The High Water Mark For Regulatory Hubris

The Government spent over £1m last year finding out if there was market failure in advisory compliance services for SMEs. Nice of them; and the short answer is – ‘nope’, nada, nowt, nine, rien, no way. Having made this ‘investment’ they’ve then buried (‘archived’) their findings in the communications equivalent of Outer Mongolia, which is odd. The detailed findings are important, however, so here’s the headlines.

The research team put a big spotlight on non-lawyers doing compliance work for SMEs. A sceptical, some would say a biased spotlight, should be revealing, so what was the result?[1]. The findings are relevant for the regulatory consultancies (who come out well), and the regulators, quangos, lawyers, insurers, and banks, who, frankly get taught some lessons.

The New Labour administration set a lot of hares running in the legal services arena, and in this instance the Anderson Review[2] concluded that something should be done about compliance advice for SMEs. Quite why they asked a recruitment entrepreneur to assess an area tangential to her core competence at best is unclear, but neither the intentions of the initial reviewers nor the competence of the subsequent teams is in question. It now appears to be more of a high water mark for an administration that simply saw no boundaries to their competence or calling. Until the RSI (The Regulatory Standards Institute) intervened and put the regulatory consultancies front and centre, no-one seemed prepared to argue that Mr Browns’ finest seeking to be legislator, regulator, inspector, insurer, advisor, certifier, prosecutor, defender, expert witness, judge, jury and bailiff all at the same time could be a tad over-reaching themselves.

Two pilot projects and a nationwide research effort were undertaken delivering significant empirical results:

- From an addressable prospect base of 22,500 firms (5% of the North West SME population) one government pilot research scheme (aka ‘no wrong door’) secured interest from 447 firms, 253 of whom registered for a free trial. From these, after the 6 months free period, 12 firms took up long term contracts[3]. Take up of a ‘free’ service for 6 months was therefore notable at 1.12% of the prospects, and 4.74% of those went on to take up a full service. Overall the take up was 0.05%. Frankly no direct marketing B2B services business would find these levels of take up remotely attractive or cost effective.

- A sister project (‘Open Market Campaign’ – OMC) started with direct mail to 30,407 firms, emails to 9,700 and telemarketing to this 30k base, ie 3 hits. They were offered £50 off an existing service. They achieved 1483 registrations: 4.8% take up for a free offer. No firms took up the offer or used the vouchers, that’s right – none, zero. Not being able to effectively give away £50 notes is an odd outcome.

- The cost of the research pilots in total was £1,104,313[4] resulting in a cost per sale of £92k which should pay back in just over 30 years. Even allowing for a direct marketing cost allocation only, the costs for the pilot which generated some sales after the 6 month trial was £74,516 generating a cost per sale £6.2k; this would render each contract heavily loss making from inception on normal commercial parameters. The best that can be said is that it was nice of the Government to prove that direct marketing (as opposed to sales force led) approaches in this market are rarely cost effective. Sadly, this lesson did not need learning – not at any rate by those in the market already.

The other findings from the research are, strangely, not being widely disseminated or trumpeted, despite their relevance to the legal service debate raging currently. Here are the key lessons:

Compliance is a stress purchase: The most common reasons for not taking up even free pilot offers can be paraphrased as (a) ‘not now’, and (b) ‘maybe later’[5]. Timing is all in stress purchases for compliance. This is easy to forget, but it is absolutely fundamental to understanding the appeal of compliance, and especially outsourced compliance. Entrepreneurs simply do not get up in the morning deciding to really crack on with compliance today

Awareness among SMEs is high: It should come as no surprise surely that 81% of businesses with no employees are not aware of these services. Awareness is highest among 10-19 and 20-49 employee firms and in effect over 70% of firms in these categories know all about it. Basically those who need to know - know.

Clients want certainty, insurance is secondary. The government’s research focus on ‘insured advice’ effectively put the cart before the horse by focusing on a prescribed solution. Most SMEs want certainty and whether the advice is insured or not is irrelevant. That some respondents’ expected ACAS to offer insured advice simply illustrates the confusion.

Awareness does not predict likelihood to purchase. An important finding was that increased awareness of the solutions did NOT make the SME more likely to buy the service. None – yes, None – of those most aware, converted to pilots or policies in this research. The research is open minded about the implications of this, but there are some basics at play: (a) SMEs only very rarely buy weapons in time of peace, and (b) it's noisy out there - upwards of 200 active sales consultants nationwide backed by even more telemarketing staff cycle through over 13million calls a year at present, so even the largest estimates of SME populations mean each firm is called probably 3-4 times every year already.

Very Satisfied: ‘Overall there was a high level of satisfaction among businesses that have used insured advice with the quality of the advice they have received.’ This finding is startling. Not because it tells it like it is, but bear in mind that there were several vested interests lobbying hard behind the scenes here to prove that law firms must inherently be better than the ‘differently qualified’. Simply put - SMEs like what they’re getting from the regulatory consultancies and their choice is an informed one.

Never Mind the Quality…: ‘Amongst those businesses that were aware of insured advice but have not used it, quality was the least frequently given factor affecting their decision not to use this type of advice.’ Another startling finding. Strip away the double negatives and basically quality of advice is Not the paramount issue for SMEs – it is not even a major concern – it is the LEAST concern. Frankly this nails the protectionist arguments of the legal lobby in particular. SMEs want the ‘poo’ gone, not polished. It is this mind-set that lawyers almost always get wrong.

Timeliness First, Cost Second: The issues which are more relevant to clients include: (a) cost (and in this market perceived cost risk and fixed fee elements are writ large); (b) insurance was not seen as a primary issue for end users at all, (all it delivers is a mechanism for fixed fee pricing); and (c) timeliness is key. Basic points all – the Market is saying: ‘Get rid of the problem for a fixed fee – insure if you must (that’s your call as the supplier) – and get out of the way, we’ve got a business to run’. This is the ‘I don’t check the Highway Code when I pop into the car to go to the supermarket’ point. Compliance takes itself too seriously and regulators always confuse their desire to change behaviour with their ability to do so.

Sour Grapes? Satisfaction was ‘high’ and only 4% were dissatisfied with the quality of advice. This is important as it means the likelihood of breaking into this market by simply offering fantastic advice quality is very low. Quite where the allegations of poor quality come from is a mystery, and maybe the definition of ‘quality’ is revealing here. It is also worth acknowledging that within the regulatory consulting industry there is already much self flagellation about the advice being compromised or not by the insurance backing; they are far from complacent even about the issue the 4% may point up.

Renewal benchmarks: 8% of the sampled SMEs had used the service in the past and were not using it now[6]. This translates into a 92% renewal rate, which over a 3 year contract (the industry standard) is 78% (of renewables). These are benchmarks the market knows and polarises around. There are good reasons why the annualised renewal rate is 92% and not 97%, mostly inherent in the fact that SMEs merge, liquidate etc more than most, but also that by definition firms facing compliance growth pangs face a higher attrition rate too.

Tick Box Fatigue? Clearly the efficacy of kitemarks is wearing thin when the desirability of a quality assurance program was raised. What should have been a resounding ‘yes’ or at least a comforting ‘it can’t hurt’ was a very equivocal 50/50 ‘maybe’ or ‘if you must’ response from clients. Noticeably in relation to prospective clients the impact was that only 38-43%[7] would be more likely to use a kited supplier. Again, satisfaction with the choices already there is clearly very high in relative terms.

Pricing is Personal. Research on pricing is notoriously misleading and basically very few people do what they say they’ll do when it comes to pricing. Economic models rarely manage to cope with the emotional baggage, especially when in a stress purchase situation. So ignore the average price expectation of £450pa; the average of free and £3k skewed among firms with no employees is probably in reality lower than £450pa, but equally tackling a discrimination claim at tribunal for £450 would be nonsense – the average figure is meaningless. Average fees based on a firm’s payroll are the norm and after a determined attempt to cull competitors over several years by the market leader with price competition, if anything prices are now rising again and averages for SMEs are probably now over £175 per month.

Industry Competition: Comparing costs to other advisors, notably banks, insurers and accountants is also largely meaningless as these are often transactional and commoditised services (usually costing significantly less than £1k pa). An SME is not going to stop paying their audit fee because they sacked someone this year and got it wrong (unless it bankrupts them). Compliance is structurally different – when it happens it can kill a business, and it is inherently an ‘infrequently occurring but complex’ event[8], often disciplinary and redundancy based. The only finding of note was that “where it was found that cost was less of an issue, use of insured advice increased’. This is a backwards way of saying that an insured component simply delivers fixed price certainty for clients – something they value.

The addressable market: Having identified that awareness was irrelevant to take up, the research still maps both and usage/awareness is highest in the 20-49 employee size category, followed by 50-249 and 10-19. The only rationale for keeping the 'no employee' categories in play would be their propensity to become employers, but the take up is miniscule; clearly the vast majority of sole traders typically remain sole traders. There remains a problem with this research, however, in that 30% penetrations at best simply do not tally with empirical research on the number of organisations and the contract volumes for the 70+ suppliers in this market. Underlying confusion over what ‘insured advice’ is may account for it. Many may simply not know that they have cover through their trade associations etc, but it would be dangerous to assume that there is a massive untapped market lying in wait in the 10-50 employee sector; there isn’t.

Who’s asking? Funnily enough when asked by a government sponsored research project how confident they were in their compliance, over 97% of SMEs said they were ‘fine, thank you’.

Freebies. When the category ‘external advice’ includes everything free via Google as well as free services from government web sites, HSE, ACAS etc the resulting statistic that only 23% [9]of users of external advice use paid for services is meaningless. The fact is clients use several overlapping free services and it is not a zero sum game. People use free stuff when it doesn't matter; when push comes to shove they use 'proper' services and bin the freebies.

Industry competition: When a ‘paid for’ service is used, it replaces the need for external (often free) advice – probably because that’s what ‘outsourcing’ means. Overall it is seen as ‘better’ than other paid for alternatives. In particular, 40% saw it as directly replacing solicitors, 34% banks, 15% ACAS and 9% HSE[10]. Research stating that regulatory consultancies are seen by 40% of the market as better than or negating the need for resorting to other legal sources such as Solicitors is important. Substitutability rankings such as these on multiple options rarely get over 20-25%, so the solicitors sector is actually taking a pounding here. Regulatory consultancies are equally favoured over bank services and once lost to a regulatory consultancy the bank will lose the two most productive hooks into SME risk reduction and legal services on-selling. To be clear, banks usually do not offer employment advice, but they will be the only source of covering a perceived £3-7k unforeseen risk - so a service transmuting this to £175 per month from now is very welcome. It is notable that whereas RBS Mentor has built a top 3 market position with a full service, few of the other increasingly innovative advisory and referral services have proved sustainable. Banks may be happy to see others manage their client risk and simultaneously lose the benefits of a £2-3k pa service, but it is puzzling why only one has decided to break the eggs in this market.

Assurance, not insurance. Attitudes to insurance within the industry vary increasingly. Some view the insurance of the advice as a guarantee of quality, some see it as an incentive to actually act against the client's best interests. Significant players offer guarantees and other variants on a self insuring theme, while more and more players are extending from profit shares into captive insurance partnerships. The BIS research suggests that 29% do not see insurance as justifying a premium (which is not why it’s there in the first place, anyway) and 24% didn’t see the need for advice to be insured at all. To what extent these are the same constituencies is not clear, but arguably between a quarter and a half do not see insurance as a major positive or negative.

So what?

Simply put – there was no market failure. More to the point, the winners in this market have shown a degree of innovation, client empathy, commercial risk management and perseverance that simply could not have been predicted. It certainly could not have been designed by government as it stumped the brightest and the best from the legal and insurance industries as well. Lawyers should have won here – they haven’t. Accountants, banks and insurers should have claimed this territory as core to their risk profiling – they’re well behind the pace. Publishers and other SME brands should have diversified – they are generally doing too little and far too late.

Safety and employment law compliance is now an established market with its own internal complexities and mores. The high water mark of the last Administration’s pride revealed one of the legal services industries best run markets – probably just where they least expected it. It should be noted, however, that it was not because the FPB and Peninsula co-operated with the pilots that the project foundered. It was a credible threat of a class action from the RSI and one aggrieved firm in particular that made the Administration choose the road it should always have been on anyway. Technical breaches of EU subsidy and competition rules leading to high profile High Court litigation would ultimately have had to be resolved at Cabinet Office and wasted considerably more than the £1m already sunk here. Normal hostilities have been resumed.

The lesson for incumbents and newcomers alike are clear:

1. Offering free stuff – however erudite - simply will not work here; plenty sell it, clients discount it. There’s a glut of free advice, much of it duplicated and increasingly devalued – few dare say it, but the quality of free and quango advice is not high and usually needs double checking.
2. Of Time, Cost and Quality – Timing is key: when SMEs need help – they really Need it. Until then, you are more likely to annoy than help if you persist in teaching people what they don’t want to know.
3. Being a brilliant lawyer specialising in employment law or safety guarantees nothing and may actually be a hindrance. Professional brands have negatives as well as positives – this market thrives on ‘not’ being lawyers, regulators or insurers.
4. For banks the issue is not giving free advice on some web gizmo like the Halifax's latest pitch, or free shrink wrap software that's never used from Barclays, it is missing out on thousands of small loan opportunities for SMEs while simultaneously actively reducing the client's risk profile.
5. It’s not about cost – it’s about agreeing a fixed price to cover a lumpy risk. Insurance helps here, but it’s not essential or much of a selling point even.
6. Quality is defined by the customers’ expectations, not some legal qualifications checklist – regulatory consultancies are consistently meeting or exceeding the expectations that matter.

Competition is not about getting 'mad' or getting 'even' - it's about getting better. This latest attempt by some vested interests to hobble these legal services upstarts failed - there may well be more. For those who want to play it straight, this is a high growth, recession resistant B2B legal services market well worth the effort.

The advice and insurance components of the regulatory consultancy service are only the tip of a complex iceberg, however. You need to be able to offer on-site installations, bespoke documentation, compliance event diary management, employee administration and safety software, dispute resolution, case management and advice from experienced professionals from industry (not just law graduate 'speaking books'). You need to be able to get people in front of troubled SMEs nationwide to explain the solution at the rate of dozens a week if possible. Insurance may help you get a fixed fee for the package, but either way take the outsourcing long contract approach of 3 years as a minimum. Match that and then find how to better it in a way busy small businesses will thanks you for and it is game on.

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[1] Employment Relations Research Series No 120: Insured Advice Pilots: Evaluation: July 2011 http://www.bis.gov.uk/assets/biscore/employment-matters/docs/I/11-1080-insured-advice-pilots-evaluation

[2] The Andersen Review: http://www.berr.gov.uk/files/file49881.pdf

[3] Table 3.12 and page 37. It should be noted that the take up was with either the Forum of Private business (a white labelled service) or Peninsula – two firms which do not truly represent the range of service levels in this industry, but significant players.

[4] Freedom of Information release 21/06/10: Insured Advice Pilots

[5] Table3.11 No Wrong Door Pilot registrees by reason for not taking out a policy.

[6] Page 22: ‘Quality’

[7] Page 22

[8] Page 25

[9] Page 30 Use of External Advice

[10] Page 31 2.3; Page 32 Summary

Legal Services - Going off the Reservation?

At the core of the debate is the concept of “reserved activities”, or activities which only a properly trained, qualified, and regulated person can be permitted to do. Only lawyers can be trusted to “do” certain things. In any other industry or process this would be seen quite simply as a restrictive trade practice, but where it is essential to the administration of justice, it is seen as a tolerable lesser of two evils.

Few would contest that a judicial system needs a process whereby the quality of advocates, the process of case management and the veracity of the testimony and documentation is kept as high as possible. The concept of being an “officer of the court” in the UK is an important one in terms of the independence of the legal system. Historically barristers were the advocate specialists and solicitors the conduct of litigation specialists, regulated by the Bar Council and Law Society respectively.

Reserved activities were extended, however, to include the conveyancing of property and the administration of probate, and on these two pillars rest much of the history and growth of the legal professions.

Conveyancing and Probate are two areas where individuals are most likely to face contentious disputes. There is, however, no commensurate need for a regulated person to be involved in buying a billion dollar warplane or buying a multi-billion pound company. Section 14 of the Stamp Act 1804 was a rather ungentlemanly compromise giving solicitors a conveyancing monopoly which is now routinely conflated with attacks on access to justice.

While defending the maintenance of historically anachronistic anomalies, the legal profession is currently uniquely slow to consider even modest extensions of legal professional privilege. The Prudential case in the Court of Appeal was an opportunity to extend officer of the court status to some types of accountant in some circumstances, but no, parliament must decide. The elision of “justice” with protectionist measures is mendacious and all too common and frankly unhelpful.

Clementi did not propose a change to the reserved activities. He could have extended them or curtailed them – he did neither. Arguably the Clementi terms of reference put the burden of proof firmly on the restrictive provision to prove its value. By the time the Legal Services Act arrived, however, it included provisions which enabled the industry regulator (LSC) to oversee insurance claims management and immigration.

The core issue is clearly closer to the one that drove Pitt in Napoleonic times – trade and taxes. Immigration is currently (erroneously) seen as one of the most volatile claims on the Legal Aid budget, and claims management is a pivotal process whereby vast calls on the public purse are in effect outsourced to the insurance industry.

The legal regulators may well see the maintenance of some reservations as an essential platform from which to ensure a viable profession. That, frankly is not their call. Any issues necessary to ensure the proper conduct of litigation - are, but they are currently insisting that only parliament can deal with these. By this logic, any extensions of protectionist reservations would require the same rigor. It is hard, however, to see how and why a £25bn industry needs protection. Perhaps it is time to remember that it was the OFT reviews in 2001 that started the whole ball rolling.

If the new regulatory regime empowers law firms to compete head to head with legal services firms from other regulatory regimes - all well and good. If they simply ramp up protectionist measures - this is predictable, but it is also highly likely to be self delusional and self defeating in the medium and long term.

(See RBP's White Paper for a fuller exploration of these issues with references at www.rbponline.co.uk)

The R Word - Recession? Don't Panic

If you are a supplier in compliance services - Recession is nothing to fear.

But don’t underestimate the upheaval in handling it. Back in the early 90s – now that was a proper Recession with a capital “R”– yours truly was able to increase sales significantly, double profitability and comprehensively stomp on the competition year after year with compliance services used by over 150k clients – it can be done. But it’s not easy.

Technically recession is 6 consecutive quarters of “negative growth”. But let’s face it – who’s going to argue that because we had one quarter of flat performance in the 6 we’ll wait and see how it pans out. It’s academic - only ivory tower economists can wait for two years and be able to tell us officially in 2010 that we’re in recession now. The rest of us have to deal with now – and it feels damned cold out there for most clients.

Recessions are different now, though. UK wide ones are rare, and even the current one may not trip all the buttons required by the old economist measures. Recessions are typically now industry specific and international in context. The UK can survive a series of “niche” recessions, such as the ones we’ve had in agriculture, manufacturing, mechanical engineering, etc as long as financial services, retail etc remain robust. The difference currently is that we’ve not been led into recession by the banks for centuries. This could be different, not just as it’s a disproportionately big part of the economy now, but also because the property and retail sectors are also sitting on their hands and that in itself can be enough to slide further. Those niche suppliers who've faced industry specific recessions know this - the point is that now the two biggest markets for compliance services - financial services and retail - are teetering on the brink.

So why is compliance different? Why when shops or banks lose growth and profitability will the guys who check their fire extinguishers be all right?

It’s important to know how Big Business panics to understand just how safe you can be. Big Business panics tend to run like this:

“Need to cut costs” leads to “Round 1”. This hits the soft targets, namely PR, recruitment, entertainment, libraries, training, and hammers down on expenses management (typically just when you actually need to reduce the hassle of doing business, rather than increasing it – but that’s FD logic, not normality).

Round 2 follows with “it’s gonna have to be heads rolling” (but not mine) – therefore start the musical chairs. Cut the HR guys? Nope – need them to do the cutting. Cut the finance guys? Nope – you need more actually as declining numbers are harder to watch than rising ones (and everyone is continually digging up the dying plants to see the roots and measure them, again – busy, busy, busy).

It’s never enough – the Bears are in charge now playing “who’s the daddy” - so sooner or later Round 3 comes. This is even more staff cuts – but this time, even the guys we like, as well as some of the Quasimodos in the back office.

The end result is usually too little too late. What’s left? Usually the stuff that’s actually really hard to deal with is still there – oversized or overpriced premises, under-depreciated cars and “stuff”, and of course, service level agreements with clients which were tight even when you had the staff to do them.

Buried deep within the pile of detritus and humiliation is typically also the compliance “long stop”. Finance people hate to cancel these (they are risk averse by nature) even though they will have been complicit in removing those who commissioned or ran them. The firms are actually more reliant on compliance issues than ever before and will have removed many of the specialists who know how to negotiate them properly.

Employee relations issues move from recruitment hassles to redundancy calculations. Safety issues shift from training to stress management and occupational health, surveying now has to include project management, etc. The likelihood of a compliance event in periods of turmoil is much higher than normal so while the shape of the service changes significantly, the client is more reliant on you than ever.

Don’t be afraid of it, don’t “gouge” (ie over exploit it), but do flex your service quickly and sensitively.

Weak staff will feed back that “XYZplc is cutting back and making redundancies, therefore we have to discount the service to secure the renewal at all”.

Good staff will say “we need to stop X, add more Y and up the contact rate with their new guy significantly to pitch for the 25% price rise now we’re doing much more for them and the client’s in-house team has halved – and PS - I can remove the discount Norman haggled out of us last year as he’s gone now”.

It takes balls, but that’s why recession is an opportunity. Like technology and innovation in a period of war – everything is accelerated and stress tested much quicker. It puts you on your mettle – just how good at flexing solutions specification and pricing are your team? Clients will pay more, but the service must be much more relevant.

If you can stand the pace – great, many won’t.

Now is the time to take market share.