To be specialised or generalised is an ongoing source of management tension. On the one hand, most architects hate being pigeon-holed, they like the new challenges diversity can provide, and they like to stretch their influence and legacy across the borders of geography, typology and design disciplines. It’s also financially prudent to diversify, as any investor knows, putting all your eggs in a single basket is a risky proposition.
On the contrary, the economic theory of specialisation suggests that one would be equally foolish to attempt to ride two horses with only the single behind. Across all professional services, clients are demanding increasingly specialized services. They’re after what Ideo call ‘T’ shaped people and practices, those with deep specialist expertise in the required field, and a broader working knowledge of other connected areas in order to provide a fresh perspective, and a willingness to collaborate.
To test if specialisation or diversification generated better financial returns, I took a sample of 111 architecture firms from Design Intelligence. I started by looking at the core components of a firms strategy, namely – number of offices, geographic regions, disciplines, and market sectors. To be honest, the initial results were about as exciting as the status of Rihanna’s next studio album.
In general, firms with fewer offices demonstrated higher revenue per person, as highlighted in Chart 1 below. This finding is also supported by Ed Wesemann’s analysis of AmLaw 200’s dataset, which shows that firms with more than one office are generally less profitable than firms of the same size with a single office. Beyond this however, it didn’t seem to matter how many geographic regions you operated in, how multi-disciplinary you were or how many market sectors you did work in, revenue per person stayed pretty much the same.
If you’ve ever encountered more than 10 pages of a management text book, there’s a good chance you’ve heard of Wickham Skinner’s principle of the “focused factory.” No operation, Professor Skinner argues, can be good at everything simultaneously. Reminding myself of the focused factory, I started to think that perhaps it wasn’t one strategic variable in itself that mattered, but rather how a firm chooses to combine their regions, services and sectors. To put it to the test, I multiplied each firm’s number of regions by their disciplines and sectors to create what I called a ‘Diversification Score’ then measured this against revenue per person. The results are below:
What I believe this correlation shows is that you can’t out run the law of averages. The more services, regions and sectors you add, the more likely you are to generate perfectly average financial returns. The data show there’s nothing inherently wrong with a firm wanting to diversify in one direction. Populous for example, work across 10 regions and they return revenue of $304,587 per person, but they only work in two sectors. It’s the approach of diversifying in every direction – the strategic equivalent of urban sprawl – that appears to be a fast track to average town.
Interestingly, unlike with the correlation between firm size and revenue per person, the correlation between diversification and revenue per person isn’t linear. Which is to say that actually, it’s not that diversification is negative, but rather specialisation is positive, to the tune of an extra $44,764 per person in revenue.
This finding is supported by a 2010 study of 102 professional service firms during the years of The Great Recession. The sample identified 27 firms they dubbed ‘high-performance’ owing to their impressive profitable growth. The High Growth group were more likely (46.1%) to rate themselves as being highly specialised as opposed to the average growth group (28.5%)
Allow me to suggest a poker analogy. A ‘call-station’ in poker is someone who can’t help but call a bet, they’re major FOMO suffers and they let it influence their play. Because a call station lacks the discipline to say no to an opportunity, they leave their fate up to chance and over the long-run are almost always exploited by more disciplined players. Diversified architecture firms are a lot like call stations, both prefer to put their fate in the luck of the draw/market, rather than risk competing at the highest level. As a result, diversified architecture firms tend to get big when the market grows and retract when the market shrinks.
It takes a lot of courage to specialise. It requires practice managers to say that the firm will live and die by its ability to solve a specific problem better than anyone else, rather than its ability to be in the right place at the right time.
Specialisation requires practice managers to treat the phrase “Just this once” like the bubonic plague that it is. Saying no to profitable or enjoyable work today, in order to gain tomorrow is hard, for sure, but being able to do things others find hard is precisely what creates competitive advantage.
To understand the power of discipline, consider the example set by New York law firm Wachtell, Lipton, Rosen & Katz (WLRK). WLRK have only one office, employ 260 attorneys and specialise in the field of mergers & acquisitions. They record a simply mind-altering revenue per lawyer of $3,185,000. Not surprisingly, the practice is the most profitable large law firm in the US on a per-partner basis according to the American Lawyer’s annual AmLaw 100 Survey and was ranked as the Most Prestigious Law Firm to work for by the AveryIndex.
Obviously the world of architecture is a long way from the highly lucrative market of New York M&A’s, but what I believe architects can learn from the example of WLRK is that the way to generate greater financial returns is to replace the pursuit of growth through diversification with the pursuit of growth through being better.