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Killer KPI's for Professional Services
- by Jeanne Urich, Management Consultant, Adexta.com, and Contributing Editor of Tips From the Trenches: The Collective Wisdom of
Over 100 Professional Services Leaders
Which Key Performance Indicators are the “gotta measures” to run your
Professional Services organization?
Which KPI’s drive success and contribute to the bottom line?
In this article you will learn:
- The growing role Services revenue plays in overall financial performance
- Which KPI’s are essential and what they mean
- Typical Key Performance targets
- Tips to improve your financial performance
As the technology market has matured, there has been a dramatic shift in overall revenue and margin contribution derived from
Services. According to a recent Association of Support Professionals survey of the Top 100 publicly traded software companies,
Services (PS and maintenance) now represent from 50 to 80% of overall revenue. Service margins have also dramatically improved, propelled primarily by healthy support margins (exceeding 80%),
Service margin contribution is now 45 to 80% of total Service revenue. Seemingly overnight,
Services have become quite respectable sources of revenue and margin.
Maintenance and Services Ratios/2006
Produced by the Association of Support Professionals – www.asponline.com
Annual survey of 100 publicly traded Software companies
- Half of the companies reported total Service revenue (Maintenance and PS) greater than 50% of total revenue.
- Eight companies reported total Service revenues greater than 75% of total.
- Eleven companies (primarily shrink-wrap software) reported total Service revenues less than 20% of total revenue.
- Maintenance represents greater than 40% of overall revenue and produces a whopping 83% median margin!
- Professional Services revenue represents from 4 to 45% of total revenue.
- Professional Services reported a median 21% margin. PS margins vary widely from negative to +46%.
What are the essential Key Performance Indicators?
With the growing contribution and significance of Services to the bottom line, it’s never been more important to effectively monitor, measure, and manage your
Services business. But with over 150 KPI’s available, where do you start?
Running a Professional Services business is very complex – and it’s a game which must be won with “singles and doubles”, not homeruns; so it is imperative to know which KPI’s are “essential”, ones you must continually measure, and ones that are “nice to have” but not essential. The challenge for all Services executives is how to balance Customers, Employees, Partners and Operations. The excellent Service leader spends 50% of her time with Customers, Partners and the Product Sales organization and 50% with employees and operations. The challenge is to continually capture new business, while ensuring projects are delivered with quality, to provide consultants the tools they need to deliver and grow their skills, while effectively running operations and ensuring revenue and cost are in alignment.
Revenue – starts with Service bookings, which convert to “clean” backlog once all required contracts, Professional Services Agreements and Statements of Work have been completed, signed and approved. Resources are then applied to work the
Service backlog. Billings occur based on the contract terms - time and material, fixed price, milestone, deliverables, etc. Your ability to recognize revenue will be determined by your firm’s accounting practices. Sarbanes Oxley has imposed a complex set of rules so make sure you understand contract obligations up front to avoid revenue recognition problems later.
Gross Margin – Margin must be measured at several different levels. Most organizations use subcontractors for
Service delivery. Subcontractors not only provide a lower cost variable workforce but can also provide a rich source of margin. For systems integrators, hardware and software pass-through revenue and margin must be closely monitored. And finally, since Professional Services is based on applying highly skilled professionals to deliver project revenue, the most important measure of all is your labor margin. Subcontractor margin, hardware and software pass through margin and direct labor margin create gross margin. For even the best-run
Professional Services organizations who command high bill rates and utilization, it is difficult to consistently sustain a
Services gross margin over 50%.
Regional Margin - Most Service organizations measure regional and line-of-business profit and loss in addition to the global
Professional Services P & L. Depending on your company’s accounting practices, corporate overhead costs may be apportioned to the region or line of business or kept in a “Corporate” overhead cost center.
For example, if your company requires a 20% PS contribution margin and your corporate overhead is 20% you will need regions to produce a 40% margin.
Service margins are typically lower in EMEA than in the US due to the increased cost of:
Fringe Benefits – employee overhead costs for health and benefits range from 22 to 25% in the US but may be as high as 40% in EMEA, plus an expensive car allowance in many countries. Vacations and company holidays - in EMEA, typically 4 weeks vacation and 12 or more holidays compared to 2 weeks vacation and 10 company holidays in the US. This extra “non-billable” time is offset somewhat by an expectation of higher billable utilization.
Contribution Margin - The true differentiator for Professional
Service profitability is how the practice manages “below the line” costs. Professional Services organizations typically produce a Global Service Contribution Margin between 10 and 40%. Typical Corporate expenses (as a % of total PS Revenue) include:
- General and Administrative (5 to 10%) – includes PS corporate management and fringe benefits, facilities, non-billable travel, IT, telecom, etc.
- Sales (6 to 20%) – includes all direct sales headcount and fringe + non-billable business development travel & expense, commissions, incentives, sales training.
- PS Engineering & PMO (2 to 5%) – includes all PS Engineering & PMO headcount, fringe & expense. Labs, tools, delivery training, project reviews.
- Marketing (3 to 5%) – includes all Service Marketing headcount & expense. Web, PR, advertising, tradeshows, sales training, customer satisfaction survey, references and
Service packaging.
Most PS organizations under-invest in PS Engineering and Service Marketing and over-invest in non-billable management overhead and non-billable travel. Sales expense is typically hidden in the regional P&L and represented as “non-billable” time for key managers and Solution Architects. As a PS firm grows and matures, investments in dedicated
Service Engineering, Marketing and Sales can pay huge dividends by making Service delivery more repeatable and efficient and
Service sales more effective.
Customer Satisfaction – for Product Companies, one of the primary “raison d’etres” for a Professional Services business is to produce reference customers. This is an extremely important measurement area yet one that is often overlooked. Unless you have a very large Professional Services business, typical Customer Satisfaction “loyalty” surveys are not granular enough to showcase delivery problems. So, no matter how small your organization, you should create a project dashboard and continually monitor project health. I recommend at least quarterly reviews of all projects with defined criteria for RED, AMBER and GREEN plus on-going knowledge sharing to continue to improve the practice and your methodology.
Workforce Plan – the lowest common denominator is the health of your
Service Delivery organization. Billable headcount represent your brand and reputation as well as your
Service Delivery capability and revenue potential. From practice inception, you should quote tiered bill rates by skill level and of course you must measure your employee’s utilization – both billable and non-billable. I always recommend creating an organizational view showing profit and loss by person. You will probably find 80% of your revenue and profit is produced by 20% of your workforce so it is imperative to know who your revenue producers are and ensure they are recognized and rewarded!
Resource “ownership” – an interesting dilemma arises when regions or practices “own” the fully loaded cost of consultants. There is a built-in disincentive to share resources. Methods to overcome “resource hoarding” include central resource management or “cost and/or revenue” sharing for loaned consultants.
Utilization - there are many different ways to calculate utilization. In the US the standard definition is based on 2080 available work hours per year – this translates to 260 available work days per year. Most standard utilization measurements subtract company holidays (10 in the US and 12 or more in EMEA). The standard “available” starting hour calculation in the US is 2000 while in EMEA the standard “available” days are typically 240. Primary differences in utilization definitions emanate from the varying treatment of “non-billable” hours for internal projects, customer satisfaction issues or business development (in the numerator) and whether non-billable personal time off is excluded from the denominator.
Regardless of your specific utilization formula, it is important to develop a “standard” utilization definition and to publicize and consistently measure it throughout the organization.
Standard KPI Definitions
What are typical KPI targets?
As technology Professional Services comes of age, standard measurement targets are emerging based on the type of Professional Services delivered – software implementation, customization and integration; hardware and network installation and configuration; management and business process consulting, etc. The targets for Software implementation consulting differ from Business and Management Consulting. More commoditized
Services command lower bill rates and require higher utilization rates. Significant factors impacting profitability include the quality and maturity of the product, geographic differences, complexity of
Service, skill level required, level of risk, etc.
“Your mileage may vary” depending on the charter and mission of your organization. If your mission is to “Create Referenceable customers” at any cost, then you may not run your
Services organization as a profit center. If your mission is to “Support Sales and drive Product Revenue” then you may run your organization on the low end of billable utilization and revenue per person and accentuate metrics around bid/win ratio, capture rate and cost of sales. Measurements for smaller, startup organizations should accentuate “building client references” rather than
Service profit. While targets for larger, more mature Service organizations should accentuate the highest possible
Service revenues and margins.
If you are running a Software Professional Services organization within a Product company, the following metrics may be right for you:
Professional Services is a “game of nickels and dimes”; the following chart illustrates how small improvements can produce Big Results! If you made just a 10% improvement in 4 or 5 of your Key Performance Measurements, due to leverage and the cumulative effect of your improvements – you could improve both revenue and margin over 50%!
Let’s take a look at how small improvements can impact the bottom line:
Revenue – the big revenue accelerators are increased sales productivity and improved bill rates. With utilization, you need to run your organization at a target billable utilization, say 75%, to cover your costs and produce margin but you may find that over utilization has the unintended negative consequence of negatively impacting customer satisfaction and attrition. In the Revenue Quadrant, the best accelerators are to improve your Sales Productivity – through better deal qualification, better marketing, better references, better training and proposals. If you improve your Sales Productivity, you may also find your bill rates improve. Billing rates are market sensitive but you can dramatically improve your realized bill rates through better estimating, better project delivery, better references and project quality. Hourly bill rates almost always produce a higher margin than daily rates. An interesting phenomenon is that a given % increase in either utilization or bill rate has a similar bottom-line impact. The corollary is you cannot make a
Services margin if you cannot charge at least double the fully loaded cost of your consultants or if your average billable utilization falls below 50%.
Margin – the best way to improve margin is to lower your costs and to make more margin on every facet of your business. Curiously, one of the easiest and best ways to improve margin is to increase the percentage of revenue delivered through subcontractors and ensure you make at least 40% margin on their work. However, be careful!! I have found the proper mix of direct to subcontract labor is about 30% subcontractors to 70% direct labor. If you over-use subcontractors you may compromise delivery quality and put your client relationships and knowledge capture at risk. You might be surprised how many practices do not adequately mark-up their subcontractors or bind them to the firm’s contract terms. You don’t want to be in a situation where you are paying your contractors on a time and materials basis but charging your customers on a milestone basis.
The other key margin lever is to reduce non-billable overhead and run a lean business. I recommend zealously measuring and publicizing non-rebillable travel and expense. If you are spending a fortune in travel for business development, this is a clear indication you need to improve your marketing, lead generation and deal qualification. Improving your sales capture rates and sales productivity is a much lower cost alternative than chasing every deal that moves because your pipeline is weak.
I like to set a “non-billable” expense target per person, say, $2500 per quarter. This target may be too low for your business development staff but it is a good number for the overall regional organization and incents your team to carefully monitor telecom charges and those sneaky free meals! Normally, you should have very limited non-billable travel expense for your technical consulting staff.
Customer Satisfaction – no matter the size of your organization, you MUST keep a master Project Dashboard and have a mechanism for impartially tracking project quality. Key metrics here are proposed vs. actual hours per task, milestone or deliverable. Catch problems early – an overrun early in a project is a clear indication to reset expectations, execute a change order or change the project manager. Failed projects ruin your reputation and can have a devastating impact on profitability.
Another key indicator of the health of your client base is the length of your payment cycle, also called Days Sales Outstanding. Most companies operate on a Net 30 day from billing payment schedule but slow payment is rampant in Professional Services. A 10% improvement in DSO produces a .4% improvement in your cash flow.
Finally, the best way to improve Sales Productivity and Project Margins is to sell more projects to your product customers. Just a 1% improvement in
Services attached to product sales can produce big gains in revenue and lower the cost of sales. Invest in Services Sales Compensation to incent your Product Sales force to include
Services with every deal.
Workforce Plan – One of the greatest financial levers you have is Retention!!! Attrition is incredibly expensive. On average it takes almost a year to recruit, hire and ramp a productive new consultant – VERY EXPENSIVE! This means you must be scrupulous with your hiring programs and invest in training to shorten that ramp time. Your most important lever is to ensure your most productive (and most senior) consultants stay with your firm. Create a compensation plan that incents them to develop new business, new employees or infrastructure. Treat them as your crown jewels, not billable objects, and find ways to reduce their travel burn.
The other significant workforce lever is again reducing overhead. I recommend a minimum 10 to 1 employee to management ratio. Pay careful attention to your headquarters spend. Designate an “Enablement” manager to create the internal curriculum, employee training plan and orchestrate all internal training. You will be amazed at how much further your training $$$ go with careful planning and central management.
In summary, there are innumerable levers for improved financial performance – pick 3 to 5 key metrics to improve each year and watch the money grow!
About the Author
Jeanne Urich is a management consultant specializing in
Service organization improvement for small to large technology companies. Her focus areas include: Strategy, Marketing, Business Development, Alliances, Finance and Operations and Human Resources. She has been a corporate officer and leader of the
Worldwide Services Organizations of Vignette, Blue Martini and Clarify. In each of these roles, she led the growth of their Professional Services, Education, Account Management and Alliances organizations and was responsible for dramatically increasing
Services revenue, profit and utilization while maintaining a balanced relationship with system integration partners. At Clarify, in less than three years, she grew the
Services organization from 50 to 720 employees and increased annual revenue from $20M to $100M while generating a 24% margin. She has a Bachelor’s Degree in Math and Computer Science from Vanderbilt University. She serves on the Advisory Board of www.psvillage.com, a preeminent on-line community for
Services executives, and is a Contributing Editor of Tips From the Trenches: The Collective Wisdom of
Over 100 Professional Service Leaders. Please contact Jeanne with questions or comments at: Jurich@jurich.biz.
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