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Killer Pricing: Based on the New Professional Services Maturity Model Benchmark
- by Jeanne Urich, Management Consultant, Adexta.com, and Contributing Editor of Tips From the Trenches: The Collective Wisdom of Over 100 Professional Services Leaders
In a rapidly commoditizing technology market, Professional Services have become the glue between disparate technologies and clients. Until now, little if any research examined Professional Service strategies and benchmarks within the context of a rapidly maturing technology environment. Adexta and SPI Research have come together to develop a comprehensive benchmark to help captive and independent technology professional service providers assess their own capabilities as well as provide a Roadmap for Achieving Professional Service Excellence.
Starting in September 2007, Adexta and SPI Research surveyed 52 technology professional service organizations. The respondents ranged from small to very large professional service organizations – within either technology companies (primarily software) or independent system integrators.
 The research report benchmarks the correlation between professional
service organizational performance and the adoption of “best practices”
and business process maturity. The study focuses on professional service
excellence across Five Service Performance Pillars — Vision and Strategy, Finance and Operations, Human Capital Alignment, Service Execution, and Client Relationships.
The research report contains an examination of how pricing and discounting strategy affects various components of the organization's ability to operate at its highest capacity. The dramatic impact of pricing and
discounting are outlined in this article. The data represented is derived from the results of the New Professional Service Maturity Model benchmark.
Bill Rates
Despite on-going domestic technical labor shortages and scarcity of critical skills, hourly billing rates have not substantially increased over the last five years (Figure 1). Domestic rates in the US ($200/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 billable labor rate is enhanced product quality and ease-of-use enabling technology professional service providers to use lower skilled and less expensive resources.
An increase in bill rate is one of the factors producing the greatest bottom line profit impact along with the additional benefit of dramatically improving the employee work environment.
This study shows best-in-class professional services organizations tightly control pricing by carefully managing their utilization and discounting. Best-in-class organizations ensure they have the right size workforce to drive premium bill rates, which in turn allows them to invest in their employees. Highly skilled, well trained, happy employees in turn
produce the best client results. These results bring to mind the old adage “you get what you pay for”.
Table 1: The Effect of Bill Rates
Figure 1: Average Consulting/Billable Staff Hourly Bill Rate
Premium rates still exist (> $250/hour) for highly skilled management consultants and technology gurus – particularly in the areas of Business Process Design, Business Intelligence, Security, SOA and Enterprise Integration.
Flat bill rates have placed pressure on professional service organizations to increase utilization and lower overhead and benefit costs to produce margin. Increasingly organizations are investing in labor-enhancing technology and tools – knowledge management, collaboration, mobile solutions, project management and quality control to wring the greatest productivity out of their workforces.
Many factors influence bill rates, but companies experiencing the highest growth also reported the highest rates. This would indicate rates are significantly influenced by demand (and scarcity of qualified resources).
The Effect of Bill Rates on Employees
Organizations with the highest bill rates consistently reported significantly greater investments in their employees – more vacation time; higher incentive payments and double the average investment in training per employee. Organizations with the lowest bill rates only provided 3 days of training per year per employee as compared to 9 days for organizations with the highest bill rates. These employee investments directly translated to employee retention. Companies with the highest bill rates reported just 7.9% attrition compared to 10.8% for companies with the lowest bill rates.
The Effect of Bill Rates on Utilization, Revenue and Margin
To produce acceptable margins, companies with the lowest bill rates put more pressure on their employees to produce revenue. Billable utilization for companies with the lowest bill rates averaged 71% compared to 66% for companies with the highest bill rates.
Predictably, the companies reporting the highest bill rates also reported the highest revenue per employee. Organizations with bill rates less than $150 per hour only generated $157K per employee per year while organizations with bill rates over $200 per hour generated $274K per employee per year.
Surprisingly, reported contribution margin for companies with the lowest bill rates averaged 20.6% while margins for companies with the highest bill rates averaged 23.5%. To make up the difference in revenue yield per employee, companies with low bill rates relied more heavily on subcontractor and offshore labor margins. Indeed, the majority of their margin came from subcontractors (28%) and offshore (43%) compared to subcontractor margin of 24% and offshore margin of 33% for companies with the highest bill rates.
The Effect of Bill Rates on Project Quality
Companies reporting the lowest bill rates tended to have longer projects (6 months) with larger project teams (7) than companies with the highest bill rates who reported average project durations of 5 months deploying 3 people. Organizations with low bill rates also tended to perform slightly more of their work onsite (51%) compared to the high bill rates companies who averaged 49% on-site.
The most dramatic effect of low bill rates was on project quality. Companies with the lowest bill rates experienced twice the project cancellation rate (3.2%) compared to companies with the highest bill rates (1.6%). The results for on time project completion were equally dramatic with only 67% of low
bill rate projects delivered on time as compared to 85% for companies with the highest bill rates. These results are a clear indication that companies who command higher bill rates also produced better client results.
The Effect of Workforce Strategies on Bill Rates
Today's professional services organizations are using a variety of workforce strategies to deploy cost
effective project solutions. Centers of excellence as well as local subcontractors and global offshore development teams are now the norm. Even the smallest PSOs
are starting to employ complex workforce solutions – often with
disastrous results. The combination of an immature product, immature
methodology and poor project management controls combined with a complex, multi-channel delivery structure can create failed projects, cost overruns and unhappy early customers. New, young technology companies and service providers should not focus on complex labor arbitrage schemes until their products and processes have matured to the point where it makes sense to offshore development and integration tasks.
A consistent theme from most respondents was that increasingly complex, multi-channel, delivery teams require strong customer
facing project management staff. Several respondents stated they are investing in the Project Management Institute (PMI) project management certification for all project management personnel. Although the cost of PMI certification is high (over $5K per Project Manager), the investment should drive higher levels of project quality and customer satisfaction and can mitigate the risk of a multi-channel global service delivery structure.
Contribution Margin
One of the most important measures of success for all PSOs is contribution margin (Figure 2). Average reported contribution margin was 22.8%. Surprisingly, reported contribution margin was almost the same for all size organizations and both embedded and independent PSOs.
In fact, reported margin remained constant despite huge variances in bill rates. This factor can only be explained by higher utilization and
reduced discretionary spending for firms with low bill rates. Subcontractor and offshore labor margins caused the greatest variation in contribution margin. Organizations with the lowest contribution margin (6.1%) also reported the lowest subcontractor margin (under 10%).
Figure 2: Annual Professional Services Contribution Margin
Many PSOs showed solid growth in terms of increasing professional services contribution (Figure 3). Many of the firms that reported the most significant increases in professional services contribution margin were small, fast growing PSOs. They actually had lower bill rates than their larger competitors but their lower rates were offset by lower administrative costs. One area of distinct differentiation was in annual employee attrition. PSOs with higher attrition rates generally had lower increases in contribution margin, which in turn highlights the need for an effective human capital strategy to reduce turnover and improve margin.
Figure 3: Year-Over-Year Change in PS Contribution Margin
Revenue Per Billable Employee
Average revenue per billable employee was $214K per year (Figure 4). The largest organizations (from 700 to over 5,000 employees) reported the lowest revenue per person at $120K and the lowest hourly bill rates of $50 to $120 per hour. They also reported the highest billable utilization ranging from 72% to 90%. This factor highlights the need for effective resource planning and scheduling.
Figure 4: Average Annual Revenue/Person for Billable Employees
Project Gross Margin
Reported average project gross margin was 35.3%. Reported project gross margins were almost the same regardless of organization size and type but varied primarily based on subcontractor and offshore resource margin (Figure 5). Industry standard target project gross margins range from 35% to 50%, and therefore can be used as a starting point in competitive pricing scenarios.
Figure 5: Average Project Gross Margin
Third Party Revenue
The use of subcontractors and offshore resources provides a valuable variable workforce alternative, which enables organizations to quickly grow and scale without encumbering high fixed payroll costs (Figure 6). Almost all of the organizations surveyed use subcontractors and/or off-shore resources. Together they delivered an average of 13.8% of professional service revenue.
Figure 6: Percent PS Revenue Delivered by 3rd Parties
Subcontractor and Offshore Margins
Average margin was 28.8% for subcontractors (Figure 7) and 44.4% for offshore resources (Figure 8). Many firms invest the same level of training and leveraged compensation to retain their offshore teams. Particularly
in India, the war for talent has led to high levels of attrition and critical skill shortages. The weakened dollar is starting to make US domestic labor more attractive and recently, US resources have started to become a viable delivery alternative in Europe, the Middle East and Africa (EMEA).
Figure 7: Average Subcontractor Margin
Figure 8: Average Margin for Offshore Resources
The Effect of Discounting on Organizational Performance
Discounting has an enormous effect not only on bill rate but also on employee retention and project quality. Companies with the lowest bill rates (under $150 per hour) experienced a high percentage of discounting at 17.9% while organizations with the highest bill rates (over $200 per hour) allowed the least amount of discounting (10.8%).
Clearly, effective pricing strategy is one of the critical factors in determining overall professional services revenue and margin attainment.
Table 2: The Effect of Discounting
Forecasting Accuracy
A Key Performance Measurement for all organizations should be forecasting accuracy. Forecasting accuracy provides insight into the quality of management, sales effectiveness and operational controls (Figure 9). Particularly for publicly traded companies, quarterly forecast “misses” are immediately punished by stock price declines. All respondents reported relatively good forecasting accuracy averaging 14.6%. Best-in-class organizations reported forecasting accuracy +/- 5%.
Figure 9: Average Revenue Forecasting Variance
Contract review time and overall deal negotiation time and approval should increase with increased project complexity. Best-in-class companies provide differentiated quoting, contracting and pricing processes by providing self-service options for simple, repetitive projects and focused comprehensive reviews for estimates, prices, quotes and contracts for complex engagements.
Bid/Win Ratio
Bid/win ratio is a good key performance indicator to measure the quality of marketing and sales effectiveness (Figure 10). A high bid/win ratio demonstrates that a firm is pursuing the appropriate type of business. In that case, sales effectiveness is high because the sales team identifies, pursues, and closes winnable business. The best way to look at bid-win ratio is in conjunction with the size of the deal pipeline. When these two measurements are both healthy, a firm is generating a high quality, large pipeline with a high probability of deal closure accompanied by a high level of forecasting accuracy.
Figure 10: Bid/Win Ratio
The Effect of Discounting on Bid/Win Ratio
The effect of discounting on bid/win ratio is notable. PSOs reported discount levels from 5% to over 30% with an average of 17.6%. The largest organizations permit the least discounting at 5%. Companies reporting the lowest level of discounting also had the lowest bid/win ratio of 4.8 wins per 10 bids. Yet companies with the highest level of discounting (over 30%) had only a slightly better bid/win ratio of 5.84.
The sweet spot for discounting was 11 to 20% producing bid yields of 6.45.
One statistic associated with discounting is that the organizations with the highest bill rates (greater than $200/hr.) have one of the lowest rates of discounting at 10.8% (Figure 11). This factor is an indication that premium firms who offer differentiated and highly valued consulting can command, demand and receive premium rates.
Figure 11: Discounting Authority By Position
The Effect of Discounting on Project Quality
Premium firms with the lowest rate of discounting also report the highest levels of
on time project delivery and employee investment. The corollary: firms
with the highest level of discounting (over 30%) reported low bill rates
of $147/hour. These firms operate a commodity business with low
contribution margins of 14.7%, low revenue per person of $187K/ year and
only 50% of projects delivered on time.
Buyers beware – firms that offer steep discounts are operating a commodity business – you may like the discount but not the results.
The benefits of delivering projects on time and on budget are obvious. The survey demonstrated the importance of
on time project delivery. PSOs that averaged 40% or less on time delivery only grew at 8%; whereas organizations with over 80%
on time delivery averaged 18% annual growth (Figure 12). If organizations must spend time trying to clean up project missteps, their energies will not be focused on selling more services and their reputations will suffer.
Figure 12: Percentage of Projects Delivered On Time
PSOs that delivered projects on time also had higher billing rates than those that did not. These rates ranged from $122/hour for organizations that deliver projects on time less than 40% of the time, up to $235/hour for those that achieved over 80%
on time project delivery. Best-in-class PSOs invest in well trained and skilled employees to improve project delivery. Additionally, they can market on time, high quality delivery resulting in the ability to charge more for billable hour.
The Effect of Who Sells Service on Performance
One of the most telling statistics in this survey is that when services are sold by the product organization, financial results suffer. While dedicated
service sales and selling by service managers show very solid results in terms of the ability to grow revenues; sales by Solution Architects demonstrated the most impressive results – from increased revenue growth (20.8%), to professional services contribution margin (24.2%). However, sales by Service Management showed the highest annual revenue per billable employee at $258K (Figure 13).
Figure 13: Individual Who Typically Sells Services
Conclusions
Bill rate combined with utilization is a leading indicator for the overall quality and differentiation of the organization. The fact that organizations with the highest bill rates tend to reinvest their profit into their employees leads to a continuing improvement cycle. Highly skilled, well trained and motivated consultants who are loyal to their firm undoubtedly produce the best results for their 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 resulting in superior project delivery and overall financial profit was one of the most dramatic findings in the study.
The level of discounting is also a leading indicator for the overall quality, uniqueness and operational excellence of the organization. High levels of discounting negatively affect almost all aspects of performance. Organizations with the highest level of discounting produced the lowest average bill rates; higher levels of employee attrition; and a significantly high percentage of heavily discounted projects (50%) were not delivered on time. However, the most telling statistic is the high levels of discounting did not result in improved bid/win ratios. Further, high levels of discounting resulted in the highest level of forecasting unpredictability at 20%. The bottom line: according to the benchmark results, high levels of discounting provided no apparent benefit and definitely contributed to poor levels of performance in most major financial categories.
About Jeanne Urich
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, 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.
About R. David Hofferberth, P.E.
Service Performance Insight Managing Director, David Hofferberth, has over 20 years experience in information technology (IT) serving as an industry analyst, market consultant, and as a product director at Oracle. Hofferberth is focused on the services economy, and in particular, on white-collar productivity issues and the technologies that help people perform at their highest capacity.
Hofferberth's background is extensive in services productivity. In 1999, he introduced to the market the solution area now known as Professional Services Automation (PSA), when he published the seminal report titled:
Professional Services Automation: Increasing Efficiencies and Profitability in Professional Services Organizations. This report helped define the PSA market and introduced the concepts behind PSA to hundreds of services organizations, as well as to members of the independent software vendor (ISV) community.
Hofferberth has spoken about PSA and Enterprise Resource Planning (ERP) around the world and has provided consulting services to both PSA suppliers and organizations to select, deploy, and utilize PSA solutions. He has also advised PSA suppliers on market and product strategy. As the PSA market grew it segmented into other markets: Enterprise Project Management (EPM) and Project Portfolio Management (PPM) markets. EPM utilized many of the concepts in PSA with a greater focus on integrated project and financial management. PPM has become a leading application in the EPM arena with a specific focus on IT management and governance.
Hofferberth's background also includes the management of application development teams and analytical tool development to support business decision making processes. Hofferberth earned an MBA from Duke University and a BS in Industrial Engineering from the University of Tennessee. He is also a licensed Professional Engineer (PE).
Adexta, Inc.
Adexta, Inc. is a management consulting practice focused on helping technology-centric businesses accelerate growth, market leadership and profitability. Visit
www.adexta.com for more information on Adexta.
Service Performance Insight (SPI Research)
Service Performance Insight (SPI Research) is a globally-focused research firm specializing in
management issues regarding information technology (IT) use in the services sector. Visit
www.SPIresearch.com for more information on Service Performance Insight.
To purchase a copy of the complete 96 page report, please go to: www.spiresearch.com/ProductPages/SPIAdexta2008PSMM.htm.
Copyright © 2008 Adexta and Service Performance Insight
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