I mentioned last week that I was launching a podcast. That episode came out and you can listen to it (or watch it) on all of your normal podcast channels:
In that podcast, I spoke to Nick Anderson, CEO of OneAccord.
When Nick took over the business, he knew he wanted to grow. But he didn’t start by rebranding or hiring a marketing agency. He started with one scary realization: The gross margins were broken.
The revenue looked fine, but the math ultimately didn’t work if they wanted to build the type of business he was trying to build.
And when gross margins don’t work, scaling can sometimes be counterproductive.
So he knew from day one that his first order of business was to redo the whole business model so that he could fix gross margins.
We talk about this in the podcast and the process that he went through.
To set the table for what he did, we first have to understand a little bit about OneAccord. OneAccord is a consulting firm that helps companies with leadership, strategy, and operational improvement. To deliver their work they rely on a network of experienced consultants who engage with clients.
On the surface, this sounds like a pretty straightforward professional services business.
Client pays the firm, then the firm pays the consultant delivering the work, and the difference becomes the firm’s gross margin.
Simple.
But the details of how consultants are structured and compensated can completely change the economics of the business.
And that’s where Nick realized things needed to change.
See, when Nick stepped in, the core issue was that the model wasn’t producing the margins needed to grow the business.
Historically, OneAccord had set a baseline of a 20% gross margin. This meant every $100 that came into the business, $80 of those dollars were going directly to the consultant.
That left them with only $20 to cover everything the firm needs to run: management oversight, client experience, systems, ops, and growth.
This model had worked at the time. In some ways, OneAccord was acting as a recruiting firm, finding the client and matching them with the right consultant, but then, because the cost structure didn’t allow it, OneAccord had almost no involvement with the client. The consultant was given free rein.
This could mean inconsistency in deliverables and performance. You could have two exact scopes, but the consultant could deliver it in a different way, which meant that those clients got a completely different experience.
This also meant that as they grew, they didn’t have enough margin to cover:
- leadership and management
- marketing and business development
- operations and support
- systems and infrastructure
If your gross margin is too thin, those things become impossible to fund. Sure you’re generating revenue, but too little of that revenue is staying in the business, meaning that you can’t cover your other costs of delivery.
That’s the dangerous spot because you feel like you’re growing, but the business isn’t actually becoming stronger.
COMMON WAYS GROSS MARGINS ARE BROKEN
And Nick is not alone in having broken gross margins. Most of the time gross margins are broken, it’s not some big mistake. It’s a series of little things that add up or changes in the business.
In Nick’s case he just wanted to change the way that they delivered their service. Instead of being a recruiting firm, he wanted to create a more cohesive model that would work with scaling.
So while your reason might be different, it likely falls into some of the most common ways that gross margins are broken:
- Changes to the business model or structure.
- Scaling has added additional costs that require previously okay margins to feel rather thin.
- A slow creep of additional costs have grown at a rate higher than the price increases, gradually shrinking gross margins.
- A lower margin product or service starts selling at a higher rate than your high margin products or services.
- You’ve done dollar-for-dollar price increases. If price is $10 and cost is $5 and you increase price by $1 when your cost when up $1, you’ve lost margins. With the new price of $11 and cost of $6, you’re still keeping $5… great! But what was was a 50% margin has turned into a 45% margin. Do this a few times and 50% margins can turn into 20 or 30% margins.
Now don’t get me wrong: there are situations where it’s okay to accept lower margins intentionally. If you have multiple products or services and the lower margin product or service starts selling more quickly, it can create more real dollars. This is great and can work if it doesn’t mean an increase in overhead cost. But, if overhead costs do need to go up. Your now lower margins could quickly result in thinner overall profits.
So how do we fix it?
HOW YOU CAN FIX YOUR MARGINS
Nick knew to build a business that felt less like a recruiting firm, he needed to connect the dots between OneAccord, the client and the consultant. He needed to rethink the model so that economics would work to allow them to be more value-added for the clients as a service provider.
Instead of simply passing revenue through to consultants, he designed a structure where:
- they established an operating system that helped make client delivery more consistent
- Added a client manager to the engagement who worked with both the client and the consultant
- allowed the person responsible for the client relationship participates in that margin
In his new model, the firm targets roughly 50% gross margin on engagements and used those additional margins to fund the infrastructure needed to grow the firm.
By adding a second person to an engagement and installing an operating system, it allowed them to better serve their clients and be able to step in on an engagement where a consultant had to be replaced.
This drastic a change meant that he couldn’t “optimize around the edges.” It meant he had to remake it from scratch. This meant lots of hard conversations with both clients and consultants. It meant increasing client fees and holding consultant pay steady.
But this was the first and necessary step before he could put his foot on the growth lever.
The same goes for you. Before you step on the growth lever, you need your foundation to be strong. Part of that foundation is sustainable gross margins.
First, we want to ask and understand:
- Do you actually know your gross margins? Make sure you know and understand all of the inputs that go into this number. How are you pricing things and what are the costs associated with that product or service?
- How have your margins changed over time? Pull the last 12 to 36 months of data and look for trends. Try and understand these trends and put a narrative behind the changes.
- What is your margin mix? Do you have multiple products or services and how do their margins differ? Again we need to go granularly into these details.
- What are the drivers of your cost increases? If you have multiple inputs into your costs, we need to understand how each of those cost levers is moving. Look at labor, materials, shipping, etc.
Once you understand all of these inputs, you can start to do the hard work to improve your gross margins.
It then becomes a simple exercise of playing with changes to:
- Pricing
- Cost Structure
- Product or Service mix
Remember that dollar-for-dollar example up above?
We don’t want to be that person because that person does a dollar-for-dollar increase year after year and gets to year five or six and realizes that they’ve dollar-for-dollar themselves out of a business.
Gross margin isn’t just a finance metric. It’s the business model, in percentage form.
If it’s wrong, growth just amplifies (or exposes) your problems.
So don’t wait until you feel the cash crunch to take this seriously. Pull 12–36 months of data, figure out what changed, and pick one lever to work this month: pricing, cost structure, or mix.
And if you want to hear the full story of how Nick rebuilt One Accord’s model to make scaling work, go listen to the episode. It’s a good one.
