Just How Important Is Leadership in Professional Services’ Success?

The proof is in the numbers
by David Hofferberth, Service Performance Insight

It’s nearly impossible to read any article on leadership and come to the conclusion that leadership does not matter. Therefore, most of us already acknowledge leadership’s importance, but few of us have been able to truly quantify its benefit.

SPI Research leadership indexLeadership 02 2014

For the past seven years, Service Performance Insight has analyzed leadership metrics in our annual Professional Services Maturity Benchmark. We ask eight core questions, which are subjective in nature yet provide significant insight into the importance of something as nebulous as leadership.

We asked professional services executives to rate the following aspects of their organization in terms of how well they operate on a 1 to 5 scale (1: not well to 5: very well). The questions include:

  1. The vision, mission and strategy of the professional services organization is well understood and clearly communicated.
  2. Employees have confidence in PS leadership.
  3. It is easy to get things done with the PSO.
  4. Goals and measurements are in alignment for the PSO.
  5. Employees have confidence in the future of the PSO.
  6. Leadership effectively communicates with employees.
  7. Leadership embraces change; we are nimble and flexible.
  8. Leadership focuses on innovation and is able to rapidly take advantage of changing market conditions.

The net result of these questions is a score ranging between eight and 40. We analyzed the results of the 2014 survey thus far with more than 100 responses and segmented the responses into those organizations that averaged at least four out of five on all questions against those averaging less than four. In other words, we put the organizations into two groups: those with strong leadership characteristics and those lacking them. Table 1 compares some of the most important key performance indicators between the two groups and how much it changed from the previous year.

Table 1: Key Performance Indicator Comparison

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The table highlights some distinct advantages of strong leadership. PSOs with leaders who truly lead the organization — with high levels of communication and collaboration — grow their organizations at a much higher rate than those lacking these qualities.

With strong leadership, employees understand what’s required of them, and can go about conducting their daily business with the confidence their work meets corporate objectives. Strong leadership helps employees get on the same page working toward a common goal. With this knowledge, employees are more productive, ultimately delivering higher levels of client satisfaction and profitability to the organization.

Communication is key

While all KPIs are important, some tend to be more so than others. Table 2 shows how organizations where leadership does a good job of communicating with the workforce outperform the others. These organizations excel in the area of communicating the PSO’s vision, mission and strategy.

Table 2: KPI Comparison Between Effective Communicators and All Others

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Also notable in this table is that those organizations with the strongest leadership achieve leadership KPIs better than all the others by more than 16 percent.

One area not covered is that as organizations grow in size, the effects of leadership become less statistically significant. Obviously, large organizations need strong leadership. However, communication suffers when large organizations are dispersed globally and employees have minimal exposure to the core leadership team. To compensate, leaders in large organizations must ensure their regional executives have the skills necessary to translate corporate goals and strategies to their workers, and have strong listening skills to give remote employees the feeling they’re an important part of something special.

Seven years of research has shown that executives must offer a clear and consistent strategy, backed by explicit expectations and goals that every employee can aspire to meet. The greater the clarity, the easier it is for employees to interpret the underlying meaning and then work to meet them.

Professional services remain employee-centric

The survey process results indicate the importance of continuing to strive for new and innovative solutions to problems. Innovative organizations provide employees with the confidence to know the organization will be around for many years to come, and they will be continually challenged and personally grow as the organization expands.

The broader economy, such as manufacturing and retail, may be just beginning to improve, but the professional services market has now had three consecutive years of more than 10 percent growth. This growth, while good for the bottom line of PSOs, will ultimately come at the price of higher attrition levels, as employees — with skills in demand — see a vibrant economy for themselves. Therefore, they will look to make more money and for greater challenges. This aspect of the work is another reason why leadership is vital.

Happy employees, who might otherwise believe there are other options available to them, will more than likely stay at their current organization if they are confident in its future, and see a path for them to personally develop and grow. Leaders must continue to offer that vision of the future, which excites and motivates the workforce to continue with the organization.

The importance of leadership

Leadership styles continue to be debated and analyzed for their effectiveness. Research thus far shows that leadership does matter, and it can be quantified. PS has many other attributes that allow some firms to perform better than others. This annual benchmark attempts to provide PS leaders with the insight to improve all aspects of the organization. However, there’s no doubt that success begins with leadership, and leaders must perform at high levels for the organization to succeed and move ahead.

Are your organization’s numbers moving in the right direction?

2014 Professional Services Maturity benchmark preview
by David Hofferberth, Service Performance Insight

Based on completed Professional Services Maturity benchmark surveys to date, we at SPI Research expect 2014 to be a strong year for professional services growth. So far, year-over-year revenue growth in the market is 12.6 percent, compared to 11.5 percent last year. If this rate holds, it will be the third consecutive year of annual growth in excess of 10 percent, showing the professional services market has fully recovered from the recession and is in the midst of a big growth surge!

The talent factor

profit 12 2013But we wouldn’t say everything is rosy in professional services, as PS executives continue to convey their difficulty in finding, hiring and retaining highly qualified professional services employees. Last year, we identified a talent cliff as a result of the market losing baby boomers and the struggle to replace them with a supply of qualified individuals with the appropriate science, technology, engineering and math (STEM) skills.

We expected this to be an issue for the next five to 10 years, and nothing has changed in last year’s assessment. For years to come, talent management will be the number one issue. In 2011, only 76,376 engineers and 43,072 computer and IT majors graduated from U.S. universities — not nearly enough to fill demand.

So far in this year’s benchmark, the average number of PS employees is 359. This figure is significantly higher than in the last three years, when organizations averaged approximately 220 employees. We haven’t had a higher average professional services size since 2009. All indicators show that PS firms are hiring and growing at an unprecedented rate.

Five Service Performance Pillars

Before digging into the latest findings, let’s review the key functional areas that we call pillars. Our hypothesis is that professional services organizations consist of five pillars that drive organizational performance.

The core tenet of the model is PSOs achieve success by optimizing five Service Performance Pillars:

  1. Leadership. This pillar represents the unique view of the future and the role the service organization will play in shaping it. Leaders develop a clear and compelling strategy, providing a focus for the organization to spur action. They also set the tone and direction for the organization.
  2. Client relationships. This pillar includes sales, marketing and partner relationships and effectiveness.
  3. Human capital alignment. This pillar focuses on recruiting, hiring, retaining and motivating a high-quality consulting staff.
  4. Service execution. Execution represents all aspects of project execution: resource management, project management, knowledge management and delivery methods and tools.
  5. Finance and operations. The financial backbone of a services firm that addresses planning, revenue, margin, billing, collections and IT infrastructure.

Five levels of maturity are defined to show progression for each pillar. It starts with Level 1, where processes are immature and employee roles are broad, and progresses up to Level 5 where the organization, methodologies, tools and governance are synchronized and structured. Level 5 optimizes and aligns all elements of the PSO for continuous improvement. On average, only 5 percent of PS organizations achieve Level 5 performance.

Each Service Performance Pillar has guidelines and key performance measurements that correspond to levels of maturity, which provide a roadmap to service performance excellence. The following sections highlight some of the latest survey findings.

Leadership

As expected, the latest scores reveal employees feel more confident about leadership and the PSO’s future. For the past three years, PSOs have shown solid growth, thus increasing confidence and optimism. It’s clear from the higher growth rates that employees feel positive about the direction the leadership has taken to get there.

On the flip side, the talent cliff has yielded two challenges: 1) increasing sales and marketing and 2) meeting financial objectives. PSOs are struggling with finding qualified employees, which could slow growth rates and profits. We expect resource management to play a larger role in 2014, as PS leaders must maximize their resources. Unfortunately, that won’t be enough. They must find, hire, train and retain a qualified workforce. Doing this could be difficult considering the low graduation rates for STEM majors.

Client relationships

For the third consecutive year, PSOs are growing in excess of 10 percent annually. Although we see their sales pipelines increasing to one of the highest levels ever, we also see that it takes almost 10 percent longer — about 105 days — to close deals compared to last year. The bid-to-win ratio, however, remains constant. It measures the number of bids accepted out of every 10 submitted. Currently, the bid-to-win ratio is at five, the same as last year’s.

One change that’s evolving is the movement toward fixed fee engagements as opposed to the more traditional time and materials engagements. The two types of engagement are close to even. Because PS executives demand more and receive greater control over their services spend, we expect fixed fee to be the dominant type soon. This evolution will force PSOs to concentrate on better service delivery and scoping projects properly.

Human capital alignment

Because of the talent cliff, we anticipate PSOs to look at their own employee base, investing in the needed skills for the organization to grow and prosper. Although specialization remains important, PSOs must have more agility and versatility in order to maintain high levels of billable utilization and keep employees motivated. Talent management will become an increasingly important aspect in the marketplace.

Since talent management will be the most important issue for the next decade, we asked questions related to the age and gender of the professional services workforce, as Table 1 shows. Currently, the average employee is 38 years old, and two-thirds of the employees are men, presenting several interesting trends.

First, most might think of someone in professional services as a grey-haired business guru, but the fact is the majority of the workforce is made up of young, energetic professionals, just a few years removed from college. With the average age in professional services approaching 40, it signifies an older employee base than our initial expectations.

Second, not too long ago, men dominated the professional services market. If someone said 90 percent of the workforce was comprised of men, most people would have believed it. Data says this market has changed, and the emergence of women in the consulting ranks has opened up greater opportunities and viewpoints. We doubt the ratio will be 50-50 in the next few years, but it could get there over the next decade as more opportunities evolve for women.

Table 1: Age of Professional Services Workforce

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Heading into 2013, one area concerned us, and that was employee attrition. So far, the predictions remain accurate, as attrition lingers around 9 percent, when it was only 7.2 percent last year. We’ve seen this rise in the past five years and expect to see the trend continue as the economy improves.

Service execution

PSOs continue to keep average billable utilization at more than 70 percent. This translates to more than 1,400 billable hours per year per consultant. While 75 percent or higher would be better, the past two years have shown the strongest average utilization in the benchmark’s seven years.

On-time project completion may be a potential problem, as it went from nearly 79 percent down to this year’s 75 percent. Considering most of the other services execution metrics have improved, this key performance indicator most likely correlates with the talent cliff. The market cannot afford for on-time completion to go down for it will ultimately reduce growth rates, profitability and client satisfaction.

Finance and operations

We’ve been monitoring two other critical key performance indicators: 1) annual revenue per billable consultant that looks at the efficiency and effectiveness of the consultants delivering services and 2) annual revenue per employee, which highlights the effectiveness of managing the workforce.

To date, revenue per billable consultant sits at $190,000, down from $206,000 in 2012, a notable decrease that needs close monitoring. The good news is that the revenue per employee has risen from $168,000 in 2012 to $178,000 this year, an indicator that PS executives are moving to get their houses in order.

2014 crystal ball

We’re expecting 2014 to be another banner year in the professional services market. Yes, in spite of the talent cliff negatively impacting the future growth for many PSOs and increasing attrition. Count on seeing changes in the next year with the need for mergers and acquisitions to grow firms. Stay tuned.

What Are the Essential KPIs for Professional Services Organizations?

How to pick the right ones out of hundreds of possibilities
by Jeanne Urich, Service Performance Insight

With the growing contribution and significance of services to circlekpithe bottom line, effectively monitoring, measuring and managing the services business has become critical. But with more than 200 metrics to choose from, where does an executive start?

Running a professional services organization (PSO) is complex. It’s a game that must be won with singles and doubles, not home runs. Thus, it’s imperative to know which key performance indicators are essential, the ones PSOs must continually measure, and the ones that are nice to have but not essential. Figure 1 shows the essential key performance indicators and Table 1 defines each KPI.

Figure 1: Key Performance Indicators — the Essentials

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The challenge for services executives is how to balance customers, employees, partners and operations. Excellent services leaders spend 50 percent of their time with customers, partners and the sales organization and 50 percent with employees and operations.

Table 1: Standard Key Performance Indicator Definitions

KPI Table

The challenge comes in continually capturing new business while ensuring revenues and costs remain aligned, all while providing consultants with the tools they need to deliver high-quality projects. Service is a balancing act requiring effective selling and quality project delivery at the same time.

These are definitions and descriptions for the most important levers that organizations can pull to improve professional service revenue, margin and customer satisfaction.

Revenue: Revenue starts with services sales or bookings, which convert to clean backlog once all required contracts, master service agreements and statements of work have been completed, signed and approved. Resources are then applied to work the services backlog. Billings occur based on contract terms: time and materials, fixed price, milestone, deliverables, etc.

The ability to recognize revenue will be determined by the firm’s accounting practices. The Sarbanes-Oxley anti-fraud law has imposed a complex set of accounting rules on organizations, requiring executives to understand contract obligations upfront to avoid revenue recognition problems later.

Gross margin: Margin must be measured at several levels. Most organizations use subcontractors and lower-cost offshore resources for services delivery. Subcontractors provide a lower-cost variable workforce and provide a rich source of margin. Systems integrators must closely monitor hardware and software pass-through revenue and margin. And finally, since PS is based on applying highly skilled professionals to deliver project revenue, the most important measure is direct labor margin.

Subcontractor margin, hardware and software pass-through margin, and direct labor margin all add up to produce gross margin. For even the best-run PSOs that command high bill rates and high billable utilization, it is difficult to consistently sustain a services gross margin greater than 50 percent.

Regional margin: Most services organizations measure regional and line-of-business profit and loss in addition to the global PS income statement. Depending on a company’s accounting practices, corporate overhead costs may be apportioned to the region or line of business or kept in a corporate overhead cost center.

For example, if a company requires a 20 percent PS net contribution margin and its corporate overhead is 20 percent, it will need regions to produce a 40 percent margin.

Services margins are typically lower in EMEA than in the U.S. due to the increased cost of the following:

  • Fringe benefits: Employee fringe benefit costs for health and benefits range from 22 to 25 percent in the U.S. but may be as high as 40 percent in EMEA, plus many countries include an expensive car allowance.
  • Vacations and company holidays: In EMEA, typically four weeks’ vacation and 12 or more holidays compared to two weeks’ vacation and 10 company holidays in the U.S. This extra non-billable time is somewhat offset by an expectation of higher billable utilization in EMEA.

Net contribution margin: The true differentiator for professional services profitability is how the practice manages below-the-line costs. Embedded PSOs within product companies typically produce a net services contribution margin between 10 and 40 percent. According to the Service Performance Insight 2013 PS Maturity benchmark, average reported net margin (EBITDA) for independent firms was 15.6 percent and for embedded PSOs, it was 23 percent.

Typical overhead expenses (as a percent of total PS revenue) include:

  • Direct labor expense (40 to 50 percent): Direct labor cost as a percent of total revenue.
  • Fringe benefit expense (6 to 10 percent): Fringe benefit expense as a percent of total revenue.
  • Subcontractor expense (7 to 15 percent): Subcontractor cost as a percent of total revenue.
  • Sales (2 to 20 percent): Includes all direct sales headcount and fringe benefits plus non-billable business development travel and expense, commissions, incentives, and sales training.
  • PS engineering and PMO (1 to 2 percent): This includes all PS engineering and PMO headcount; fringe benefits; and expenses such as labs, tools, delivery training and project reviews.
  • Marketing (1 to 2 percent): This encompasses all services marketing headcount and marketing expenses, such as Web, PR, advertising, trade shows, sales training, customer satisfaction survey, references and services packaging.
  • IT (1 to 2 percent): Comprises all IT capital expense, depreciation and headcount costs.
  • General and administrative (5 to 20 percent): This includes PS corporate management, facilities and non-billable travel.

Most PS organizations underinvest in PS engineering and services marketing and overinvest in non-billable management overhead and non-billable travel. Sales expenses may be hidden as non-billable time for key managers and solution architects. As a PS firm grows and matures, investments in dedicated services engineering, project management office, knowledge management, marketing and sales can pay huge dividends by making services delivery more repeatable and efficient and services sales more effective.

Customer satisfaction: For product companies, one of the primary raison d’etres for a professional services business is to produce reference customers. This is a crucial measurement area, yet it’s often overlooked. Unless the organization is very large, typical customer satisfaction loyalty surveys are not granular enough to showcase delivery problems.

No matter how small the organization, executives should create a global project dashboard to continually monitor project health. SPI Research recommends at least quarterly project reviews with defined criteria for red, amber and green, plus ongoing knowledge sharing to continue to improve intellectual property and standardize the project delivery life-cycle methodology.

Workforce plan: The lowest common denominator is the health of the services delivery organization. Billable headcount represents an organization’s brand and reputation and its services delivery capability and revenue potential. From inception, executives need to quote tiered bill rates by skill level and measure employee utilization — both billable and non-billable.

SPI Research recommends creating an organizational stack ranking showing profit and loss by person. Executives may find 80 percent of company revenue and profit is produced by 20 percent of the workforce, which means it is imperative to identify the top revenue producers and ensure they are recognized and rewarded!

Resource ownership: An interesting dilemma arises when regions or practices own the fully loaded cost of consultants. This produces a disincentive to resource sharing. Methods to overcome resource hoarding include central resource management and cost or revenue sharing for loaned consultants.

Utilization: Organizations calculate utilization in many different ways. In the U.S., the standard definition is based on 2,080 available work hours per year — this translates to 260 available workdays per year in EMEA. Most standard utilization measurements subtract company holidays (10 in the U.S. and 12 or more in EMEA). The standard available starting-hour calculation in the U.S. is 2,000 and the standard available days in EMEA is about 240.

Primary differences in utilization definitions emanate from the varying treatment of non-billable hours for internal projects, customer satisfaction issues or business development (in the numerator) and whether non-billable personal time off is excluded from the denominator. Some organizations measure billable utilization as the actual number of billed hours divided by the total available hours (including non-billable roles), while other organizations report billable utilization based only on their billable roles and exclude all of the hours of their non-billable staff.

Regardless of a specific utilization formula, it is important to develop a standard utilization definition and to publicize and consistently measure it throughout the organization.

Recommendations for improving financial performance

With increased global competition for business and resources, consulting organizations must continually improve. These improvements cut across every aspect of the organization, and all departments must work together to achieve services performance excellence. Executives need key performance measurements, integrated business applications and a plan for continual advancement.

In sum, there are many levers for improving financial performance. Thus, executives should pick three to five key metrics to improve each year and watch the money grow!

A Comprehensive Human Capital Alignment Strategy

The dollars and cents add up
by Jeanne Urich and Dave Hofferberth, SPI Research

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Most professional services (PS) executives monitor a handful of key performance indicators (KPIs) to determine the success of their organization. Some of these metrics include growth rates, earnings before income taxes, depreciation and amortization (EBITDA) or contribution margins, days sales outstanding (DSO) and client satisfaction. However, these indicators are the tip of the iceberg — they are a result of successful planning, development, sales, service delivery and invoice management. If done well, client satisfaction will also be at an acceptable level.

Popular KPIs are easy to see

To make sure that these, and many other high-level KPIs, meet organizational goals, PS executives must look at the details behind these indicators for the root cause of their success or failure. Across professional service organization (PSOs), indicators appear in each of the five Service Performance Pillars:

  1. Vision and Strategy: A unique view of the future and the role the service organization will play in shaping it. A clear and compelling strategy provides a focus for the organization and galvanizes action.
  2. Finance and Operations: (CFO) The ability to manage services profit and loss — to generate revenue and profit while developing repeatable operating processes. Elements of this pillar provide long-term financial stability.
  3. Human Capital Alignment: The ability to attract, hire, retain and motivate employees. With changing workforce demographics, human capital strategy has increased in importance.
  4. Service Execution: The methodologies, processes and tools to effectively schedule, deploy and measure the quality of the service delivery process.
  5. Client Relationships: The ability to effectively communicate with employees, partners and customers to generate and close business and win deals.

By doing things “right” in each performance pillar, firms can measure PSO success. The impact of activities in one pillar can positively or negatively impact the activities in another. Successful PS executives understand the balance required to achieve their ultimate success.

Profits matter, and they start with people

One of the more interesting aspects of research focused on billable PSOs is the importance of an integrated human capital strategy. Finding, hiring and retaining key employees are just the beginning.

SPI Research has analyzed over 160 performance indicators and correlated them with the leading KPIs used by many PS executives to determine success or failure. The model we built segments organizational maturity into five levels, where Level 1 is the base level for beginning firms or those that do not operate efficiently or effectively. Level 2 is for average performance, and increasing performance continues on to Level 5, where less than 5 percent of the PSOs surveyed meet the stringent criteria to be market leaders. Most of the performance indicators in this study trended up or down, depending on their positive or at negative impact on performance.

We have found that the number of performance indicators with extremely strong correlations to success are within the human capital alignment pillar — meaning, the employees, and how they perform once onboard in the firm (Table 1) dictate ultimate success or failure. The problem is that there are many KPIs associated with human capital. So which ones should PS executives consider?

Table 1: Human Capital Alignment performance indicators tied to performance levels0709 2Source: Service Performance Insight, February 2009

We have learned that some of the more notable performance indicators include:

  • Non-billable project hours: Leading PSOs (Level 5 performers) averaged only 80 hours per year per consultant of non-billable time. Contrast this figure with less mature PSOs that averaged over 300 hours annually! At bill rates of $150/hour this difference is over $33,000 in reduced billings per consultant per year. Therefore, PS executives should strongly encourage non-billable project hours stay under 2 percent.
  • Standard job descriptions exist for all positions: 100 percent of the Level 5 performers had standard job descriptions versus 62.2 percent of Level 1 performing PSOs. The leading performers keep the descriptions “standard,” which makes it easier to recruit and hire. Reducing the hiring and ramping time also shows up in increased financial performance. PS executives should mandate that HR create standard job descriptions to provide clarity in job positions.
  • Skill profiles exist for all employees: Our research shows 100 percent for Level 5 versus 43.2 percent for Level 1. The leading PSOs have skill profiles for their employees and make them visible to other practices within the company. This visibility increases the overall consultant utilization rates and shows executives around the organization which skills are most in demand, and what their appropriate pricing might be. PS executives should mandate that HR create skill profiles to provide individual clarity to keep employees visible and billable.
  • Performance reviews tied to industry benchmarks: 100 percent of the leading firms tied performance reviews to industry benchmarks versus 25.1 percent of Level 1 performing PSOs. Employees who can see what is expected of them compared to their peer group (inside and outside of the organization) perform better knowing they are treated in accordance with industry standards. Obviously, they must believe the standards are unbiased or performance and satisfaction would suffer. PSOs should maintain a database of industry benchmarks and show it to employees when appropriate.
  • A well-understood career path for all employees: The difference here is quite large, 100 percent for Level 5 versus 26.4 percent for Level 1. It makes sense in that employees who lack a clear understanding of their potential within an organization feel less sense of loyalty and therefore will not perform as well as highly motivated individuals. PS executives should mandate a potential career path guide for employees, which shows where people in their position could end up in the next one, two and five years.

It should be noted that these performance indicators are not overly expensive to implement, and leading PSOs consider this necessary in successfully maintaining a high-quality workforce.

Other performance indicators have a strong correlation with organizational performance, these just happen to be in the Human Capital Alignment pillar. Some of the KPIs don’t necessarily optimize success when they grow too large or too small. For instance, information technology spending as a percentage of revenue tends to show the best results when it’s approximately 4 to 6 percent. Obviously, no spending on information technology would severely, negatively impact performance, as would excessive spending, anywhere over 10 to 15 percent.

Consider programs that improve human capital alignment

We recommend PS executives work with their human resource teams to develop a human capital alignment strategy both visible and understandable by the workforce. Employees should understand management’s expectations and how those expectations will drive compensation, promotions and other areas that impact performance.

When employees understand their performance goals, they can work with their managers to make sure they attain them. For instance, most PSOs have utilization targets. The calculation of utilization is usually clear to the employees, and therefore, they understand how they are performing. Employees will meet with greater success if they come into the job with a clear understanding of these requirements and a skill profile that helps them become more visible and billable.

Employees must come into the job with a clear understanding of what their career path could potentially be if they successfully remain with the organization over several years. To keep these employees motivated and challenged, the PSO must offer various education and training programs to keep employees up-to-date on the latest skills required for them to succeed.

“World class” relies on human capital

Many factors go into creating a world-class professional services organization. Fluctuating economic cycles and changing client needs can cause stress and poor performance on the workforce, resulting in turnover and reduced profitability. These external factors can make life difficult in the highly charged and competitive professional services sector.

Greater clarity of expectations for the workforce provides for a work environment that helps reduce many of the issues related to external factors. PS executives must ensure the organizational strategy and directives are clear to the workforce and that their workers understand management’s expectations.

With this type of clarity, workers will feel a greater empowerment to operate in a manner consistent with the needs of their organization. In professional services, it always starts with the workforce. It ends there, too.