As you reflect on another tax season, what are you going to do differently next year to stop the madness? As we all know, Einstein is credited with saying that the definition of insanity is doing the same things over and over again and expecting a different result.
Just because you have this set of clients who interact with you in a certain way does “not” mean that’s the way it always has to be. You have choices.
Pareto for Profit™ is a key strategy for accounting firms pursuing a better way. We recommend an annual review of your client base where you analyze where your noise is coming from and where the opportunities lie.
In Pareto for Profit™, you will gain:
- An understanding of the activity and profitability of your client base
- Identification of your firm’s scalable zone
- Identification of the risks in your client base and where all your time is going
- Identification of your breakeven price
We call Pareto for Profit™ our secret weapon because it is kind of obvious, but so many firms miss it. Or when they do dig in and analyze their client base, they fail to take action to make the changes they know they need to make. (That is “not” allowed when you are a part of the ReNew Group, by the way.)
Let’s start with a definition of Pareto. The Pareto Principle states that for many outcomes, roughly 80% of consequences come from 20% of causes. In business, it is commonly said that 80% of a business’ revenue will come from 20% of its customers.
We find that typically in the accounting profession, 80% of revenue is generated by approximately 30% of clients in many firms. There are some often overlooked consequences of this.
For example, running around serving the 70% of clients generating just 20% of the firm’s revenue can result in firms:
- Ignoring their best clients
- Dreadful (and worsening) tax seasons
- Burning out team members and what we refer to as trading dollars (meaning you take on more labor and more overhead to service unprofitable revenue)
Most firms in the accounting profession are focused on revenue growth. The old way of thinking in this game is more clients + more revenue = more profit. However, unless those clients and that revenue is of the “right quality,” that assumption is likely to blow up in your face.
We can point to many examples of $300,000 revenue firms being more profitable (on a net income per partner basis) than firms with revenue of $1,000,000.
The primary reason for that is that most firms have more clients below breakeven price than above breakeven price. In other words, those firms are confusing revenue with profits. It is a classic mistake—and one, no doubt, that you wouldn’t allow your clients to make if you were advising them.
That’s why you must treat your own firm as your No. 1 client, by the way.
Now, if you run a very small firm, you might be thinking you do not need to worry so much about breakeven price because your overhead level is so low. If that’s the case, let us emphasize the importance of “Opportunity Cost.”
If you continue to take on more of the wrong sort of client, your time will be consumed dealing with the wrong sort of work. We hear time and time again from small firms that when they stop and think about it, they cannot believe how they have fallen into a trap of running around doing things that are clearly out of scope for clients paying less than $1,000 a year.
Perhaps that’s an issue you need to fix.
Let’s illustrate Pareto for Profit™ by showing you the sort of work we do with our clients.
At Figure 1, you will see an extract from the Pareto for Profit™ analysis that we do with every firm we work with.
This is a small firm:
- 177 clients, $274K revenue
- $1,550 average revenue per client
- 76% of revenue comes from 51 clients, being 29% of the total clients
We go into a lot more detail and analysis when we do this with our clients but here is a quick explanation of the color coding.
In yellow at the top are clients in what we refer to as the Fragility Zone. These are clients that are usually large for this size of firm. They often are not as profitable as you think, can place high demands on your time and create a risk for your firm if they leave.
The clients in green are in what we call the Scalable Zone. These are usually good clients with upgrade potential, but they are underserviced, because too many accountants spend too much time in the Insanity Zone.
That’s the zone shaded red, where you often will find large numbers of low-paying, unprofitable clients.
And it is the Insanity Zone that is the root of everything bad in tax season.
Also, note that just above the Insanity Zone is a slightly lighter green zone where you often will find a lot of clients lurking. We refer to that as the Danger Zone. It can sometimes be caused by bad clients being upgraded by selling more partner time. This is “never” a good idea. More on the Danger Zone later in this article.
Now let’s look at a slightly larger firm; see Figure 2 below.
This firm has 203 clients and $1.1M in revenue, so an average of $5,500/client.
One thing that might jump out at you here is that the Insanity Zone does not go away simply because you grow your firm.
In this case, as referenced above, the firm is “trading dollars”—it has had to take on more labor and more overhead to support the revenue and the result is more than half of the clients are unprofitable for the firm (every client in the red, Insanity Zone technically is unprofitable once you allocate labor and overhead).
When you fall into this trap and continue to chase revenue, it becomes more and more ingrained in the firm’s culture. It can still be fixed, but it takes a realization “now” that you must take steps to change your approach.
Fortunately, our proven process makes that simple for you. And the good news if you are running a small firm is you are nimble and agile enough to set the rules early on, so do not hesitate—the longer you leave it, the bigger that red Insanity Zone will become and worse your tax seasons will be. This is the old way of thinking demonstrated in numbers.
So, if that’s the old way, what’s the new way? The new, or ReNewed way of thinking is to build your firm around target clients only; clients who appreciate the value you create and want a year-round, holistic relationship with your firm—and will pay for that value.
A model where all clients are profitable for your firm, meaning less tax season, more profit and more freedom.
This is Pareto for Profit™ in a nutshell. You can have a life, make good money and your model does not have to be about tax season and chasing revenue.
Remember, you have choices. You can, if you choose, design a firm like our client, Perry Ghilarducci. Perry runs an accounting firm in Sacramento. He came to us when his firm had revenue of $816K from 508 client groups. He felt stuck and he told us that the firm was completely reliant on his efforts.
Now, Perry’s revenue has increased by 91% because he took action on his Pareto for Profit™ analysis. Profit is more than double what it was when he started working with us. And very importantly, average revenue per client is up by 411%.
One interesting point that some of our clients have raised is that when you terminate a batch of loss-making clients, your breakeven price will increase, and you will find clients who were previously in the Danger Zone (remember, the Danger Zone often evolves as bad clients are “upgraded” by selling more partner time) now drop into the Insanity Zone.
In other words, clients who were previously profitable are now loss-making. That’s because the costs previously absorbed by the clients you terminated now need to be absorbed by the remaining clients.
Many accountants use this rationale to justify keeping the new loss-makers as clients. We do not think this is smart if you are pursuing a Target Clients only strategy.
Mark your calendars for the webinar, “How to Command Premium Pricing By Leading With Advisory”
Aug 10, 2 (EST)
Clients in the Danger Zone (whether they are still there or have dropped into the Insanity Zone) can be the most difficult to serve. They are probably small, place high demands on your time (remember, some of them probably landed in the Danger Zone because you raised their price by promising more contact), only require low level, once-a-year compliance services, they may be uncooperative or your systems and processes are not well suited to them.
The key point is that clients in the Insanity and Danger Zones are certainly consuming resources that could be better deployed if you could find more target clients and as long as you continue to serve them, you will not have time to position your firm to attract target clients.
In other words, it is a never-ending game where your goal is to consistently upgrade your client base… and your team, so that they can handle more target clients.
Food for thought as you start to think about how to stop the madness, so that next tax season is very different from what has happened in the past. As you reflect on that, here is a post that one of our clients recently wrote in our A Better Way online forum. It might give you some of the ideas and impetus that you need to make the changes you know you should make:
“I wanted to take a moment to share some progress we have made during this season. Some of you recall that we made some bold moves with pricing and clients going into 2022.
Last year, our recurring Accounting/Tax/Advisory revenue was $1,225M with 610 total relationships.
That represents average relationship/client revenue of $2,008.
Fast forward to 2022, our engaged client revenue for Accounting/Tax/Advisory is currently at $1.415M with 425 relationships.
That is an average of $3,329.
Based on the trend and the remaining engagements we are expecting, we will be close to $1.5M and perhaps 450 relationships. Profit margins will increase by around 50% for this year as well.
The most powerful part is that the compliance clients that have not engaged us will be evaluated, and those that we no longer desire to work with will receive separation letters. We do not “need” the work to achieve budget, so why kill ourselves on the wrong clients.
Last thoughts: Reduced clients most definitely equate to reduced stress and reduced email volume. It is the peace that I am after and more stable profitability.
Thanks to all of you for the support and encouragement. This is the year that sets the tone for the future.”
If this resonates with you, let’s talk. You can book a time for an introductory, no-obligations chat HERE.
And if you’d like to hear from our clients so you can better understand some of the results they achieve, check out some short video testimonials HERE:
Join us Aug. 10 , 2 p.m. for the webinar, “How to Command Premium Pricing By Leading With Advisory.” SIGN UP HERE today.
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