I recently got an email from 4 former colleagues, all on the same day, that a firm I used to work for a long time ago had missed payroll. It was a very saddening thing, for sure – one of those things that make you ache for people that are stuck in companies that are falling apart. Because of the nature when bad consulting firms die (bad economies) rather than limp sickly along (good economies) – the death of a firm almost always happens at the worst time for the true believers who stuck through to the end.

How does this happen though? What is it that makes a firm die.

At one level, technology consulting is not that complex of a business. You have people, you bill them out on projects, and the difference between what they bill and what they cost is your profit. How can you possibly screw that up?

A healthy firm retains earnings during the good times, so it can carry at least some of it’s people through the lean times – at least to a point. There are firms that don’t do this, firing savagely exactly to demand (aka “zero bench”), but most of them quickly devolve into body shops since people generally figure out when they are being sold a consulting company when they really are working in a contracting company. If we are talking about consulting, then we have to assume one of the functions of the consulting firm is to smooth out demand so that consultants can be buffeted against the raw ups and downs of the markets. A firm that fails to put up these buffers does not die in the sense I am talking about, but rather, it simply morphs into a staffing company.

When a consulting firm dies, on the other hand, it is usually when whomever runs it decides to suspend reality and operate as though things are fine for far too long. Consulting firms who experience sales lulls will have to lay off consulting staff at some point. If demand goes down 20% over the course of a year, and it stays there, there will need to be adjustments to staff to meet the new lower level of demand. Cutting too slowly typically will cause utilization of the entire consultant base to slip below the minimum level to create any profit at all. Such a firm starts to take on debt to keep people, since there is no other source of money to make payroll.

What happens then? Well, taking on debt means that, all things being equal, getting to “even” will be harder. Since getting even is more difficult, riskier and risker projects have to be undertaken, or the cuts that do occur have to be of the much more savage variety. The action that gets taken, at this point – tends to be much more difficult, harmful to morale, and ultimately, hurts the chance of recovery in the first place.

By this time, if fear has not set in yet, it probably is now. Everything is high stakes. Every deal *has* to get done. Even if it means compromising the estimate, lying to the customer, or otherwise taking more risks. Round and round we go in the death spiral, until there is nothing left other than those few consultants who managed to survive despite the company – being sticky at their client – rather than because of the company.

Sadly, by this time, the number of billing consultants bringing in revenue is small, but the management overhead has not shrunk nearly enough, and even if you operate a zero bench, and paid off the debt, AND cut salaries significantly, it still can’t make money. Making payroll becomes an act of further and further desperation, until such time as things like receivables loans are being taken out. It is not long before bankruptcy ensues, and the only asset left are the aforementioned consultants who are on long term staff augmentation assignments. If that. Sometimes, nothing is left whatsoever.

How can a firm avoid this? It helps to make sure – no – make certain – that overhead is being managed aggressively. And by overhead, we mean managers who don’t bill, directors who don’t bill, IT departments that make internal tools, and so forth. You may need some of these things, but especially during a recession, you need to look at each of these positions, especially the high level ones that tend to try to build empires of other non-billables. Personally, the humane thing to do, in my opinion, is to try to use the network you generate in the firm to find external jobs for those folks, rather than just fire em. That way, instead of having a pissed off former executive, you have a guy grateful that you made a smart business decision and found them something else to do – and possibly a new *buyer*. While I am not a big fan of consulting firms acting as job placement firms, doing so for high level non-billable staff is a big exception, as far as I am concerned.

The next thing to avoid this is to be brutal about honestly. If the pipeline really looks terrible, you have to be honest with people, and you have to be honest with yourself. It might mean you have to let people go. Doing so carefully, and based on merit – i.e. actual skill relative to salary – to the degree you can backfill projects – is critical. If you are not transparent about why certain people stay or go, it will be assumed it is based on spurious political factors. If you are going to do it on trailing 12 month utilization, at least be honest about it, so people understand the reasons.

The third thing to avoid is to make sure you continue to invest in the people you intend to keep. This is not the time to stop investing in training, networking events, or god forbid, allowing your sales people to invest in developing the business. Bad times are when you need to distinguish your capabilities and be very smart about your investments, not simply stop.

Lastly, it is critical to think with your head, not with your heart, when confronted with bad times. I see more firms get in trouble because the decision makers make those decisions out of fear, rather than evidence and data. Fear spreads, causing people to react too harshly, cut too savagely, estimate too aggressively, over-promise, and under-deliver. Check your fear at the door – don’t make business decisions from the same place you run from tigers.

Recessions are awful times. However, they do have a useful function, in that they rightfully kill off firms that ride the tide up during good times – but have no foundation to survive bad times. The upside is that better firms can take up the old project portfolios, usually doing a lot of fixing of problems that the old firm caused. Thankfully, when better times return, those survivor firms are the first in a position to pick up the consultant/victims of the previous firm.