In professional services, successful firms tend to be either small or super-sized. There’s very little middle ground.
Take health care, for example. Shouldice is a small, 89-bed hernia hospital in Canada that, over the past several decades, has provided excellent health outcomes for patients, a congenial work atmosphere for doctors and nurses, and handsome economic returns for its owners. The hospital’s leadership has forsworn expansion to avoid diluting its unique offering.
But then we also have Narayana Hrudalaya, a cardiac hospital headquartered in India that has grown dramatically over the past two decades by following an approach its founder calls “the Walmartization of healthcare.” The hospital delivers world-class results for cardiac patients, provides an excellent work environment to its medical staff, and has yielded outstanding returns to its stockholders. The hospital can drive costs down and benefit from specialization because of its high volume of activities.
"With growth, the way a firm is managed has to change, and that change is not easy."
Among law firms, Wachtell Lipton maintains a premium market position, an exciting work setting for its lawyers, and remarkable profitability for its partners. And then we have the multinational Magic Circle firm Linklaters, which offers seamless, cross-jurisdictional, cross-practice legal services to its clients, the opportunity to work on complex matters with highly skilled colleagues to its lawyers, and very good profitability to its partners.
There are several other similar examples. But there are very few instances of successful mid-sized professional service firms. Some professional service firms excel as small, informal, and specialized organizations. Others are large, formal, and broad in their client base and service offerings. Firms that are in between are in a challenging zone, a “Bermuda Triangle.” Several small firms enter this zone as they grow; not all emerge as successful, large firms.
The Bermuda Triangle exists because, with growth, the way a firm is managed has to change, and that change is not easy. Small firms operate informally. Continuing an informal approach to management strains performance as a firm grows. Costs begin to increase and errors in operations and service delivery begin to cumulate. Formal systems and processes have to be introduced. They improve operational efficiency in large firms. However, the transition from informal to formal management is difficult and changes the culture of the firm. Several firms find it difficult to navigate this transition.
The term “Bermuda Triangle of Management” was first used by D. Darryl Wyckoff to explain why the operating ratio—operating cost to revenue—was highest for mid-sized firms in his 1973 study of the trucking industry. It applies, perhaps with even greater power, in the human-capital-intensive professional service industry.
Potential benefits of scale
If professional service leaders wish to scale up their enterprises, they must first answer a critical question: Why? How would scale provide an advantage for my firm?
Scale can benefit a professional service firm in four ways:
Cost economies. If a firm incurs significant fixed costs, operating at a large scale helps distribute the fixed costs, reducing per-transaction cost. Narayana Hrudalaya, for instance, has installed cutting-edge expensive equipment for heart procedures, but the high volume of its operations drives down per-procedure cost.
Demand economies. A large footprint is a differentiator for some services. Linklaters’ clients, for example, derive comfort from knowing that the firm has the resources to work on large, high-stakes, complex matters. A 2007 analysis found that the firm’s average billing rate rose as more offices worked on a project, suggesting that clients particularly valued Linklaters’ ability to work on cross-jurisdictional matters.
Learning economies. Major strategy consulting firms, such as McKinsey and Boston Consulting Group, tout the benefits of having a broad universe of clients, effective internal knowledge management systems, and sharing cultures. Those features, they assert, help them learn best practices from their multitude of engagements, ensure the confidentiality of specific information, and apply cutting-edge knowledge to assignments.
Network economies. Across various professions, firms such as Coursera in distance learning, Axiom in legal services, Eden McCallum in management consulting, and Gerson Lehrman in expert services present themselves as platforms that bring together professionals and clients. As in other platform settings, scale is important because of network effects: the more clients, the more professionals will want to join the platforms, and vice-versa.
Not all firms need scale
Simply becoming bigger is not the key to success for professional service firms. In contemplating whether to scale up, leaders of a professional service firm must ask the following questions:
- Do our operations incur significant fixed costs?
- Do our clients (and potential clients) value working with large firms?
- Do we have the internal processes and culture to learn while working on client matters and apply the knowledge gained to other client engagements?
- Are we trying to establish a platform that connects clients with professionals?
If the answer to one or more of these questions is in the affirmative, the leaders must then weigh the benefits of scaling up against the costs of formalization. Only if the benefits outweigh the costs should the firm scale up. However, none of the benefits of scaling up accrue by themselves. The firm’s leaders must ensure that, as the organization grows, its systems, processes, and culture evolve to benefit from its scale.
Professional service firms can thrive as focused, informal, specialized, low-fixed-cost practices. They can also succeed as large, formal, high-fixed-cost organizations. But leaders should be cautious about ending up somewhere in between, suffering the costs of not formalizing appropriately without gaining from scale advantages. These are the firms that risk sinking in the “Bermuda Triangle.”
A version of this article was first published on ( LinkedIn).
About the Author
Ashish Nanda is a senior lecturer and the C. Roland Christensen Distinguished Management Educator at Harvard Business School.
[Unsplash/Akira Hojo]