Engaging Executives

The Innovation Imperative
in Professional Services

June 2002

Companies rely the services of professionals to create new business, marketing, legal, and financial strategies that drive growth and innovation.  Ironically, the professional service industry is one of the least innovative in the economy, with a business model that has remained unchanged for over a century.  Is this a case of the doctor not taking its own medicine?

Background

Professional service organizations are in the business of delivering distinctive expertise to their clients. Professional services include such disciplines as law, accounting, engineering, and marketing communications as well as myriad forms of consulting including management, human resources, and information technology.)

Market forces are putting intense pressure on professional service organizations to develop distinctive services and sustain profitable growth.  The economic climate has tightened demand for professional services. Commoditization has made it difficult for firms to differentiate their services.  Clients' problems have become more complex while their expectations have risen.  And truly top talent remains hard to find and hard to keep.

Barriers to Innovation

Professional service organizations often find innovation to be difficult because their business model is inherently restrictive.  Time-based billing penalizes productivity improvements.  Saving an hour means less revenue, not more.  Barriers to entry are also low. Professional services are fundamentally about people and ideas.  There are few capital requirements and few economies of scale.  Furthermore, firms’
intellectual property rarely qualifies for defensible legal protection.

The use of project teams to deliver services adds further challenges.  First, project teams are people-intensive with dis-economies of scale. Doubling the amount of work requires doubling the project team. Because of greater coordination costs for a larger team, double the work product typically requires more than double the cost.  Secondly, project teams are poor structures for diffusion of innovation.  The lessons learned on a project typically remain as tacit knowledge in the minds of the team members themselves.

Innovation in professional services is also hindered by organizational factors. Most firms are highly decentralized and have a culture averse to structure and authority.  They lack systematic methods for creating new service offerings.  The result is a portfolio of undifferentiated, commoditized services whose profit margins are under constant pressure.

Firms’ governance structures inhibit innovation. Partnerships require collaborative decision-making and tend to work towards consensus through a lengthy process of “syndication.” The result is a conservatism and sluggishness that slows decisionmaking and hinders investment in entrepreneurial activities.

Entrepreneurial activity in most firms is penalized by rigid career paths. Professional service firms are based on the same model as artist’s studios from the Renaissance.  Partners, like studio masters, take in young apprentices whom they train in the craft of their profession.  Apprentices who master the craft become partners themselves.  Innovation and entrepreneurship are rarely rewarded, and typically discouraged, as they distract from the path to mastery and partnership.

Incremental Innovation

Because of these barriers, innovation in professional services is typically incremental, not strategic. Professional service organizations stay within their disciplinary boundaries.  Consider a large merger and acquisition.  A variety of disciplines are involved, each of which must be coordinated with the others. The legal strategy must line up with the business strategy, which must be consistent with the communications
strategy and be reflected in the accounting and financial agreements.  The situation is ripe for an integrated solution. Yet each piece of the transaction is typically handled by a different provider: law firm, investment bank, strategy consulting firm, communications firm, and accounting firm. Although partly regulated by law, much of the lack of coordination and collaboration is a cultural artifact and a preference for professionals to stick to their field of specialty.

Most innovation in professional services is incremental and does not lead to differentiation or competitive advantage.  A new computer system passes for innovation at many firms.  Strategic innovation is considered the opening of a new office or a merger with another firm in the same field.  Since there are few economies of scale in professional services, these strategies rarely create a competitive advantage – just a higher cost structure.

Firms will occasionally create new methodologies, new service offerings or new practice areas.  But these creations are typically reactive.  After a few engagements are completed in a new area a firm will typically package the learnings into a new service offering. Rarely do firms proactively identify and develop opportunities for new services in the way that product companies do through R&D and product
development.

Innovation Imperative

For decades, the basis of competitive advantage in professional services has been firms’ reputations. In the future, strategic innovation will become as important as reputation in separating winners from losers.  To survive and prosper, professional service organizations will need to overcome the barriers to innovation.  They will need to be more proactive, finding new sources of revenue, differentiation and competitive advantage. They will need new approaches along multiple dimensions:

• Business models that create sustainable profits
• Delivery methods with greater economies of scale
• Service offerings that stand out from the competition
• Organizations that foster ongoing innovation
• Strategic alliances that deliver more value to clients
• Clients whose needs are unmet by traditional providers
• Relationships that deliver value in entirely new ways

The firms that manage an evolving portfolio of innovative service offerings will earn the best reputation, clients, talent, and growth.  Firms that adhere to an obsolete business model, tied to a single discipline with a rigid organization will disappear.

Innovation Strategies

The good news for professional service organizations is that they are well positioned to become engines of innovation and entrepreneurship. The core assets of professional services are intangible: Knowledge, Talent, and Relationships.  Professional service organizations can experiment with and launch new services more easily than manufacturers can launch new products. They do not need to invest in
mass-market research, retool an assembly line, or acquire extensive distribution channels. In the space of a few months, a project team with a few lead clients, a potential alliance partner, a marketing consultant and a couple software developers can test a service offering at very low cost.

Ironically, professional service organizations are the best examples of the future of our economy.  Their assets are all intangible.  Their products are all services. They specialize in 1:1 marketing. Talent and ideas are their lifeblood.  And yet they are one of the most conservative industries in the economy. Can you think of any other industry whose business model has remained unchanged for over a century?