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practices and measurements considered best in class in 2007 when SPI first created the model appear lackluster and outdated today.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.

 

Bill Rates Are Increasing!

2010 Professional Services Maturity Model Benchmark survey early results
by Jeanne Urich and Dave Hofferberth, SPI Research

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The technology professional services industry is recovering from the worst recession of a lifetime. The good news: With recovery, bill rates are returning to previous levels and aggressive discounting has begun to subside.

The early results from the 2010 Professional Services (PS) Maturity Benchmark survey show significant growth in year-over-year technology professional services revenue and achievement of 2010 PS revenue targets. The significant improvement in revenue achievement is the direct result of increasing bill rates accompanied by a lower level of discounting.

Across the board, average bill rates for most technology consulting job titles have improved moderately to significantly. Bill rates for almost all job categories have returned to pre-recession 2007-2008 levels after two years of decline.

The average business consultant bill rate showed the greatest percentage improvement (110 percent), from $171 to $188 per hour. Only the average senior manager/partner bill rate category is showing a year-over-year bill-rate decline — from $232 to $222 per hour.

Establishing a rate sheet

Competitive pressures in the technology professional services industry have created “mini-markets” for technology skills. The most prolific technologies — Oracle, SAP and Microsoft — have well-established bill rates for specific skill sets. Most technology services providers that focus on these platforms understand the unwritten “market rate” for consultants, but huge variances in price ranges occur, depending on services provider reputation, specialization, industry knowledge and skill sets.

Bill rates in emerging technology areas are far less predictable, but a best practice for all services providers is to establish a rate sheet based on skill level with uplifts for risk, complexity, geography or terms. Base your rates on analysis of market rates combined with consultant cost.

In the technology professional services industry, the “rule of thumb” is to establish rates at a minimum of two times (2X) the fully loaded average cost of all the consultants in that job category. In many other professional services specialties such as legal or accounting, the bill rate rule of thumb is four times (4X) the average base salary for all specialists in that job category.

For project managers, here’s a simple example for establishing a published bill rate:

  • $100K average annual salary for all the project managers at a particular skill level.
    • Add $20K for 20 percent average uplift for benefits; selling, general and administrative costs, and overhead plus IT and facility cost allocations.
    • Add $10K for 10 percent average annual bonus.
    • $130K average loaded cost.
    • $260K required average revenue per project manager (2X loaded cost).
    • 1,400 billable hours per year (70 percent billable utilization).
    • $186 per hour required average bill rate.
    • $205 per hour published bill rate accommodates an average 10 percent discount.

Average bill rates flat for the past five years

The interesting news is that domestic rates in the U.S. ($200 per hour on average) have remained relatively constant since 2000 because of increased global labor arbitrage and pressure from low-cost offshore providers. Another factor influencing the billable labor rate is enhanced product quality and ease of use, enabling technology professional service providers to use lower-skilled and less expensive resources.

Premium rates still exist (more than $250 per hour) for highly skilled management consultants and technology gurus — particularly in the areas of business process design, business intelligence, security, service-oriented architecture and enterprise integration.

Flat bill rates have placed pressure on professional services organizations to increase utilization and reduce overhead and benefit costs to produce margin. Increasingly, organizations are investing in labor-enhancing technology and tools — remote services delivery, knowledge management, collaboration, mobile solutions, professional services automation and quality control to wring the greatest productivity out of their work forces.

Many factors influence bill rates, but companies experiencing the highest growth also reported the highest rates. This correlation indicates that demand (and scarcity of qualified resources) significantly influences rates.

Increasing bill rates

Our research shows an increase in bill rates can have a dramatic positive impact on both profit and the employee work environment. Best-in-class professional services organizations tightly control pricing by carefully managing estimating, discounting and contract terms.

Leading services providers charge premium rates because they are recognized as specialists in their focused competency areas and have a demonstrated track record of producing excellent client results. The leading firms tend to pay more than average to ensure they hire only the best and brightest. They protect their rates by limiting discounting while providing employee incentives for achieving quality and profit targets.

Time after time, we have seen leading firms create a “circle of excellence” where their hiring practices contribute to building a quality work force that consistently delivers successful client outcomes. This leads to an excellent reputation, which supports a premium rate structure and ongoing investments in employee development.

Unfortunately, the exact opposite “circle of commoditization” is seen in “me too” services providers that compete on price. Bottom-feeders treat both their clients and their work force as commodities. Because they have a low rate structure, they cannot pay enough to attract or retain a premium work force, which means they must compete on price. Once a services provider becomes known as “the low-price leader,” its only successful strategy is to run a lean and mean organization with no frills and limited investment in employees or skill building.

Services providers should carefully review their market positioning and pricing to ensure they have not become “staffing providers” when they intended to be “solution providers” because the level of accountability for superior client outcomes directly influences pricing strategy.

The effect of bill rates on financial performance

Table 1 shows the impact on financial metrics as professional services organizations (PSOs) increase bill rates. Firms with average consulting bill rates of less than $150 per hour tend to be much smaller than organizations billing out at more than $200 per hour. The firms with higher bill rates can afford the luxury of more overhead and greater investments in employees and sales and marketing than those that bill less.

Table 1: The effect of bill rates

BillRateEffects

Source: Service Performance Insight, November 2010

The table shows organizations achieve significantly higher professional services contribution margins as bill rates increase, as well as significantly higher annual revenue per employee. Firms that sell services at higher bill rates control discounting and produce greater levels of profitability. Obviously, firms that charge more should make more. But firms can only attain higher bill rates by continually providing high-quality services that offer significant value to clients.

The cause and effect of higher bill rates

Bill rate combined with utilization is a leading indicator of the overall quality and differentiation of the organization. The fact that organizations with the highest bill rates tend to reinvest profit into their employees leads to a continuing improvement cycle.

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

The correlation between high bill rates and employee investment that result in superior project delivery metrics and overall financial profit is one of the most dramatic findings from the early results of the 2010 PS Maturity Benchmark survey.