Consultants’ ‘Profit enhancers’
When an organization hires management or IT consultants, line managers must ensure that the consultants deliver the results promised. In this article, I summarise six techniques used by consultancies to maximize their own profitability. Some of these are just savvy business, some are dishonest, some are fraudulent – all are widespread throughout the consulting industry. By making organizations aware of these practices, I hope they will be better armed as they pay out their consultants’ usually generous fees and expenses.
1. Excessive profitability
A junior consultant will typically be paid around £30,000 ($45,000) a year. So with social and other costs, the consultancy may be paying around £1,000 per week. But they will usually be charged out at £7,000+ ($10,000+) per week to private sector clients – for larger public sector projects some consultancies will go down to £5,000+ ($7,500) per week. A more experienced consultant may cost the consultancy £2,000 ($3,000) per week, but can be billed at £12,000+ ($15,000+) per week. So while many manufacturing businesses make gross margins of around 80% and retailers are at about 100%, management consultancies generally target gross margins of 500% to 800% – a rather striking and enormous difference from the margins any of our clients would ever make. Surprisingly, very few clients do the simple mathematics and ask why they should be paying over £300,000 ($450,000) a year for an inexperienced junior consultant who is probably being paid just over a tenth of that.
2. Retaining travel expenses rebates
Last year three consultancies agreed to pay a former client around $100m compensation, when they were sued for “unjustly enriching themselves at the expense of their clients The lawsuit was that for a decade the three firms worked with outside suppliers such as airline firms and travel agencies to obtain rebates of up to 40% on airfare and other costs that were not passed along to clients.”
The way this works is simple. The consultancy sets up a deal with a travel agent, hotel chains and the main airlines for an end-of-year rebate. The consultancy invoices the client for the full travel and accommodation costs, sometimes even adding on an administration charge. At the end of the year, the consultancy receives a rebate from the travel providers. None of this rebate is ever passed back to the clients who have paid for all the travel and accommodation in the first place. The defendants claimed they had “discontinued this practice” however this is contradicted by a recent e-mail from a consultant from one of the companies, “Here’s how we do it every time. We state in our contract that we will bill for ‘actual’ expenses. Then we bill them for your air travel expense. Then we get a kickback on your air ticket. But we don’t give the client back the kick-back.” One British consultant estimated that his employer had stolen over £20m from just one client in this way.
3. Billing for non-client work
In most consultancies, partners or directors divide their time up amongst their various clients and allocate a certain number of days each month to each client – even when this time is actually not spent working for that client. Moreover, you often find ordinary consultants being told to charge clients for time spent on internal consultancy business. To quote a consultant from a 100,000 plus employee firm, “I was at an internal meeting with more than 100 other consultants. Partner told us to charge the day to the project so we could bill it to the client as it was almost quarter end and we needed to make our numbers.” Just this one apparently innocuous decision will probably have cost the client over £100,000 ($150,000).
4. Overcharging for overhead
In many consultancies, clients pay for fictitious overhead costs. At one major consultancy an extra 10% was automatically added to consultancy fees supposedly to cover overhead costs. So, with each consultant costing £300,000 ($450,000) a year, clients would also be billed for another £30,000 ($45,000) to pay for administrative overhead. Yet the London office, for example, had about three hundred consultants and around fifty administrative support staff – secretaries, receptionists, human resources, bean counters, marketing support, resource managers, trainers, information centre researchers and document production. Yet, with the 10% add-on, our clients were being charged for the equivalent of about three hundred administrative staff – hence the salaries of up to two hundred and fifty support staff were not being spent, as the staff simply did not exist.
5. Relocating staff
Many management consultancies are international and move their staff around the world at their clients’ expense. On £2.3 million ($4m) project I helped sell in Britain to a regional health authority, the consultancy did not have sufficient UK based staff. As our CEO wrote in an internal memo, “the project took place at a time when we were still heavily supported by U.S. expats. Naturally we accommodated them and their families and a proportion of these costs were charged to the client.”
So our NHS client had to pay thousands of pounds a week extra for these imported consultants in what a subsequent official investigation described as “a financial fiasco.”
6. Cheating on flat rate expenses
Frequently consultancies will agree with the client that expenses will be around, for example, 12% of fees. Each week the client will be billed for this 12%, then at the end of the project there will be a reconciliation between the 12% paid by the client and the actual expenses incurred.
On a project for a leading manufacturer of military aircraft, missile systems and satellites, we had agreed 12% but were actually only running at about 7%. The account vice president informed the rest of the consultancy that he had room to soak up expenses both from other projects and from our head office, rather than paying money back to the client.
Very occasionally, clients would audit our expenses. If they found some real horrors, we’d just say there had been an administrative error and refund the minimum necessary to keep the client happy.