Knowledge Based Service Economics and the Big 4

Note to readers:  this is an incomplete white paper that I prepared. I think I can take this and tune it to Veracity so that we show how Veracity is best leveraged and why our model will win.

Openwater Advisors specializes in helping the owners of knowledge based service businesses (KBS) to maximize the value of their investment.  A knowledge based service business is one where the primary product is 'know how'.  Consultants, software makers, colleges and even churches are all KBSs.  Know how is an example of what economists call a nonrival good, meaning that one person's use of a particular piece of knowledge does not preclude others from using it.  Thus a specific unit of 'know how' can be distributed to as many people as are willing to purchase and make use of it.

This nonrival characteristic drives the principal form of differentiation among KBS:  distribution.  Let me provide a mundane example from my consulting past.  One of the services that my firm provided to corporations back in the 1980s was sales force effectiveness.  We would work with sales organizations to identify areas where they differed from 'best practice' and help them develop and implement plans to get there.  Today, much of the content of our traditional effectiveness study is encompassed in an on-line web service called Salesforce.com.  Essentially, what Salesforce.com did was take the know-how from thousands of years of experience running top sales forces and embed it in software and associated workflow that can be accessed at a modest cost from any internet connection.

Several interesting things happen when you take expertise and embed it in this manner:
Knowledge is leveraged - the number of clients a traditional 'meatware' consultant could help at any one time was limited by the hours he had available and the geography he inhabited.  By contrast, with a web service an essentially limitless number of people can make use of the designer's insights and expertise at the same time.
Pricing plummets and demand soars - by disconnecting the expert's time investment from the delivery of the service, the web service provider drives the marginal cost of providing his service almost to zero, enabling far lower prices to the market.  This in turn radically expands the addressable market for the service.  The minimum scale for sales effectiveness solutions, for example, shifted from hundreds of thousands of dollars to hundreds of dollars.


Solution value soars - Despite the massive reduction in price, the overall market value of the leveraged solution is vastly greater than that of a traditional consultant.  In other words the knowledge leverage far exceeds price destruction.  Thus beyond the  minimum scale needed to amortize the investment to embed the know how, a highly leveraged KBS like Salesforce.com is always far more profitable than traditional consulting.
Changing service delivery changes everything else - Leveraging service delivery means lower revenue per unit but many more units.  This change poses serious challenges to the traditional way of marketing, selling and administering the firm.  Even the types and mix of people change.
Value becomes portable - Traditional consultants  have a hard time selling their practices.  This is because the value of the the practice is lodged in the brains of its Principals.  By taking that knowledge and embedding it in software,  the traditional consulting expert creates an asset that is far easier to monetize.

The leverage-price-value connection holds across a wide range of different KBS distribution strategies:  including traditional management consulting, implementation consulting, BPO, traditional application software as well as web services.  See the chart above.

Relationship Holds Within Large Firms
The leverage-price-value relationship not only holds between firms, it applies within large firms that provide   multiple solutions around a specific service line.  Take for example Tax.  Tax services include everything from strategic consulting to return preparation for corporate clients and the affluent down to  HR Block, Turbo Tax and at the bottom: the IRS' online free web service.  (Some hawk eyed reader will point out that the IRS' free service generates no revenue so therefore has no value but of course they are generating immense revenue from the site).

What's interesting is that the top accounting firms with all of the expertise ceded the bottom of the Tax market to outsiders.  Why?  I think one of the reasons lies in the dual nature of the Big 4 value chain.  For some services like tax preparation, the Big 4 have become extremely efficient, by organizing services via large scale software enabled offshore facilities, they are actually able to undercut the middle market firms.

"$65 and hour?  We can't touch that" - Senior Partner of successful mid-market firm (ex PW)

Yet the vast majority of this complex middle market tax preparation business is in other's hands.  This is because while delivery and administration are scale sensitive and highly leveraged, the acquisition and management of client relationships is not.  For economic, historical and risk reasons the Big 4 limit client acquisition and management activities to a limited number of highly paid 'insiders' who bear the enterprise risk and get its rewards (aka:  Partners).  This radically limits the size of the customers that can be economically pursued, captured and managed - it drives the Firms towards a big client strategy.  The mid-market providers don't deliver a better technical service, in most cases the market is extremely fragmented with many small firms and sole practitioners providing supoptimal service.  What they do have is a willingness to accept rewards far lower than Big 4 Partners achieve and have virtually none of the independence or high profile liability issues.

Leveraged Capability Creation
At this point I wanted to discuss how someone with a lot of different intellectual capital could analyze which bits are most leverageable and then take them through a process of doing so.  Didn't get to that.