Taking the PSO’s pulse
by Jeanne Urich and Dave Hofferberth, SPI Research
Sell, bid, win, deliver and collect. It sounds easy, doesn’t it? Unfortunately, things can go awry quickly with professional service sales, execution and delivery. Before work can begin, there must be a sale. While no one takes this for granted, professional services organizations (PSOs) must optimize sales processes and pipelines so they can sell profitable work that leads to successful projects and happy, referenceable, bill-paying clients.
Many PS executives look at the win-to-bid ratio and use it as a barometer of sales success. Indeed, this figure is important, but it only tells part of the story. PSOs can have high win-to-bid ratios that do little good when inflated at the expense of margins.
One area executives must concentrate on is beginning of the quarter backlog. This project backlog is an excellent predictor of future success, as it enables the PSO to put a strategy in place to optimize both delivery and future sales.
How backlog affects billing and margins
SPI Research defines project backlog as the total value of unexecuted contracted orders or projects. Quarterly project backlog includes executed or closed contracts that have not yet been billed. Quarter beginning backlog comprises clean sales orders that the PSO has booked (closed) and can deliver and bill within the current quarter.
Sales planning 101: The number of bids with an estimated price, close date, delivery date and billing date provides the underpinning of revenue and margin forecasts. If everything goes according to plan, the PSO meets its revenue and margin targets. Unfortunately, especially in today’s economy, not everything goes according to plan.
An excellent way to meet both revenue and margin targets is to have a well-constructed backlog of work in the queue. Thus, if actual delivered revenue and margin are in poor health, adding more staff, working additional billable hours and delivering work early may be the cure.
SPI Research realizes every PS executive knows building up service backlog improves their potential of delivering higher profit. However, many PS executives might not realize how inter-related backlog is to other key performance indicators (KPIs).
Backlog research results
SPI Research has examined the 26 largest PSOs with over 300 employees in the most recent benchmark survey and verified the importance of increasing project backlog. The table below highlights the direct correlation between backlog and the following areas:
- Revenue per billable employee.
- Margin target achievement.
- Billable utilization.
Table 1: The Impact of Project Backlog
This table shows that as backlog increases so do these three critical KPIs. Higher backlog allows employees to complete more work, as more work is available to them. This increase in work shows up in higher utilization levels, which means that employees bill more hours. It also generally leads to higher bill rates, given the PSO has the luxury of only bidding on desirable, lucrative engagements. And more hours at a higher bill rate yields both higher revenue and profit.
SPI Research has tracked backlog in billable PSOs for the past three years. In 2009, the average quarterly revenue backlog reported was 42.8 percent (49.1 percent in 2007 and 42.7 percent in 2008). Although average backlog remained the same in 2008 and 2009, many firms reported suspended or cancelled projects and longer sales cycles and deferred purchase decisions. This translates into less billable work.
Backlog is one of the most powerful predictors of future performance. In better times, best-in-class backlog ranged from 70 to 100 percent of the current quarter revenue forecast. Backlog is the fuel for growth. An anemic backlog forces firms to close and try to convert bookings to revenue all within the same quarter.
Fuel in the tank
A larger backlog represents “fuel in the tank” and improves an organization’s ability to grow while increasing the accuracy of financial forecasts. Firms with light backlogs rely heavily on discounting and scramble to “make” their quarterly revenue commitments. SPI Research believes this causes a firm to spiral into a compromised economic position.
PSOs that report less than 40 percent of their quarterly revenue target in backlog showed lower revenue per person, lower project margins and poorer attainment of financial targets. Unpredictable revenue and “feast or famine” work cycles combined with unnatural “Hail Mary” sales deals are symptoms of a light backlog.
Build up your pipeline
For smaller firms, keeping a balance between marketing, sales and delivery is problematic. Smaller firms also contend with more hybrid roles that drive down billable utilization and cause sub-optimization of both selling and delivery roles.
As early as possible, small firms benefit from investments in dedicated sales and marketing. This allows sales to sell, marketing to market and delivery personnel to focus on delivering excellent work. The most effective way to grow backlog is to improve sales and marketing effectiveness. If this fails, it forces the PSO to cut staff or accept lower profit based on lower revenue projections.
Managing your backlog is like managing your pulse. It typically doesn’t receive enough attention until things deteriorate. If backlog gets too low (similar to a low pulse), PSOs begin to discount heavily. This may improve the backlog, but it reduces long-term growth and profitability. If backlog is too high, PSOs face the problem of insufficient or overworked staff, which can quickly deteriorate client and employee satisfaction rates, and again, long-term growth and profitability.
Your organization can use many key performance indicators to track overall performance. Quarterly backlog is one of the more important ones, and sales and PS executives should regularly analyze and discuss it. Slight fluctuations in backlog are no cause for concern. Yet keeping an eye on backlog can prevent significant fluctuations from becoming the norm, leading to a reactive organization with frequent “boom and bust” cycles. Looking ahead can help ensure long-term health and predictable growth for your PS organization.