In professional services, successful companies tend to be either small or very large. There is very little middle ground.
Take health care for example. Shouldice is a small, 89-bed hernia hospital in Canada that has achieved excellent health outcomes for patients, a pleasant work environment for physicians and nurses, and substantial economic returns for its owners over the past few decades. The hospital’s leadership has sworn off expansion to avoid diluting its unique offering.
But then we also have Narayana Hrudalaya, a heart 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 best-in-class outcomes for heart patients, provides a great work environment for its medical staff, and has delivered outstanding returns for its shareholders. The hospital can reduce costs and benefit from the specialization due to its high volume of activity.
“As growth comes, the way a business is run must change, and making that change isn’t easy.”
Among law firms, Wachtell Lipton maintains a premier market position, an exciting work environment for its attorneys and remarkable profitability for its partners. And then we have the Magic Circle multinational law firm Linklaters, which offers its clients seamless, multi-jurisdictional and multi-practice legal services, their lawyers the opportunity to work with highly qualified colleagues on complex matters, and their partners a very good return on investment.
There are several other similar examples. But there are very few examples of successful mid-sized professional services firms. Some professional service firms are characterized as small, informal, and specialized organizations. Others are large, formal, and broad in their client base and service offerings. Companies that fall in between are in a challenging zone, a “Bermuda Triangle”. Several small companies enter this zone as they grow; not all emerge as successful large companies.
The Bermuda Triangle exists because as it grows it needs to change the way a business is run, and that change isn’t easy. Small businesses work informally. Continuing an informal management approach weighs on performance as a company grows. Costs begin to mount and errors in operations and service delivery begin to accumulate. Formal systems and processes must be put in place. They improve operational efficiency in large companies. However, the transition from informal to formal management is difficult and changes corporate culture. Several companies are finding it difficult to manage this transition.
The term “Bermuda Triangle of Management” was first used by D. Darryl Wyckoff to explain why the operating ratio – operating expenses to revenue – was highest for medium-sized companies in his 1973 study of the trucking industry. It applies, perhaps with even greater force, in the labor-intensive professional services industry.
Potential benefits of scaling
When service leaders want to grow their businesses, they must first answer a crucial question: Why? How would scaling benefit my business?
Scaling can benefit a professional services firm in four ways:
Costs economies. When a business incurs significant fixed costs, operating on a large scale helps spread the fixed costs and lower the cost per transaction. For example, Narayana Hrudalaya has installed state-of-the-art, expensive equipment for heart surgeries, but the high volume of his surgeries lowers the cost per procedure.
demand economies. A large footprint is a differentiator for some services. Linklaters clients, for example, find comfort in knowing that the firm has the resources to work on large, complex, high-stakes matters. A 2007 analysis found that the company’s average billing rate increased as more offices worked on a project, suggesting that clients particularly valued Linklaters’ ability to work on cross-border matters.
learning economies. Big strategy consultancies like McKinsey and Boston Consulting Group tout the benefits of a broad client universe, effective internal knowledge management systems, and shared cultures. They claim these features help them learn best practices from their wide variety of engagements, ensure the confidentiality of specific information, and apply cutting-edge knowledge to tasks.
network economies. Across industries, companies 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 professionals and customers together. As with other platform settings, scaling is important due to network effects: the more customers, the more professionals will want to join the platforms and vice versa.
Not all businesses need scaling
For Professional Service Firms, getting bigger is not the key to success. When considering whether to scale, executives at a professional services firm must ask themselves the following questions:
- Do our operations incur significant fixed costs?
- Do our customers (and potential customers) appreciate working with big companies?
- Do we have the internal processes and culture to learn while working on client issues and to apply the knowledge learned 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 positive, executives must weigh the benefits of scaling against the costs of formalizing. The company should only scale if the benefits outweigh the costs. None of the benefits of scaling come naturally, however. Business leaders must ensure that as the business grows, its systems, processes and culture evolve to capitalize on its size.
Professional service firms can thrive as focused, informal, specialized practices with low fixed costs. They can also be successful as large, formal organizations with high fixed costs. But leaders should be wary of falling somewhere in between, bearing the costs of inadequate formalization without reaping the benefits of scale. These are the companies that are in danger of going under in the “Bermuda Triangle”.
A version of this article was first published on ( LinkedIn).
About the author
Ashish Nanda is Senior Lecturer and C. Roland Christensen Distinguished Management Educator at Harvard Business School.