Boutique firms often grow but do not scale. On this episode, Lawrence King, CEO of Headstorm discusses how to work smarter, not harder and why improved leverage increases incomes and wealth.
Sean Magennis [00:00:15] Welcome to the Boutique with Collective 54, a podcast for founders and leaders of boutique professional services firms. Our goal with this show is to help you grow, scale and exit your firm bigger and faster. I’m Sean Magennis, Collective, 54 Advisory Board Member, and your host. On this episode, I will make the case that sometimes boutiques grow, but don’t scale. I’ll try to prove this counter-intuitive theory by interviewing Lawrence King, CEO of Headstorm. Headstorm is a technology consultancy dedicated to building innovative technical solutions for Fortune 500 companies. Fast growing start ups and literally everything in between. Lawrence’s expertize includes designing, developing and supporting distributed systems, cloud platforms, mobility data analytics and token based security models. You can find Lawrence at www.HeadStorm.com. Lawrence, great to see you and welcome.
Lawrence King [00:01:24] Thanks for having me, Sean.
Sean Magennis [00:01:26] Such a pleasure. So too many boutique owners are growing but are not making more money in the process. Can you briefly share with the audience an example of how you’ve dealt with this issue?
Lawrence King [00:01:37] Yeah, I think that there becomes a time if you’re not, there was a point in which we weren’t too focused in terms of our service offerings. And and in doing that, you’re trying to solve lots of different problems and you end up throwing lots of bodies at it. Bodies that you’re throwing at it may be their skill sets may not match up with the work that’s needed or they just in many cases, it the profitability would would get hit in that way. But you’re growing, you’re still adding revenue incrementally, but your profitability is really taking.
Sean Magennis [00:02:13] Yeah, listen, you’ve hit the nail on the head. And so there are, you know, there are some thoughts that I’d like to to get your input on that we recommend. So I’ve selected five things I’ll walk you through and get your thoughts on each. So the first is if revenue growth and headcount growth are proportional, the owner doesn’t increase necessarily his or her income from that growth. So it’s not until headcount growth is decoupled from revenue growth that an owner grows his income. What are your thoughts on this?
Lawrence King [00:02:48] Yeah, that’s a little bit of a tough one, because if you think about it growing literally eight or linearly, I could say if a company, if their net net, let’s say they’re a bit as 15 to 20 percent, yes. And I know that if if I’m doing 10 million this year and 20 million next year and and I’m operating the business the same way, I’m just adding headcount and my mark, my EBITDA is already 10 or 15. I’m going to get more, you know, revenue, right? I think that where that where that starts to fall apart is, is as you start to scale those profit margins. They don’t they don’t stay the same. And as you’re adding headcount, you’re also probably not running a leveraged model. And so your your EBITDA and end number is going to be, you know, much lower than probably where you started.
Sean Magennis [00:03:35] Yes. Yes, that’s that’s an excellent point. And you know, it brings us to our next question, which the top expense by a wide margin for a professional services firm is their labor cost and more headcount. Naturally, more means more expense, potentially less income. And as a firm takes on more work, don’t they need more heads to complete it? Or how do you think differently about that?
Lawrence King [00:04:00] Oh man, it’s yes. But to get to a leverage model is is really a challenge. It actually forces you to start with the service offerings in mind. You have to really focus on what you’re offering and scope. It is something that you can hire against, something that you can train against and something that you can deliver against with low cost resources. And so if you’re trying to deliver all different types of solutions, you’re never going to get that opportunity.
Sean Magennis [00:04:26] You know, you’ve again, you’ve dovetailed right into the next thing that I was going to talk about, which is re-engineering your service and also you’re scoping. So let’s talk about leverage then. So the definition of leverage is the number of employees to owners. And an example of how to calculate the leverage leverage ratio is a firm with, say, 30 employees with three owners would have a 10 to one leverage ratio. The higher the leverage ratio, the more money the owner makes. So why is this? You know, it’s because a profit pool divided by three people is obviously better than a profit pool divided by up to 10 people. How do you think about leverage in this context, Lawrence?
Lawrence King [00:05:09] Yeah. So I look at it as a shape and we’re a leveraged pyramid.
Sean Magennis [00:05:14] Yeah.
Lawrence King [00:05:15] And I can tell you that when we hire to maintain that leverage, I’ll give you an example of last year. Last year, the way that we were hiring, we were hiring very reactively to different projects. And we actually when I looked at our staff from consultants, senior consultants, project leaders, directors and partners, yes, we formed a diamond.
Sean Magennis [00:05:32] Interesting.
Lawrence King [00:05:33] And so I built out this whole pro forma so I could play out the numbers and see if I was to hire against the forecast and maintain my pyramid to where I had more consultants than I did senior consultants, more senior consultants than I did project leaders and middle management and so forth. Yes, there’s a gain of about 10 percent there to the gross margin. If you manage that properly. Mm-Hmm.
Sean Magennis [00:05:56] I mean, that’s that is a unique ability and kind of what I would advocate probably your secret sauce in that area. So when you you’ve spoken about owners often have expense of senior staff performing junior grade work. This obviously destroys profitability and owners income. And so what do you think the fix is for for that scenario?
Lawrence King [00:06:21] I think how we solve it is when we build our project teams, the project teams take on pyramids in and of themselves, and there is utilization pyramids in there. And so if we have a partner that’s managing quality, they’re probably billable five percent of the time. I like it. And then a director is also a part of that, and he’s probably billable 10 percent. Yep. And then as part of our expectations framework, the directors know, hey, overall, you need to be billable for 30 to 50 percent of the time, but your other, you know, 60 and 70 percent needs to be focused on high value, high, high fee craft. Yeah, I the type of work and that could either be doing business development activities, thought leadership, building intellectual capital within the firm that we can resell coming up with new go to market service offerings. Yes, all of those type things. So we really break it down in terms of what the expectation at every level is and the allocation of time from billability to working on internal intellectual capital.
Sean Magennis [00:07:25] I mean, it sounds remarkable and you’ve obviously got the process and the systems down, you know, almost to a fine art. How do you how do you keep track of that? What sort of tools techniques do you use to keep track of that, Lawrence?
Lawrence King [00:07:38] Yeah, great question. So the very first thing I started that drove that really drove that our strategy was building this pro forma. I knew it. Let me start with the end in mind. So I said, Listen, I want to be able to do a 20 to 25 percent EBITDA. Yeah, so that means I have to do if my is probably going to be 20 to 25 percent and I know that my gross margin has to be 50 at all times.
Sean Magennis [00:07:59] That’s right.
Lawrence King [00:08:00] I know what we pay our staff now. I just have to work. I know how many PTO days they have. I know the vacation, the holidays, how many hours are there. And then I look and I plug all that in and it spits out the rates that I have to charge. And then I look at those rates and I say, Wow, those are high. How are we going to get those? Yes, that’s when it’s a pivot moment. They say, Listen, we have to be super focused. We have to come up with go to market strategies and engagement models that aren’t time and materials based, their fixed fee, even contingency based, and they have to be tied to high value solutions that we’re delivering in order to get that. And so that’s really framed up how the focus of where we’re we’re looking at if we want to compete, if we think of consulting as a spectrum, staffing on the far side and then high end differentiation on the other, we want to compete over here, so we have to be delivering those types of solutions. Got to get back to earlier question. So we built an internal application called MTM Headstorm MTM. And what that does is it’s a dashboard every day as a as a leadership team. This is directors and partners. We look and we see what their utilization is across the company. We see what the realization is by project and we try it. We’ve got a threshold there that we try to be at 100 percent realization. That’s meaning that we’re charging 100 percent of our standard rate. If it’s if it’s the partners have the opportunity to to discount it by 10 percent if they want to. But we have to. But the pro forma accounts for that. And so if this matches, if we’re staying within this 90, 90 percent to 100 percent realization, then we’re on target with the pro forma. And that’s really sort of how we manage where these projects are. And then we got a bench, you know, and there’s times where, yes, you hire we we now if you hire, reactively, what we’ve done is if you hire, reactively, you get a project and then you start hiring for it, you’re going to compromise talent, you’re going to compromise the roles and the leverage. Yeah. So rather and you may have attrition and culture issues down the road. So we did areas as we simply created a forecast to give to our recruiting department to say, you need to hire this many of each of these levels every month. And that will make sure that we
Sean Magennis [00:10:04] stay, stay in that pyramid.
Lawrence King [00:10:06] In that pyramid. And then it’s up to us as as the partners to sell the work and to make sure that we’re putting those people, you know, getting them busy and billable.
Sean Magennis [00:10:15] You know, thank you for sharing that because what that illustrates to our listeners is the importance of being on the data and the information and the intelligence of what’s happening daily. You said that, you know, your MTM system gives you a view every day, and I’m assuming that that also, you know, enables you to to really accurately address the trigger point for your pivot because you can’t afford to pivot just, you know, once a quarter, once a year or once every six months, right? I mean, you could you could be pivoting literally on a daily basis with with with what you have at your fingertips.
Lawrence King [00:10:49] Right. That’s right. And and so we really manage that. We also look at so so we have our utilization, we have our realization. And then we’ve got with Pipedrive is our CRM. Yes, it’s really cool because we book in there all of our existing work and income that’s coming and the revenue coming in monthly that’s already sold work. Yes. And we have forecasted work on a monthly run basis. So we know, hey, we’ve got enough in the pipeline that we’re going to be doing, you know, two million next month or whatever those numbers are. And that gives us a really predictable way to think about staffing and hiring, scoping these scoping right.
Sean Magennis [00:11:31] Which is critical. Lawrence, this is fantastic. I mean, you know, the idea of leverage is not new. It’s obviously been around for a long time, and it means that the solutions are readily available. I mean, your examples of. Of how you built MTM, how you’re running Headstorm. A just extraordinary and I think a really important lesson for our listeners who are building boutique professional services firms is take Lawrence’s his lessons and really apply them. It’s not easy to run a professional services firm. It’s not easy to maintain leverage right?
Lawrence King [00:12:05] No. It’s a challenge.
Sean Magennis [00:12:07] It’s a challenge. But the way that you’ve architected it and the tools that you’re using, the information that you’re getting on realization, on utilization, on seniority, on scoping, very, very key. So this will help you if you adopt some of these lessons and insights, it’ll help you work less, hopefully earn more, work smarter and not harder. So this brings us to the root cause of the big issue. Revenue outside of scope should be turned away. Lawrence, what do you think about that?
Lawrence King [00:12:40] Absolutely. Yeah, yeah, absolutely. I’m doing. I’m doing it today.
Sean Magennis [00:12:44] Excellent. So again, this allows you as an owner to balance expense of senior staff and allocate assignments to junior staff capable of doing the work at good cost profile. It’s what pushes up the leverage ratio and your pyramid example of what allows an owner to make more money as the firm grows. So, Lawrence, this takes us to the end of this episode and as is customary, we end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool is a checklist, a style of checklist as a yes, no question, we aim to keep it simple. So in this instance, if you answer yes to eight or more of these questions, leverage or lack thereof is not preventing you from scaling. If you want to know too often, then poor leverage may be the reason that growth is not equating to your personal income. So, Lawrence, I’m going to walk you through these, and let’s begin.
Sean Magennis [00:13:42] So number one is your leverage of employee to owner at least 10 to one?
Lawrence King [00:13:47] Yes.
Sean Magennis [00:13:49] Excellent. Number two is the proper mix of junior middle and senior staff clear to you?
Lawrence King [00:13:56] Yes.
Sean Magennis [00:13:56] Yeah. Given your example, I mean, that’s so well done. Number three, do you understand the skills mix of a project before you sign it?
Lawrence King [00:14:06] Most of the time, most of the time, I would say the only caveat there is is that potentially if you don’t have the staff but you want to take the project, then then you know, kind of putting some. We tend to air on putting, you know, more senior people in for junior roles in that case. Yes, but it has to be a strategic account. There has to be a reason for doing it.
Sean Magennis [00:14:25] And then, you know, at your fingertips, what are you know, what your return is going to be on that? All right. Yeah. So number four, do you understand which revenue is good and which is bad?
Lawrence King [00:14:38] Yeah, it’s hard, but you know, all revenue seems good, but there’s there’s a lot of times that, for example, you know, if the account’s not a strategic account, if it’s not one that is going to become a flywheel, yes, there’s just distract you if it’s going to take away your bench. So you might perhaps miss out on another opportunity. Yeah, those are the types of things that go through our head and we make those decisions.
Sean Magennis [00:14:59] Excellent. Number five, do you have a zero tolerance policy for one off projects?
Lawrence King [00:15:07] Mostly, I think it just comes back down to the strategic nature of the project.
Sean Magennis [00:15:12] Number six, do the owners work on the business instead of in the business? Do you work on the business instead of in the business?
Lawrence King [00:15:21] I am. That is that’s a great question. I am transitioning, that is a tough one because I still bring in, you know, probably the lion’s share of the revenue. Yes, and I need to keep that going. But realizing that I this to create the value for the firm, I need to be able to hand it over with, you know, turnkey where I’m not needed. And so a lot of the focus is building processes and training and right now, that type of thing. So I could step step away more.
Sean Magennis [00:15:52] And that’s brilliant. You know, the first step is in acknowledging that and then it’s literally having the discipline and holding yourself accountable to getting there, right? But it’s it’s a balance. Everything is every business is nuanced. Number seven, do your service offerings come with procedure manuals for the staff?
Lawrence King [00:16:09] Yes. Yeah, so we call them playbooks, are run books.
Sean Magennis [00:16:12] Excellent. Number eight, do you assign work to teams strategically versus reactively? You address that a little bit.
Lawrence King [00:16:21] Yeah. When we have a bench, it’s more strategic. Yes, when we don’t have a bench and we’re just trying to, you know, take on new projects and hire at the same time, it becomes a little bit more reactive, but there’s a balance. We’ll try to make some strategic folks on the account and then come back a couple of months later and fix it. Maybe rebalance it.
Sean Magennis [00:16:43] Excellent. Number nine, does your hiring plan forecast demand for a specific leverage ratio?
Lawrence King [00:16:51] Yes, absolutely.
Sean Magennis [00:16:52] And number 10, do your financial goals match up with the leverage ratio assumptions in your business plan?
Lawrence King [00:16:59] Yeah, that’s that’s the that’s that’s pro forma that drives everything. I’m on that thing probably twice a week.
Sean Magennis [00:17:04] I love it. I bet you. I bet you. Three quarters of the people listening and the members of Collective 54 would love to get insights on that from you.
Lawrence King [00:17:12] So happy to share. It was great building it, going through the process of building it, understanding all of the levers. Just going through that process now makes me understand it that much better.
Sean Magennis [00:17:23] Well, you can see it. I mean, you’ve got your you’ve got all of the all of the information, all the facts at your fingertips. So, Lawrence, thank you. In summary, scaling means working less and making more. It does not just mean growing. If you want to earn what you’re worth, decouple revenue growth and headcount growth. Follow the leverage tips that Lawrence has given you, and your definition of success is not the number of employees you have, but rather it’s how much net income you produce. Lawrence, a huge thank you for being with us today.
And if you’ve enjoyed the show and want to learn more pick up a copy of the book The Boutique How to Start, Scale and Sell the professional services firm written by Collector 54 founder Greg Alexander.
And for more expert support, check out Collective 54, the first expert community for founders and leaders of boutique professional services firms. Collective 54 will help you grow, scale and exit your firm bigger and faster. Go to Collective54.com to learn more.
Thank you for listening.