I recommend profitability analysis as a tool routinely. While there may be arguments as to the method of overhead application from firm to firm, the end results of these analyses are rarely so flawed that they are not useful for improving performance. The principal benefit of profitability analysis is that it promotes accountability. A firm that understands the basic economics of their practice has the competitive advantage of knowing who to reward and by how much.
Another principal benefit of this information includes the ability to more intelligently allocate resources, manage costs and strategically direct business development efforts.
Profitability analysis and compensation
As a general rule, I recommend that profitability results be a component of compensation. Firms must embrace the reality that properly paying members according to their profits is the best way to ensure the long term success of the firm. This is true for two reasons:
- Firms that are profitable are able to attract and retain better people
- Compensation based on profitability is sustainable, as the underlying economic value is reality based
The theory behind the use of this profitability information in the compensation process is that a large portion of a member's compensation, after a certain point in his or her career, should be based on the profitability of their book of business. More simply, everyone is ultimately paid according to their contributions.