What if ‘best practice’ is wrong?

George Bull is Chair of Professional Services Group at Baker Tilly

There was once a poster at Watford Junction railway station, just outside London. Advertising the local shopping centre, it read ‘Little blue dress, little blue dress, my life would be complete if only I could have that little blue dress’. So it is with best practice: people within a firm readily incline to the view that, if they are adopting best practice, then professional life will be complete. What can possibly go wrong for the firm?

Best practice may be defined as ‘a technique or methodology that, through experience and research, has been proven to reliably lead to a desired result’. Let’s take a look at two examples in relation to resilience, sustainability and financial stability.

These demonstrate that best practice may lead a firm to the wrong place, albeit for the right reasons.

First, resilience and sustainability. Firms may decide to disperse different parts of their business to different locations to achieve cost savings, benefit from financial incentives or take advantage of local expertise.

This may be achieved by the firm opening offices in new locations or by entering into outsourcing contracts with third-party service providers.

A clear purpose, great systems and shared commitment should result in a level of transparency and functional effectiveness which maintains the quality of client service at a competitive price, and with a decent profit share for the partners. Some would call that best practice.

But what seems like a great business plan may undermine the resilience and sustainability of the firm. At its simplest, the bigger the physical separation between the moving parts of a business, the greater the risk that something will go wrong through exposure to uncontrollable systemic risks.

These include exposure to a pandemic, a cyber- or bio-attack, an energy failure or unexpected event such as a tsunami or volcanic dust cloud. If all this sounds implausibly far-fetched, ask any Head of IT at a law firm which outsources work to India.

Most of the outsourcing data traffic between the UK and Mumbai passes though the optical fibre submarine communications cable known as SEA-ME-WE 4.

That cable has suffered serious damage 13 times in the last six years, as a result of equipment failure, criminal activity, marine accidents or environmental events. The most recent ‘outage’ was for four weeks in November/December 2014 during which internet speeds were greatly reduced.

The lesson is clear. Systemic risk exposure can be triggered by choices made while following business ‘best practice’. To maintain the resilience of the firm, additional short-term investment costs may be required to protect against longer-term risk exposure. In this specific example, outsourcing or offshoring should be seen as a route to long-term benefits, not short-term profits.

The balance between long term and short term is at the heart of my next example, in relation to financial stability expressed through partner compensation systems. Some best practices may have begun as good practices, but practices whose harmful effects only materialise many years later. Yet with short-term consequences that are quite positive, firms go ahead and implement them, not connecting the problems of today with the practice adopted years ago.

The last great swing of the goodwill pendulum took place in the 1970s, when most firms ceased to be ‘goodwill’ partnerships and became ‘income’ partnerships, distributing profits in full each year to partners whose place at the table was funded by borrowed capital.

This trend was reinforced by subsequent tax changes which meant that partners suffered a higher effective rate of tax if they left profits in the firm.

Coupled with the ready availability of bank funding, this meant that by 2007-2008 most law firms entered the financial crisis with weak balance sheets and a full distribution culture.

For many, the next seven years were painful. Law firm failures resulted in restrictions on the availability of bank funding. Pressure on margins reduced profits available for distribution, while the urgent need for many firms to regain financial stability resulted in an overdue but painful move away from full distribution policies.

Many sovereign nations experienced the same pain! For law firms, many of the effects of this have yet to be seen, including more firm failures, distressed mergers, team and partner moves. But it’s becoming clear that a short-term approach to partner compensation systems is incompatible with long-term financial stability. Firms with ‘best practice’ full distribution policies should urgently review, and if necessary rectify, the economic incentives given to partners.

So, if best practice may be flawed practice, where does it come from? The two key sources belie the flaws.

First, homogenised management education. Business schools from Boston to Beijing teach a standardised approach to business management which, in the absence of experience, relies on replication and can therefore overlook or amplify risk.

But experience alone may not be enough. Most experienced executives have strong beliefs about what works and what doesn’t, so assign more resources to the things they are confident about, eager not to waste them on activities with less prospect of success. As a result, they make their own beliefs come true. Only later may it become apparent that some of these practices are bad habits masquerading as efficiency boosters, their real consequences lying hidden.

Questioning ‘best practice’ when it is presented to you and uncovering such flaws may significantly boost the resilience, sustainability and financial stability of your firm, to the benefit of your people, your clients and, eventually, us all.