Money Ball

How professional service bill rates drive profit
by David Hofferberth and Jeanne Urich, SPI Research

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In 2002, the Oakland A’s, the nation’s lowest-paid Major League Baseball team, cracked an 11-game losing streak, coming back to win 20 games in a row. The team set a new American League record and won the American League West Division championship.

The premise of Money Ball — both the book and movie — is about changing the rules of the game by using statistics instead of intuition to hire and ramp undervalued baseball players. The idea is to wring the maximum number of wins out of every player dollar by identifying value based more on “on base percentage” than subjective characteristics like good looks and drive.

That sounds a lot like the PS Maturity™ Model. The original and continuing foundation of Service Performance Insight’s PS Maturity™ Model is that overall performance is not based on home runs. Instead, it’s a combination of singles and doubles in the form of winning business processes, systems and people. The PS Maturity™ Model measures, analyzes and correlates 180 Key Performance metrics to create a Maturity scorecard for each participating organization. Like baseball player statistics, the Maturity scorecard helps diagnose strengths and weaknesses and what it takes to advance to the next level of maturity.

The Maturity scorecard diagnoses maturity based on five dimensions, called Service Performance Pillars:

  • Leadership.
  • Client relationships.
  • Human capital alignment.
  • Service execution.
  • Finance and operations.

Grounded on input and participation from more than 800 PS organizations in the past five years, the PS Maturity Model™ itself has continued to evolve and improve. Business practices and measurements considered best in class in 2007 when SPI first created the model appear lackluster and outdated today.

With this as a backdrop, Service Performance Insight (SPI) has published the “2011 Professional Services Global Pricing Report” with input from 200 PS organizations representing a global consulting workforce of nearly 12,000 consultants.

The major takeaway from the largest technology professional services (PS) pricing study is that success comes from the right combination of pricing policies combined with outstanding service delivery quality and workforce efficiency. The two primary profit levers professional service organizations possess are bill rates and workforce productivity, frequently called billable utilization. PS organizations tend to concentrate more on productivity, often ignoring price improvements, which can produce instantaneous and sustainable profitability.

The cause and effect of higher bill rates

Price realization based on realized bill rates in combination with billable utilization is a leading indicator of the overall quality and differentiation of the professional services organization. Professional services organizations (PSOs) with the highest bill rates and price realization tend to reinvest profit into their employees, which in turn leads to a continuing improvement cycle.

Highly skilled, well-trained, motivated and loyal consultants undoubtedly produce the best client results. Because of this, satisfied clients provide referrals and buy additional services, resulting in improved sales effectiveness.

One of the consistent themes in five years of benchmarking is the correlation between high bill rates and employee investment resulting in superior project delivery metrics and overall financial profit. Yet, bill rates only tell a part of the story. The market, the types of services provided and the reputation of the firm primarily govern rates. SPI Research has seen management consulting senior partner daily rates as high as $8,000, while Indian software development resources cost as little as $25 per hour.

The top strategic management consultancies don’t publish their rates, nor are they visible to their clients. These rates are justified based on the significant “bet your business” types of projects these firms deliver. High rates indicate the strategic business value top firms provide.

At the other end of the spectrum, the lowest bill rates are shown in the hardware and networking sector, where providers mainly focus on implementation. They haven’t yet moved to more strategic consulting services. Staff augmentation garners low rates because the client assumes almost all of the responsibility for successful business outcomes. Clients are buying a “body” with a specific skill set as opposed to a project based on a defined business outcome.

Differentiation, specialization and market growth drive rates upward while commoditization and shrinking market demand drive rates down. The law of supply and demand is evident in the pricing report by the fact that software-as-a-service (cloud) services now command a 20 to 30 percent premium over traditional enterprise software bill rates.

Bill rate sensitivity chart

As part of this pricing study, SPI created Figure 1 to demonstrate the important role bill rates play in generating profit. This figure depicts a 100-billable-person PSO and shows the effect bill rates have on profit (the left axis in $millions). SPI has normalized consultant cost to reflect a 100-person workforce with an average loaded cost per person of $135,000. ($100K base salary, $20K in fringe benefits, $10K bonus and $5K in non-billable discretionary spending).

The figure allows an organization to analyze the effect of bill rates on profit. This organization will be profitable at an average bill rate exceeding $250 per hour with average utilization of only 30 percent (600 hours per year per person). Conversely, with average rates below $175 per hour, average utilization must be 60 percent (1,200 hours per year per person) or higher to achieve a minimal amount of profit.

Figure 1. 100-Billable-Employee PSO — Bill Rate / Utilization / Profitability Sensitivity

BillSensitivity
Source: Service Performance Insight, October 2011.

Why is pricing important?

In a labor-based business like professional services, profit comes from the right balance of revenue and costs. PSOs have a very high fixed labor cost, so the two primary profitability levers are either lowering cost (sourcing strategies; limiting benefits and overhead; using virtual business models; restricting discretionary spending on IT, travel, training and recruiting) or increasing revenue (higher bill rates, higher revenue per person and higher billable utilization).

For three recessionary years, most PSOs have focused intently on the cost side of the equation and run very lean. Now with a glimmer of economic improvement, it is time to concentrate on growing revenue through a combination of rate, market expansion and productivity enhancements.

Published versus realized rates

This study compares PSOs’ published bill rates versus realized bill rates — in other words, the actual hourly bill rate firms receive. In general, realized rates are approximately 80 to 90 percent of published list rates. The difference between published and realized rates reflects both discounts and written-off consulting hours.

The report looks at four primary job categories:

  • Management.
  • Project management.
  • Business consulting.
  • Technical consulting.

And it assigns three corresponding experience levels per job family. Of the 12 job titles SPI Research analyzes in this report, technical consultants achieved the highest percentage of realized rates, with a realized rate of 90 percent of the published rate.

Interestingly, SPI Research found the greatest disparity between published and realized rates associated with the most senior-level positions in each job category. The most senior resources in any job category commanded the highest list rates but reported the highest levels of discounting.

Key questions around lower price realization are Is the high level of discounting due to an excessively high target bill rate? Is there more room for discounting because of a higher list rate? Is it hard to establish incremental value for more senior resources? SPI Research suspects the answer is a combination of these factors.

Pricing Strategies

Pricing strategies vary dramatically by market and geography. European PSOs prefer daily rates, which may or may not include travel expense. The percentage of time-and-materials-priced contracts across all markets and geographies was reported to be 58.8 percent. Each year a greater proportion of contracts across all verticals and geographies are fixed-price, reflecting client interest in shifting more risk and accountability to service providers. A comparison of pricing strategies across PS vertical markets reveals IT consultancies and PSOs within software companies depend heavily on time-and-materials-based pricing strategies.

Hardware and networking providers and SaaS PSOs have shifted the majority of their work to service packages and fixed-price contracts, while management consultancies favor time-and-materials-based contracts but may include performance guarantees.

Table 1. Pricing Structure by Organization Type in Percentages

2010FeeStructure
Source: Service Performance Insight, October 2011.

Consultant resource mix is changing

Worldwide, the traditional consulting pyramid is alive and well, with the percentage of resources in management (7 percent), project management (19 percent), business consulting (16 percent) and technical resources (58 percent) still reflecting that project managers and technical resources perform the bulk of the work and generate the majority of profit.

The shape of the pyramid varies dramatically by vertical market and geography, with management consultancies supporting a top-heavy partnership structure while traditional outsourcing destinations like India rely on a high constituency of technical resources.

Across the technology consulting industry, SPI Research has seen a significant change in employee job skill distribution. In the past, 70 to 90 percent of resources were technical consultants. Now 30 to 50 percent of consultants are focused on project management and business consulting, reflecting the underlying technology shift to easy-to-use-and-configure products. Today’s consultants spend more time analyzing and improving their clients’ business problems and processes than doing software development or writing code.

With more than 53 percent of the work delivered off-site, more consultants are working virtually. Even the smallest consultancies have started taking advantage of offshore and near-shore skilled labor to reduce cost and to fill hard-to-find competencies.

Signs point to an unstable global economy for some time to come. Bill rates aren’t uniform around the world. Across the board, global consulting bill rates are rising slightly while target utilization rates have plummeted.

In general, this is a good trend for service providers and consultants because it signifies a greater demand for their most valuable services and people, while the pressure to work excruciating hours may be subsiding. However, as the reality of increased consulting demand outstrips available supply, expect to see average billable hours increase beyond the low targets set.

Around the world, a significant price disparity exists for the same job categories within the same industry segments. If an organization can establish its brand and reputation as the highest-quality supplier in its market space, it can command the best rates.

Conversely, for service providers stuck in a commoditizing rut, the only viable strategy is to head for higher ground by expanding into a more lucrative market. For example, low-end enterprise resource planning providers will find new opportunities and premium rates if they add vertical expertise or take on new cloud technologies and services. SPI’s research indicates the unlimited possibilities for establishing new, exciting and profitable service lines will require significant leadership, vision and courage.

The use of a global workforce isn’t limited to the largest service providers, as small boutique consultancies have begun taking advantage of labor arbitrage. Firms that offer management consulting (strategy, IT, etc.) along with implementation (new applications, business process re-engineering, etc.) are in greater demand and can charge higher rates.

The bottom line is that the consulting industry thrives. Expect not only increased bill rates, but also significant labor shortages ahead. Top-performing firms will focus on both recruiting and retaining top talent while making sure they take advantage of rate increases to fund these investments.

Money Ball puts forth the notion that undervalued teams and players can compete and win by focusing on “getting on base” while leaving richer teams to “swing for the fences.” SPI’s research proves the winning formula is to focus on productivity and quality combined with high-value pricing strategies.

Measuring the right statistics to find untapped gold can be translated into improved productivity and higher rates wins in the end. Both Money Ball and the PS Maturity™ Model prove statistics don’t lie. Using them intelligently to field the best possible team at the lowest possible cost puts not only runs on the scoreboard, but also profit into shareholders’ wallets.