency contract with a skeptical client, Shannan says, is dangerous because the client may feel very little investment in producing the desired results.
Another pitfall of contingency-based contracts, Shannan says, is oxymoronic: Too much success may make the client feel cheated, thinking that the consultant put in too little work and the results came too easily. For that reason, he says, it is important that both parties understand that the consultant’s performance-based pay is not tied to the number of hours he or she puts in.
Where an attitude shift is a tricky thing to measure, certain types of projects lend themselves to pay-for-performance deals. Where effectiveness is easily and quickly measured–assessing the benefits of a revamped computer system, for instance–contingency arrangements are more popular.
And for a cash-poor company that needs to overhaul its operation to stay in the game, contingency consulting may be the only way to go.
Regardless, Hendricks warns, it is important that both client and consultant understand all the pros and cons of such arrangements.
Though he never takes a job on contingency, Whelan says, his clients can be sure of achieving the goals they set forth early in the consulting relationship.
“We’re very accustomed to having our feet held to the fire,” he says. “We don’t expect to get paid until we’ve succeeded.”

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