Published 14 Nov 2019
This post is going to be different from what you’re used to.
Normally I share my insights about branding, behavioral psychology, and design. But today I’m going to go meta: I would like to discuss consulting as a discipline.
Last week I spoke to someone who doesn’t think you should hire consultants because they lack skin in the game. (This is not a new take: Nassim Taleb expresses a similar sentiment.) Now, unsurprisingly I take issue with this idea. Of course I would, right? I make a living consulting clients on brand strategy and design!
In this post, I will offer my thoughts on the topic.
Is it true that consultants don’t have skin in the game?
Now, on the surface I think the “skin in the game” critique of consulting is a reasonable one. When I read Nassim Taleb’s book (aptly titled “Skin In The Game”), his point about consulting made me pause and think for a while. I don’t want to make my money in a dishonourable way, and it seems to me that if the “skin in the game” critique is correct, consulting would not be an honourable means to make a living. Was I in the wrong business?
But after giving it some careful thought, I don’t think the critique is correct.
First of all, we must ask ourselves whether it’s actually true that consultants don’t have skin in the game. I will specifically focus my analysis on my kind of consultancy, which is to say very small and specialized as opposed to, say, Big Four management consultancies.
No: Client acquisition
Let’s look at how client acquisition works. For most small consultancies, the majority (90%+) of our new business comes through referrals.
This means, that if we fail to produce results for our clients, we receive fewer referrals, which causes business to suffer.
No: Opportunity costs
Now, you might object: “But you still get paid by existing clients even if you don’t produce results.” That’s true, but your analysis ignores the opportunity costs of working with a client.
When we take on a client engagement, that means there’s someone else that we can’t work with during the engagement. Resources are limited in general, and especially so in one-man consultancies.
This means that, beyond just keeping the lights on for X amount of weeks or months, the consulting fee itself does not allow us to grow; the referrals and case study that you can build on the back of the engagement do.
No: Soft forms of skin in the game
The typical conception of skin in the game is that it needs to be economic, but life is more complicated than that. There are lots of factors that can play just as important of a role in motivating human behaviour, aside from money.
Here are just a few “soft” versions of skin in the game, off the top of my head:
- Reputational costs
- Costs to personal relationships
- Costs to honour and integrity
The reality of risk
Now, you might contend: “Yes, consultants risk burning bridges and relationships if they don’t produce results, but they can afford to screw up one engagement—whereas for their client, the same mistake could potentially bankrupt them.”
So the problem then is that consultants do have skin in the game, they just don’t have enough of it. The asymmetry between the potential downside for the consultant and the potential downside for the client is too great.
Increasing the amount of skin in the game?
Before getting ready to write this post, I was curious to see what other people had written about the subject. One blog post that I came across suggested that consultants should accept performance pay in order to increase the amount of skin in the game.
That sounds interesting in theory, but I don’t think it’s a viable solution. Here’s why:
First of all, there’s inevitably a trade-off between the amount of risk incurred by the consultant and the amount of risk incurred by the client. This trade-off is accounted for by the level of compensation.1
Basically, ceteris paribus, the more a client pays the more risk the consultant will take on.
If you want to make sure that you don’t have to pay anything if the project goes wrong, you’ll have to compensate by paying a lot if the project goes right (perhaps 100% of the expected value of the engagement: if the consultant’s work generates $1 million extra in revenue for you over the course of a year, you pay him $1 million instead of, say, $30,000).
So if the whole compensation consists of performance pay, it will approach—or exceed—100% of the expected value of the engagement. Considering that entrepreneurship is literally = taking risks in order to get more value than you gave, I don’t think this is a particularly attractive proposition to most.
But there are less radical ways to implement performance pay. For example, you might do half as a “traditional” payment and the other half as performance pay. But given that most consultants don’t operate on 50% profit margins (alas!), this kind of structure would necessitate an increase in the base compensation as well.
And then, on top of these complications, you also introduce a conflict of interest. By conditioning payment on reaching certain metrics, the consultant is incentivized to chase those metrics even if doing so would negatively impact other aspects of the business. This is the same kind of mechanism that we observe in large corporations and even democratic states, where CEOs and politicians chase short-term gains at the expense of the long-term health of the company or country (because bad things that happens four years later, when someone else is in charge, is not their problem).
Skin in the game doesn’t matter
My final objection to the criticism that consultants lack skin in the game is this: It really doesn’t matter. At least not in the way you might think it does.
The real argument of Nassim Taleb is that skin in the game promotes the selection of better decision-makers on a macro level.2
Skin in the game immediately weeds out outright malevolent actors, and over time incompetent actors. It basically operates as a soft eugenic selection pressure on the evolution of large organisations and markets.
But it doesn’t give individuals better decision-making skills. Someone with skin in the game is just as likely to mess up as someone without skin in the game.
In fact, research bears this out: People who have money to lose do not make better decisions or predictions than people who do not.3
Uneasy lies the head that wears the crown
Funnily enough, people who object to consulting are usually quite happy to hire employees.
But if they do something that hurts the business, employees suffer similar consequences as consultants and freelancers: they get fired (and then they find a new job). As far as I can tell, there are two differences between employees and consultants/freelancers: they usually stick around longer, and they tend to be more conservative (so they’ll be less likely to recommend changes that might rock the boat).
The harsh reality for business owners is this: no one cares as much as you do.
In return, you reap most of the rewards. Elon Musk is hailed as a hero, even though his engineers undoubtedly are the ones responsible for much of the technological innovation produced by Tesla and SpaceX. But Elon alone assumes ultimate responsibility for the things that go on in his companies: both the successes, but more importantly, the failures too.
Heck, even in a formally equal partnership between two co-owners, one will usually shoulder more responsibility, work harder, and invest more sweat equity in the business than the other. This is a function of different personality types & external circumstances (one of you might simply “need” success more than the other).
So what are you to do?
I think there are three options:
Don’t listen to anyone but yourself. Problem: your knowledge is limited and probably flawed, both on account of the information you have and the perspective you have. Sometimes you need other perspectives in order to progress (which is the whole premise of consulting in the first place!).
Listen to everyone: Consultants, books, online gurus, family members, strangers on the street, etc. Problem: the overwhelming ideas out there are either bad or not applicable to your situation.
Finally, you can choose to take advice from trusted advisors who are knowledgeable about the thing they advise on—without rescinding your responsibility to evaluate the advice and negotiate it if needed (you know, thesis, antithesis, synthesis—that sort of thing).
I think you can guess which one I favour.
Not every insight needs to be taken to its logical conclusion. That includes Taleb’s concept of skin in the game.
In fact, while preparing myself to write this post I found out that Taleb himself worked as an advisor to the UK government4 — obviously without assuming any of the potential downside of his advice (beyond reputational damage). And, as he readily admits, Taleb also made a successful career for himself in hedge-fund management, investing other people’s money (he did have his own money in the funds he managed, but the stakes were small enough that he could afford to gamble away all the fund money without personally going broke).
In my opinion, the benefits of hiring consultants, advisors, and freelancers are usually much greater than refusing to do so. And yes: Of course I’m biased in this matter, but if I didn’t believe this to be true, I’d be in a different business. Who wants to make their money dishonestly?
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