Fixing the design industry’s economic problems isn’t simple. But research by two Senior Fellows at the Advanced Management Institute shows how design firms can not only survive, but thrive in today’s economy.
For Kyle V. Davy, AIA, and Susan L. Harris, Ph.D., a two-year-long research project with 23 design professionals as research partners led to the conclusion that the industry must break out of its old economic model. They believe that architecture and engineering firms should move away from selling hours, and instead take stock of what value they are creating for clients.
The research findings, which also draw on more than a decade of ongoing research projects at AMI, are presented in their report: Discovery: A Search For New Models of Practice, now available from the Advanced Management Institute (details below).
Davy and Harris came up with nine key findings which outline how design firms came to have the business model they use today, why it no longer works, and what firms must do to survive in the future. Davy and Harris explain that the old business model is focused on selling hours and making short-term profits; the new business model they propose takes a longer-term approach based on creating value. Under the new model, design firms take on the role of partner and strategic advisor to their clients.
“Value creation lies at the heart of a professional design firm’s performance,” write Davy and Harris. “Design professionals create value as they shape the built environment where people live, communities thrive, companies prosper, and society progresses. That value and the compensation they earn for their efforts are directly linked to their own organizational success."
Here is a summary of their key findings:
1. Design firms are trapped in an antiquated business model. Design firms operated in a boom period following World War II. Standard agreements set their fees, and A/E professionals enjoyed relative independence. But recessions in the 1970s and ‘80s forced firms to adopt new business practices: marketing, strategic planning, financial and accounting systems. In the 90s, while the U.S. economy shifted from being capital-based to being knowledge-based, project delivery methods changed, and design firms were challenged by new competitors, they stayed with the old, familiar business model- and began to fall out of step.
2. Design firms can catch up to the knowledge economy by becoming "Living Companies". Davy and Harris differentiate between economic companies and living companies. Living companies exist to fulfill their own potential and become as great as they can be and perpetuate themselves as an ongoing community, according to Arie De Geus1, whose work, along with that of James Collins and Jerry Porras2, is cited by AMI.
“Profitability is a symptom of corporate health, not a predictor,” according to De Geus. Living companies are learning organizations, have a strong sense of identify, are tolerant and decentralized, with a diverse, entrepreneurial staff, and utilize conservative financing, minimizing their debt to provide flexibility. In comparing the two models, Collins and Porras found that a portfolio of visionary companies outperformed a comparison set of economic companies by a factor of six over a 65-year period: A dollar invested in the visionary “Living Company” portfolio on Jan. 1, 1926, would have been worth $6,356 by Dec. 31, 1990. A dollar invested in the economic company portfolio would have grown to just $955.
3. Design firms must create value, not sell hours. Davy and Harris discuss how the focus on utilization has trapped design firms in a vicious cycle: in the escalating effort to boost utilization, firms cut research and development, training and coaching time, and arrest efforts to build their infrastructure and prepare the firm for the future. While this drives up profits in the short term, eventually this tactic erodes the firm’s creative and innovative abilities, leaves staff overworked and prevents the firm from confronting real market conditions. We must realize that design firms don’t sell hours-they create value. Even Wall Street recognizes the importance of non-monetary value, using such intangible assets such as brand awareness, human capital, knowledge assets and leadership qualities of management as measures of valuing a company’s stock.
4. Design professionals must understand living systems, business ecosystems and value networks. Again, Davy and Harris turn to the work of De Geus, who argues that a living company is nested within a hierarchical structure that connects outwardly to larger living systems (community, nation, society) and inwardly to smaller business units. Each system works to preserve itself, and each is dependent on the health of the larger living systems it is a part of.
Business ecosystems are communities made up of interacting organizations and individuals. Business ecosystems typically revolve around one or more central companies, such as Wal-Mart, which has a network of businesses around it who align their strategies around Wal-Mart’s needs and actions, and contributing value to Wal-Mart and each other. Design companies contribute value to the ecosystems that form around their clients. Value networks describe the value created, assessed and exchanged within living systems. Design firms must examine these systems, learn how value is assessed, and decide where they fit and how they can contribute to the system’s success.
5. Design firms need to examine their work with clients in terms of collaboration, transformation and experience. Citing the work of Ronald Heifitz, Davy and Harris outline three types of work.
All three types of work have different implications for creating value, and therefore different implications for pricing.
6. A new ecology of design firms. It is not too late for design firms to adapt their business models, to become living companies matched to their client needs, Davy and Harris write. They don’t have to be commodity providers. They needn’t cede the role of strategic advisor to management consulting firms, design-build companies and foreign competitors. The advent of the Internet spawned a boom in the invention of new business models. While eBay created a new model for the garage sale, and Charles Schwab wiped out it’s own traditional brokerage by starting an online brokerage service, design firms failed to embrace the move towards evolution and diversity. By adhering to a single business model, design firms came to look like a single commodity to clients: as far as clients can tell, design firms are all alike and all produce the same product.
In nature, this lack of diversity is often the precursor of disaster-life forms that can’t adapt often succumb to changes in the environment and the competition of more flexible new arrivals. New species of management consulting firms, design-build companies, and foreign competitors have already eroded the design firm’s traditional role. Design firms must move quickly to increase their diversity from one another, and adapt to their clients’ needs for Type II and Type III work. An increased diversity of design firms can both survive and thrive in the new economy.
7. The design industry must understand the evolutionary role of technology. Davy and Harris outline six major trends transforming the world of design firms:
8. The design industry must lay the foundation for a new ecology of firms. Davy and Harris applied the information/ technology trends described above to these basic questions: Who do you work for-is your client capital-intensive or knowledge-intensive, is it a local or global company? What is your business providing-integrated or segmented services, one-of-a-kind design, mass production or mass customization? How does your business provide services-alone or through a network/alliance, centrally organized or through self-organizing or collaborative methods? All have different implications for fee structures. Davy and Harris discuss three types of pricing, based on how your firm fits in it’s “ecological niche”: prices that reflect the provider’s perception of value being supplied, or value pricing; prices that reflect the value of an ongoing relationship, or retainer pricing; and a scenario in which design firms become their own clients by owning and operating their own projects-the investment-based approach. Breaking out of the old economic model means moving away from selling hours.
9. Design firms can create value by transforming design. Just as the digital spreadsheet revolutionized the world of finance, design firms can revolutionize how we use, work, and modify the built and natural environments. Design firms are critical to the processes that create the infrastructure for human society, and are critical to the processes by which we preserve and sustain the larger natural environment that humanity lives within.
Clients need the wisdom and imagination that only design firms can offer them. But in order to survive, the design industry must take stock of alternative business models, look at how they fit into their client’s business ecosystems, and have a clear understanding of what value they bring to the design process. They must leverage the new tools available to them through technology and advances in management techniques to create new design processes and new forms of value for their clients. l
The Advanced Management Institute for Architecture and Engineering is a consulting, training, and research firm based in San Francisco. Copies of Discovery: A Search For New Models of Practice are available from AMI for $75, including shipping. AMI can be reached at 415-617-0210, or email@example.com
1 Arie de Geus, The Living Company, Harvard Business School Press, 1997
2 James C. Collins, Jerry I. Porras, Built to Last: Successful Habits of Visionary Companies, Harper Business, New York, 1994
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