By Dave Hofferberth and Jeanne Urich, Managing Directors, Service Performance Insight, LLC
This is the third article in a three-part series examining the metrics that matter for running a professional services organization and the elements of the professional services income statement. Part one looks at key metrics, typical targets and the incremental impact of small improvements. Part two provides descriptions and industry averages for the critical components of the professional services income statement — both revenue and expense. In this article, we focus on the top 20 percent of professional services organizations to reveal the best practices that set them apart.
Based on eight years of benchmarking more than 2,000 professional services organizations, by far, the most important questions and variances come from our income statement analysis. Both revenue and costs show enormous variability — not just by type of organization as in embedded versus independent — but also by PS vertical such as IT consulting, management consulting and embedded software versus hardware as well as by organization size.
There are no definitive right or wrong answers as services-based businesses are comprised of many different business models. The secret success formula is based on maximizing the productivity and profit of each business line while limiting unwarranted overhead. Our research shows that the most successful services businesses also tend to be the fastest growing. Growth comes from being well-positioned in expanding markets. The best firms understand where the market is going and create unique services to provide an early-mover advantage for their clients and themselves.
Flat or negative growth in a services business is deadly because of the high cost of finding and retaining talented consultants. Without enough new and interesting work and clients, high-priced consultants will start looking for new opportunities where they will be able to grow their skills and income.
What the leaders do
Each year, we conduct an in-depth analysis of the top 20 percent of PS Maturity benchmark participants to uncover the reasons for their superlative performance. Table 1 compares the top 20 percent consisting of 44 organizations to the other 80 percent comprised of 176 organizations to highlight how leaders generate revenue and where they curtail costs.
Table 1: PS Income Statement Comparisons Between the Top 20 Percent and Average Organizations (in percentages)
The leading organizations produced almost twice the net profit of average firms! They derived more revenue from their own direct labor and relied less on revenue from subcontractors and pass-through revenue from reselling software, hardware and other materials. Time and again, our analysis finds the leading firms are extremely well-positioned in fast-growing market segments. They tend to be the premium supplier in their space — able to command the highest rates and garner the best clients and projects.
While the leaders perform well in a number of areas, several are worth noting:
- Direct labor: Leading organizations generate higher direct labor margins compared to average firms. They tend to have the best people and clients and, therefore, can charge the highest rates.
- Subcontractors: While having an external pool of resources is generally a good idea, the best firms primarily sell and deliver with their own internal resources, reducing or eliminating the inefficiencies and potential quality issues of a third-party resource pool. Leading organizations place a premium on exceptional project delivery, so they use their own employees and arm them with unique tools, templates and methods, using subcontractors sparingly. This strategy helps the leaders maintain the highest levels of delivery quality while continually enhancing their brand and competencies.
- Sales and marketing: Leaders tend to spend less than average firms on sales and marketing. Interviews reveal that they are well-positioned in growing markets, with the majority of new clients and opportunities coming from referrals. Leaders also tend to be more specialized than average firms, which means their services are more unique. As such, they’re less likely to encounter stiff competition. Target buyers come to them, reducing their cost of sales and marketing. Leaders are more efficient at sales and marketing because their target clients are better defined, and they are able to reuse knowledge and know-how gained from previous engagements.
- In today’s competitive environment, establishing a high-quality brand and reputation is imperative.
- Go deep. Starting out, it is better to be highly specialized in a high-growth area. Premium firms start as domain experts. With success, the firm can expand both geographically and horizontally.
- Leaders must focus “on” the business … not “in” the business. In other words, they need to pay attention to the strategy, direction and operations of the firm, not day-to-day firefighting.
- Drive year-over-year top-line revenue growth of more than 10 percent. The PS sector consistently grows at greater than 10 percent. If your organization is not beating the benchmark, you are falling behind.
- Make more margin on all aspects of the business: Measure margin by service line, by geography, by client, by team and by consultant. Analyze winning strategies and replicate them.
- Don’t put all your eggs in one basket. Make sure no one client or a handful of clients make up more than 15 percent of your business. Client and portfolio diversity limit risk.
- Drive EBITDA to at least 15 percent, the PS industry benchmark. This requires gross margins of greater than 45 percent and keeping costs to less than 30 percent of total revenue.
The one thing that makes the difference
As your organization grows in numbers of people, practices, geographies, etc., it becomes increasingly difficult to manage finances. The fastest-growing and most profitable professional services organizations integrate their core business solutions with their accounting system (enterprise resource planning). These organizations simply operate better, in large part due to enhanced visibility to all aspects of the business.
Our research shows the highest-performing organizations have invested in integrated information systems in which all aspects of the business — marketing, sales, service delivery, HR and finance — work together with one source of the truth for clients, projects and employees. Integrated business applications reduce manual data reentry and reduce errors from information duplication for clients, deals, projects and contracts.
Employees are not forced to input the same information multiple times into the customer relationship management, professional services automation and HR systems as an integrated information system captures key information once and then reuses this information to provide insight to different aspects of the business.
Most of the firms surveyed in our benchmark utilize a best-of-breed CRM from a vendor that is different from their ERP supplier. And most do not connect the CRM to ERP, thus missing out on attaining the full benefits of CRM. A CRM solution connected to ERP provides PSOs with greater clarity in terms of the services marketed and sold as well as their potential profits and cash flow. They are able to quickly assess and capitalize on their best markets, their best clients and their best service lines.
Why integration matters
Integration between CRM and PSA ensures service delivery has visibility to the deals and opportunities in the pipeline, and sales can see the status of projects and change orders. Finance can review contract terms and conditions to ensure bills are generated and payments are collected that conform to finalized contracts. All of this information drives timely, fact-based decisions while empowering employees at all levels to swiftly react to changes and issues.
As PSOs move from disconnected CRM to its integration with the core ERP solution, they achieve better performance metrics in terms of bid-to-win ratio and deal pipeline, to name a few. These benefits provide greater stability and more success in the marketing and sale of services. As the competitive environment intensifies, expanding sales to new clients, winning bids more frequently and increasing the deal pipeline lead to faster growth and greater profitability.
Most professional services organizations utilize PSA solutions. The benefits are clear in terms of increased billable utilization and overall project management success. However, not all of the firms integrate PSA with the core financial management solution; without this integration the potential benefits of PSA are reduced. Connecting the ERP and PSA solutions allows collection of project-related information such as time and expense as well as billing milestones while enhancing the view of budget to actual revenues and costs.
PSA is both a strategic and tactical solution for professional services. The information contained within PSA not only helps PSOs grow more efficiently and effectively, it also provides visibility into the types of clients and projects that are a best fit. PSA integration with ERP is critical. We have found many of the most critical financial metrics such as revenue per consultant, employee and PS profit increase substantially when these best-of-breed solutions are connected.
Follow the money
There are obviously many ways PSOs use cash. Their largest expenditures are for people as the business is labor intensive and labor driven. These firms use cash to recruit, hire, train and compensate their employees, and each of these costs is variable.
As work is delivered, there are costs associated with travel and materials along with employee costs. Marketing, selling and general and administrative costs account for a large portion of a PSO’s expenditures.
What is important here is that the only way to make money is through invoicing and bill collection. Even though the mandate is to deliver high-quality projects on time to your clients, the billing process and your success or failure with collections ultimately drive revenue and profit.
Tips to make more money from professional services
Here are a few tips to maximize profit:
To get a FREE copy of the 2016 PS Maturity Benchmark – please complete the benchmark survey before December 1st, 2015http://spiresearch.com/psmaturitymodel/2016psmm/