Get an early peek to help prepare for the year ahead
by Jeanne Urich and David Hofferberth, SPI Research
In 2007, we developed the PS Maturity Model™ as a strategic planning and management framework. With over 5,000 service and project-oriented organizations using it to chart their course to service excellence, it’s now the industry-leading professional services (PS) performance improvement tool.
The 2012 Professional Services Maturity™ benchmark will come out in early February 2012. While the release is over a month away, we can already see the market has picked up based on survey responses from over 150 professional services organizations. Although this information isn’t the final tally, it presents a strong preview of what to expect.
The PS Maturity™ benchmark looks at approximately 180 key performance metrics used by professional services organizations (PSO) to measure and improve productivity and profit. In the latest survey, the independent providers (management consultancies, IT consultancies, architects, engineers and marketing) outnumber the captive service providers (PS within hardware and networking, software and software-as-a-service) by a margin of two to one. Thus, the survey leans heavily toward independent service providers who are primarily focused on service growth and profitability as opposed to embedded PSOs who must also focus on driving product revenue.
Growth is back!
In recent white papers and webcasts, we’ve predicted strong growth in the professional services (PS) sector. Our preliminary analysis shows this to be true, with revenue growth doubling from the anemic levels of 2009 and 2010 (3.6 percent and 7.6 percent respectively), to double digit year-over-year revenue growth of 14.2 percent in 2011. Clearly, the PS market bottomed out between 2008 and 2009, recovered slightly in 2010, and now returns full-throttle in 2011.
At the same time, profitability (Earnings Before Income Tax and Depreciation) has also risen significantly, growing from less than 7 percent in last year’s benchmark, to almost 19 percent in 2011! Obviously, this growth in profitability isn’t simply a result of higher revenue. It also means that the leaner, meaner professional service organizations of 2011 are more productive and profitable than they were in 2008 before the recession started.
Increased operational efficiency helps PSOs survive
Because there are no labor contracts or unions that prohibit layoffs, PSOs could have easily reduced headcount when conditions headed south. Savvy PS executives know that eliminating talented people with hard-to-find skills in a people-based business can harm morale in the long-term. That’s why the best-of-the best organizations did everything in their power not to reduce headcount.
The survey results thus far have showed an increase in the percentage of employees who are billable. When we initiated the first PS Maturity™ benchmark in 2007, this figure hovered around 68 percent, and crossed the 70 percent plateau in 2010. Currently, with over 150 responses, it sits at slightly under 75 percent.
This increase shows that instead of laying off consultants, PS executives have worked to increase the number of billable personnel on staff. This meant that executives shifted many non-billable positions to at least partial billability. This change from non-billable to billable headcount also contributed significantly to the huge profit improvements shown in 2011.
Throughout the recession, PSOs reduced their reliance on subcontractors and third-party resources, with less than 12 percent of top-line revenue delivered by third-party resources. This strategy favors preserving work (and positions) for direct employees by eliminating subcontractors.
Over the past five years, we have seen the reliance on third-party revenue decline from 13.8 percent to 11.6 percent. This has proven to be a good approach for maintaining and invigorating a loyal workforce while ensuring valuable skills and knowledge remain “in-house.”
Now as the economy improves, PSOs must build stronger performance and career management disciplines to ensure loyal employees are also the most productive employees. At the same time, a robust market still exists for mercenary, freelance consultants as long as they have strong specialized technical skills.
With fewer overhead resources, firms have invested heavily in improved business applications. Better resource management also contributes to the increase in profitability from 2010 to 2011. Billable utilization has increased by over 1.5 percent in absolute terms equating to over a 2 percent increase in relative terms. This trend means PSOs are annually billing roughly $5,000 more per consultant, which translates directly to bottom-line profitability.
Improving sales also helps
We can attribute further profitability improvements to an increased emphasis on sales and marketing, especially in the development of new services. In 2009, most of the PSOs surveyed did not strongly focus on the development of new services, let alone finding new clients. In this year’s benchmark, one of the standout findings is that many PSOs have developed new service offerings, and are successfully selling them to their existing client base.
Considering they already have a relationship, this evolution makes sense. Repeatedly, we have found the most successful service organizations develop deep relationships with their top clients. As they become trusted client advisors, these clients rely on them to help solve new challenges, essentially underwriting new service product development. As economic conditions improve, service innovation will be one of the core drivers of growth.
While service innovation takes center stage, clients continue to shift more accountability and risk to their service providers. Again this year, the percentage of time and materials priced work has declined, while the percentage of fixed price work has increased. Over the past five years, time and materials priced work has declined from over 60 percent of revenues to 52 percent in 2011 while fixed price work has increased from 30 percent to 46 percent.
This trend will continue to accelerate indicating that firms must get a handle on their costs, estimating practices and project quality controls. Integrated business applications are becoming mandatory to help PSOs capture level of effort and costs to ensure estimating accuracy improves.
Losing money on projects is a going-out-of-business strategy so today’s firms focus on researching competitive pricing strategies and deploying best-qualified yet lowest cost resources. They tightly control estimates, pricing and discounts to ensure every project starts profitably. Then they apply strong project management governance to keep projects on track. Disciplined sales and service delivery execution have become the name of the game.
Watch out for attrition
An improving economy and faster growth have some negative side effects. Perhaps, the most critical being increased voluntary employee attrition. During the “Dot.com” era, PSOs were accustomed to seeing attrition rates in the 15 to 20 percent range. However, as the economy struggled, this figure declined to less than 7 percent.
We predict attrition for 2011 to be approximately 8 percent. Although not devastating, it could be a precursor of things to come. Leading PSOs worked to avoid layoffs during the recession, and it would be a shame for firms to see talented consultants leave once the economy moves forward.
At the same time, the days of huge annual salary increases are over. A recent Aon-Hewitt compensation study predicts annual salary increases in the professional service sector will be 3.1 percent in 2012. Over the past five years, all organizations have shifted to a heavier reliance on variable compensation. The same study forecasts professional service variable compensation will average 14.6 percent.
As firms move to lower base salaries and more reliance on “pay-for-performance” variable compensation, a key success factor will be identifying the top performers and rewarding them disproportionately. Cash compensation is only part of an effective talent management strategy. Successful talent management requires clear measures of performance while providing skill and career growth options and programs.
From our client interviews and projects, today’s greatest challenge is “finding qualified consultants.” Only the largest consulting organizations have deep enough talent growth programs to rely on college hiring as they are able to invest years into growing well-rounded consultants.
The majority of mid-size and smaller PSOs depend on stealing skilled employees from their competitors and clients. This situation must change if the professional service industry wants to sustain double-digit growth. We predict the war for talent will spur leading PSOs to focus on new hire ramping programs. This should shorten the length of time for consultants to become productive, but it will add additional training and overhead costs taking a bit out of profits for the fastest growing organizations.
PS has a long way to go
For nearly two years, signs have indicated a market turnaround. However, we believe much needs doing to grow the services marketplace faster and more profitably. For the last five years, PS executives have juggled increased client demands with a changing workforce and greater regulatory scrutiny.
They have succeeded despite the downturn in the global economy, but must relentlessly concentrate on all aspects of the business to speed growth. The market constantly changes and they must learn to anticipate and embrace change to stay on top. The juggling act will continue. Despite this, PSOs can face and take advantage of a new era of growth and profitability with the right attitude, workforce and tools.