The price paid for most management consulting work is based on either a daily rate or some variation of a flat-rate fee based on what is being delivered. Enterprise software pricing is also often fixed. In both cases, the client pays this with some expectation of benefits and even an “ROI” for the customer).
When I worked as a Lean healthcare consultant for J&J, we would sign flat-rate contracts with our clients that were based on the number of weeks we would be on site (and how well the client could negotiate with our leaders) and the results we expected to get based on past projects (the value to the client).
I sometimes hear about a Lean consultant who will work for a client for no up-front fee. The consultant gets paid only a percentage of cost savings that are realized (and the travel expenses). I'm not sure that's a very good idea and this blog post is a chance for me to share my thoughts and for you to comment. This might be a bit controversial and there might not be a “right” answer, so let's please have some respectful debate.
Working as an independent consultant, I charge a flat rate (plus travel) for the short assignments I carry out, such as a one-day site visit or a “kaizen kickoff” event that might last a few days. This flat rate includes prep time and follow up activity (to avoid having to track and/or charge some sort of hourly rate for that). I try to keep the pricing simple. When I'm paid as a speaker, that's based on a flat rate, as well, one that's mutually agreed upon.
The price for a consultant (or a speaker) is ultimately set by the market. It must be a price the client can be happy with (leaving them with more value than they paid) and something I can be happy with (a good income for me and enough to pay for taxes, CPA fees, insurance, and other overhead that comes with running a business). Our professional services pricing at the technology company KaiNexus is generally handled the same way – a fair, mutually agreeable fixed price based on the services (and value) that will be delivered.
You might ask, “Wait, but don't you guarantee your work? Doesn't the customer determine value and worry about that, not time spent?” Well, sure. Like many consultants, I guarantee my work. My contract always says the client can cancel for any time, for any reason, and they can ask for a refund if they want. Nobody has ever asked for a refund. I rarely get pushback on my quoted price, which maybe means I'm not charging enough, but there's more to life than absolutely maximizing the price I get for each engagement.
The value of consulting work can be subjective or it can be measurable (or both). The value can also be long-term or there can be short-term benefits (or both). This is where I think a “contingent” fee can possibly cause more problems than it's worth.
Like many things in life, contingent or “shared savings” deals might sound good at first, on the surface, but maybe aren't that good in practice. One parallel I'd draw is that it sounds good to offer a percentage of cost savings to employees who participate in a suggestion box system. At first glance, you'd think that people like money, so therefore paying people for suggestions would be “win/win” for the company and the employee.
But, in practice, these “pay for improvement” incentive approaches quickly get dysfunctional (as described well in the book Ideas are Free and addressed a bit in our Healthcare Kaizen series). As Daniel Pink said so well in the book Drive, incentives (such as sales quotas) work… but they have side effects and that needs to be considered. I think Dr. W. Edwards Deming would have had some strongly-worded thoughts on this too.
For example, he said on individual merit ratings…
I think the same thing would apply when deciding “merit pay” for a consultant.
You can't blame a client who doesn't know better for thinking “shared savings” is a good idea. It sounds good. They might think, “There's no risk” or “The consultant is guaranteeing results.” But I'm not sure either of those statements is true.
For one, the results a client gets (measurable or immeasurable) are not just a function of the consultant's skill and effort. A lot of it depends on what the client does (or doesn't do) and how much leadership they exhibit (or don't). My advice to consultants would be to not take on these arrangements unless you're really good at selecting clients who you know will put their all into this.
When I worked for J&J, we sometimes discussed doing a “contingent” deal if the client was balking at the price. But, we decided to not do this for multiple reasons, including the ones I bring up below (which should be viewed as my personal opinions, not J&J's). Our leaders also decided that if we couldn't convince somebody of the value of our work upfront, then we shouldn't be doing it.
1) Lean is not primarily about cost savings
If you're working solely for a percentage of cost savings, that might drive decisions that aren't in keeping with generally accepted Lean principles.
Lean isn't a “cost cutting” system. It's a system that focuses on improving flow (reducing delays in a process) improving quality – these are the two pillars of the Toyota Production System and they go hand in hand (improving one improves the other, and vice versa).
From The Toyota Way Fieldbook:
Here's a great post by Bill Waddell on this topic.
As has been said, costs are something to be measured, not something to be managed. They are measured (as an end result) not managed (trying to directly reduce them).
It's easier to measure costs (or increased revenue) than it is to measure other factors. Well, you can measure safety, but how does the consultant share the benefits of that? If the hospital prevents 10 patient falls, does the consultant only get shoved and knocked down once? How do you share the savings of reduced patient waiting times in the emergency room? Reduced waiting times might result in higher patient volumes, but that doesn't always mean the hospital gets paid more… so how does the consultant share that savings?
I'd be afraid that “sharing cost savings” would drive too much focus, for the client and the consultant, on cost. Lean is about “SQDCM” – or safety, quality, delivery (on-time delivery or reduced waiting time), cost, and morale. These are the core measures, the balanced measures, you tend to see in a Lean organization.
Shared savings contracts might be most appropriate for methodologies that are solely about cutting costs. For example, there are specialized consultants who will come into a hospital and tell management how many people to fire, based on spreadsheets and benchmarks (the type of consulting I'd never want to do). If management only cares about cost cutting, and the consultant is fine with that, then this type of deal might be just fine. But, not for Lean.
2) It's not Lean to drive short-term costs
Lower costs (or better financial performance) should be an end result of doing all of those other things well (safety, quality, waiting times, staff morale). If a hospital improves quality and fewer patients fall and get pressure ulcers, the hospital might save money (since they generally aren't reimbursed for preventable errors). That sort of cost savings is a good result (good for the patients, the staff, the hospital, and the payer), but it's not “cost cutting.”
Dangerous cost cutting might be short-term cost cutting. Principle #1 (the first principle!!!) of The Toyota Way management system says to make decisions based on the long-term, even at the expense of the short-term.
Short-term cost cutting could be driven by layoffs or cutting of services. That's not beneficial for all involved (it might be bad for staff, patients, and the community). I want to do a good job for my clients, but I don't want to be pressured into short-term cost savings. If I had a client who wanted to use Lean methods or Kaizen for short-term cost savings, I'd just walk away and refuse that work – that's not really Lean.
If Lean is more like farming than hunting, is the consultant willing to wait years to get paid when the seeds that are planted finally germinate and yield crops? What if the right decision in a situation is to spend more THIS year to reduce costs over the next FIVE years? How does that get divvied up with a consultant and when?
3) You have to be careful about “soft savings”
There's a lot of “funny money” accounting that takes place with Lean (or other types of projects and consulting engagements). As a friend pointed out, a consultant (or an internal Lean team) might claim something like this:
The improvement saved 10 minutes, therefore it saves 10 minutes x 10 nurses x 50 times a day = 100 hours / day x $40/hour = $4000/day x 365 = $1.5 million a year.
That's “soft savings.” Freeing up time is good, but can you give the consultant a percentage of those hours? No. A reasonably savvy CFO would, quite reasonably, be a stickler and ask if you've reduced overtime or other payroll costs by $1.5 million. No? Then, it's not savings. It can't be shared with the consultant.
Freeing up time might allow nurses to provide better patient care, which might lead to fewer errors, which is good for all, including saving the hospital money (if the payment mechanisms reward quality).
But, hospitals always have MANY initiatives going on, simultaneously, to free up nurse time and to reduce errors. What percentage of the prevented infections were due to the Lean initiative? How would you ever calculate this? Does it matter, unless you need that number to decide how much to pay the consultant?
4) Shared savings might lead to lying, arguments, and lawsuits
Good consultant/client relationships are built on trust and mutual respect. So should the relationship between employer and employee. But, that's not always the case.
Any time you have incentives where a percentage of cost savings are shared with an employee (through the suggestion box or Kaizen program) or shared with a consultant (through their contract), then you're bound to have arguing.
The client has a natural financial incentive to downplay or sandbag the cost savings number. The consultant has a natural incentive to exaggerate (or “fully capture”) cost savings or revenue increases. I don't want to be in the middle of arguments like this. I'd especially like to avoid situations where there's ill will and the possibility of lawyers being brought in.
So, what do you think? Am I a coward who is rationalizing not taking on “at risk” work (and were the J&J consulting group leaders cowards)? Or, are clients and consultants who agree to these contingent contracts all making a big mistake?
What are your thoughts and experiences? Share your thoughts and comments and please state of you're a consultant or a client.