AE Firm Financial Transparency: How Much & To Whom

financial transparency in a ae firm

Co-Author: Kate Allen, PE, MBA

Working in the architecture and engineering (AE) industry for so many years, we’ve discovered that firms who get comfortable with a high level of transparency almost always enjoy better employee engagement and increased profitability. It’s a bit of a culture shift, to be sure, but once the adjustment is made, firms find that they’re better positioned for success. Plus, employees today tend to appreciate transparency and the ability to understand some of the “why” behind the business.

However, a significant concern of many firms is that by sharing financial information, employees will gain the ability to deduce confidential information such as employee salaries. Implementing a robust system that combines financial management and benchmarking ratios helps firms improve their performance without giving too much detail away.

Transparency Does Not Drive Profitability, But…

A few years ago, an industry expert (now a college professor) conducted a study to see if financial transparency at AE firms increases profitability. Somewhat surprisingly—especially to those of us who advocate being open about the numbers—he found no correlation between the two. Simply being more transparent about firm performance did not drive better results for firms.

But, and this is important, he found that employee engagement drives higher firm performance, and transparency produces greater engagement. However, there’s an asterisk here: principals must educate their teams about the economics of operating a firm so that they have a foundation from which to understand the numbers.

Most people in the AE industry have little to no financial education, and the vocabulary alone can place people outside their comfort zone. This situation makes it hard to understand, for example, why a firm has to charge a client a particular rate and pay team members at a significantly lower rate to stay financially viable.

The EIEIO Principle

In our work with clients, we encourage what we humorously refer to as the EIEIO Principle. In this case, Old MacDonald had a firm! The principle specifies the order in which a firm should move from financial secrecy to financial transparency:

  • Education
  • Information
  • Engagement
  • Incentive
  • Output

By following this approach, firms gain the desired behaviors they are seeking from their team.

Education has to come first because, as noted above, architects and engineers tend to have minimal background in managing a firm’s finances. You will likely encounter resentment, anger, or frustration if you deliver numbers many may not understand. Fortunately, it’s easy to bring employees up to speed quickly with something like a “lunch-and-learn” series that addresses key performance indicators (KPIs) and other financial considerations.

Once everyone understands the metrics important to AE firms, you can share information about your firm and where it stands relative to those numbers. For example, you might show them how a direct labor multiplier is constructed or how labor utilization impacts the firm’s overhead.

Now you’re in a position to talk with employees about the difference between the KPIs of high-performing firms and those of your firm and explain changes that can be made to close gaps. This level of understanding tends to produce the engagement you’re seeking. (And if it doesn’t, you may have some personnel decisions to make!)

With their new perspective on the firm’s operations and how their efforts can improve the bottom line, employees have a strong incentive to work more efficiently and effectively. This sentiment is especially true in firms with an end-of-year or quarterly (or month or project) financial reward based on results. Team members are more motivated when that extra income feels within their reach! The result? An increase in both the quality and quantity of your firm’s output.

How Deep? How Fast?

When firms decide to use the EIEIO Principle, the following two questions typically are:

“How deep into our organization should we go as far as sharing financial information?” and

“How quickly should we make information available?”

Hopefully, your principals already understand what’s driving profitability. So, in terms of depth, your project managers (PMs) are the key to leveraging financial transparency to improve performance. It’s hard to create goals for entry-level team members who don’t yet have budget responsibilities, so they aren’t ideal candidates for this kind of initiative. PMs have both the need for financial education/information and the ability to impact profitability directly.

As for timing, once you’re confident that PMs grasp the economics of running a firm, you can start introducing them to your firm-level financial metrics. Then, over time, they become more deeply involved in the firm’s performance, which can position them for an ownership and leadership stake if they (and you) are interested. And your more junior team members can be groomed to take the next step.

Next Steps

To learn more about the relationship between benchmarking and key performance metrics, we invite you to join our upcoming webinar.

Brad Wilson, CMA, CDA