In this post I’m suggesting that financially successful firms should think about dedicating a person or small team to a small number of high-risk, high-reward engagements. These engagements would be managed under different risk/reward criteria, more like a venture capital fund and less like a marketing agency.
Pricing & Risk
One of the most profound ideas on pricing that I have encountered comes from Ronald J. (Ron) Baker in his book Implementing Value Pricing. In it, Baker suggests you view your client portfolio as you would your investment portfolio, and seek to balance your low-risk, low-reward clients with moderate- and high-risk/reward clients in a way that lets you sleep at night. Every business owner has a different tolerance for risk and therefore the overall balance of the portfolio will vary from owner to owner.
Nassim Taleb, in his book Skin In The Game, gets even more prescribed when it comes to taking risk. In general he says, people should seek to take on more risk in their lives but only when those risks do not pose an existential threat to the person, family, business, etc. When it comes to investing, Taleb advocates a “barbell” approach to risk with a significant amount of low-risk investments, balanced by a small amount (but still higher than what most people take) of greater risks and with little to nothing in between. Taleb’s basis for this approach is “prediction errors.” In investing, prediction errors would include the likelihood of getting some fundamentals about the future of a company, category, asset class or the larger economy wrong.
Personally, I don’t see the prediction error corollary to your client compensation plans, so my intuition is to embrace Taleb’s first idea of more high-risk/reward investments (but never to the point where they will threaten the firm) built on a base of low-risk investments, but I would also include some moderate-risk/reward engagements as well, as Baker advocates.
In my last post (Five Levels of Pricing Success) I characterized selling time as your lowest risk/reward pricing option and performance pay—value-based pricing with some compensation at risk—as the highest. In between those extremes there are many moderate-level risk/reward pricing models. I cover the spectrum in more detail in my book Pricing Creativity: A Guide to Profit Beyond The Billable Hour. Your venture firm, team or business unit (I’m using these terms interchangeably) would handle the small number of performance pay deals where you put significant compensation at risk in exchange for a much larger upside.
The In-House Venture Firm
The in-house venture team has visibility into all the deal flow early on, before proposals are presented to clients. They identify those opportunities where it makes sense to craft a high-risk/reward engagement.
Why might you have a separate team dedicated to such engagements? It’s not necessary—the venture firm could remain an abstract idea, a label that you simply apply to those select high-risk engagements. But creating a different business unit creates a cultural barrier. “Our larger team handles the low- and moderate-risk work—the bulk of our client engagements. And this smaller team over here works on one, maybe two, high-risk engagements.” This venture team, everyone understands, does work that may pay little or even nothing in fees, because the compensation is heavily weighted to incentives for outcomes. The hope is that one or two of these engagements will succeed and transform the financial fortunes of the firm.
Who Runs This Team?
Let me be clear that I’ve seen this idea in operation only a couple of times. Each time the venture team had one dedicated employee that was a partner or minority owner. This person is entrepreneurial in nature—almost too entrepreneurial to be running client accounts—but is also not the most senior steady hand on the agency wheel. They’re not the CEO but are of that stature. They have strong business skills, can operate at the highest levels of client organizations and they have a grasp of value-based pricing and the legalities and other logistical complexities involved in such entrepreneurial engagements. They are creative problem solvers who think big and are not afraid to ask clients for large payouts—in cash, equity or other forms—as a reward for helping the client create extraordinary value.
This is such a specific person that I don’t think it makes sense to create a discrete venture unit unless you have somebody like this on your team and you’ve been wondering about the best role for them.
Marc Andreesen says his firm Andreesen Horowitz is pitched by 3,000 startups a year, they seriously consider 200 and they invest in just 20. By that measure, no more than 10% of the deals you are already considering or competing for might be ripe for a high-risk/high-reward engagement where you put a significant portion of your compensation at risk in exchange for an even more significant upside.
What Opportunities Go to The Venture Team?
Engagements that might qualify for the venture team typically have the following criteria present:
- The chance to create significant and easily quantified economic value
- An entrepreneurial client willing to share the reward in exchange for lower upfront fees and greater risk-taking
- A sense of confidence and trust between all parties, i.e. you trust the client to not restrict access to key people, data and performance metrics or otherwise try to rob you of rightly-earned incentives
This eliminates most large, established enterprises. (I wrote about this in my post You Don’t Really Partner With Your Clients.) Earlier stage companies with entrepreneurial owners, flatter hierarchies, no procurement department, and lots of growth potential (and sometimes little cash) make the best candidates for these types of engagements.
A High-Risk Venture
Understand that this unit, should you choose to form it, is a venture investment itself. It is a high-risk endeavor that may never pay off. In a venture capital firm about 8% of the investments generate all economic gains, with the rest effectively going to zero. That’s a 12-1 ratio. And while those numbers might scare you off, remember that every proper VC investment is all-or-nothing. You can mitigate your risk by taking some fees to cover costs. But whatever you take up front in fees, you will generally give up multiples of on the back end in incentives.
So if you’re not willing to fund your venture unit on those long odds then don’t do it. But if you have this unique person on the team, if the firm’s margins are high enough, its financial position secure enough and you have the appetite for it, consider investing in a venture unit where one success has the potential to generate the equivalent of years of profit.
Think about it. And if you do take the leap, I’d love to hear from you.