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Metrics that Matter: Measuring Professional Services Business
- by Thomas E. Lah, author of Mastering Professional Services

There are easily over fifty meaningful metrics a management team could use to assess their professional services business. The issue is determining what specific metrics provide the greatest insight. Unfortunately, revenue and profitability are not the beginning and ending of your measurement process. These two metrics provide very limited insight into the strengths and weaknesses of your PS business. In this article, we will introduce a practical framework managers can use when selecting the appropriate metrics for their PS organization. Future articles will discuss types of metrics in more detail and discuss the process of defining and deploying a metric strategy.


What Metrics?

When it comes to the professional services business, managers will quickly agree on a short list of metrics that are “must haves”. Yes, you need to understand the utilization rate of your consultants. Revenue and bookings are obviously critical to track. Then what? Load costs? Project Margins? Employee turnover rate? The debate begins. Table 1: Ten Professional Services Metrics provides ten metrics for a professional service organization that I have pulled from the appendix of my book, “Building Professional Services: The Sirens’ Song. I can articulate the specific value of each one of these metrics. I can explain how each metric provides specific business insight. Despite this, I have yet to meet with a Professional Services organization that has all ten of these metrics at their finger tips. I am learning that metrics are a “premium” activity for most service organizations. “Yes, it would be nice to have all this data and insight, but we don’t have the staff, time, or systems to generate lots of metrics.” Resources are tight. You do not want to add metrics for the sake of having one more number to review. You want to carefully add metrics that bring true strategic insight and help you improve the state of your business. You want to add metrics that matter. How do you do this?

In the well-received book “The Balanced Scorecard”, David P. and Norton and Robert S. Kaplan introduce the concept that “existing performance measurement approaches, primarily relying on financial accounting measures, are becoming obsolete”. Norton and Kaplan are convinced that metrics that focus simply on financial performance “hinder an organization’s ability to create future economic value.” Furthermore, they state “the success of organizations cannot be motivated or measured by financial metrics alone.” I believe their warning is particularly relevant for human capital intensive businesses. In a Professional Services business, future quarterly revenues and profits are a direct reflection of how your employees and consultants will execute their jobs over the next three months. Do they have the right skills? Are they motivated? Are they building deep relationships with your customers? Last quarters revenue and profit numbers will provide little insight into answering these telling questions.

To help companies accept the reality that there is more to a healthy business than profit and loss numbers, Kaplan and Norton engineered a balanced scorecard that has four distinct categories companies where companies should track data:

1. Financial: ROI, revenue growth, revenue, mix
2. Customer: Customer satisfaction, account share
3. Internal: Quality control, time-to-market, operational efficiency
4. Learning and Growth: Employee satisfaction, training, skills development

1. Functional Perspective: What business function does this metric help evaluate? Your sales organization? Your delivery teams? Service Marketing?
2. Economic Perspective: Almost every internal company initiative has one of two objectives: improve operational efficiency or create future revenue (economic value). Does the metric track improvements in operational efficiency or assess the economic value of the business?
3. Timeframe Perspective: Just like economic data, is the metric a leading or lagging indicator of how the business is performing? Does the metric indicate you currently have a real problem, or does the metric warn that soon you will have a problem if the current trend continues?
4. Scope Perspective: Does the metric measure the performance of specific individuals, specific projects, or the entire business unit?
5. Stakeholder Perspective: Does this metric provide insight on how your external stakeholders view you? External stakeholders would include customers and partners.

• ZONE 0: Lagging, Economic Value. Metrics in Zone 0 represent how the business has actually performed. Metrics in this zone are the ones ultimately used to evaluate a management team and include Total Service Revenues, and Profitability.
• ZONE 1: Lagging, Efficiency. Metrics in Zone 1 indicate you have a serious and immediate problem in the way you are running the PS business. If operational efficiencies are not improved, Revenues and Profits will suffer.
• ZONE 2: Leading, Efficiency. Metrics in Zone 2 provide early warning that you may have efficiency issues. Poor performance on these metrics does not mean revenue and profits (Zone 0) will be immediately impacted. However, these metrics are a pointer to areas that, if not addressed, could impact future financial performance.
• ZONE 3: Leading, Economic Value. Metrics in Zone 3 provide insight on how the business will be doing in the future. Are you creating economic value that will generate future revenues and profits? Or, are you whittling down your intellectual and human capital in order to pay today’s bills?

Figure 1: Metrics Perspective Graph Introduction

Figure 2: Completed Metrics Perspective Graph

• Functional Perspective: Utilization is used to evaluate the service delivery function.
• Economic Perspective: Utilization evaluates the efficiency of your service organization.
• Time Frame Perspective: Utilization is a lagging metric. When utilization goes down, you have a problem now. After the low utilization report comes in, you can’t recapture those lost billable hours. Like airplane seats and hotel rooms, you cannot inventory consulting capacity.
• Scope Perspective: Utilization is used to evaluate the performance of individual employees. This data can then be used to evaluate the health of projects and eventually the overall business. In other words, utilization is a metric that can provide insight on all levels of your PS business.
• Stakeholder Perspective: Utilization is an internal viewpoint. Your customers and partners are not concerned about your utilization rates.

• Functional Blind Spots: Not specifically evaluating sales, marketing, or services engineering.
• Economic Blind Spots: Not evaluating the return on investments you are making into the business. Not understanding the economic potential of your service portfolio. Yes, you may be utilized today, but what about six months from now?
• Time Frame Blind Spots: You have no leading indicators that will warn the business may be heading south.
• Stakeholder Blind Spots: You have no indication how customers and partners feel about the services you are delivering.

Figure 3: Mapping Utilization

Figure 4: Ten Service Metrics

1. There is not one metric that provides an external perspective. How do customers view the business? How do critical partners feel about your skills and ability to deliver? None of these metrics provide insight on how the external world views your business.
2. 70% of these metrics are lagging. They provide little insight on what direction the service business is moving: positive or negative. Yes, you may have made money this quarter, but are you headed in the right direction? Hit rates, sales costs, and backlog do provide leading information — so you are not totally blind. However, you have no leading indicators on the health of the service portfolio or the skills of your staff.
3. No leading metrics to evaluate the health of projects. Project profitability tells you after the fact how it went. Are your projects on track now? Are you getting better at managing your projects?

• Very few (if any) leading metrics.
• Limited insight on the cost and effectiveness of your service sales activities. You may track revenues and bookings, but not hit rates, sales costs per rep or sales cost per project type.
• Very little insight into overall operational efficiency. Are you getting faster, better, cheaper in the way you deliver your service portfolio?
• No hard metrics to evaluate the specific activities of service development and service marketing.

• You can’t manage what you don’t measure—every senior manager will agree to this truism. Even though we all agree to it, we have a tough time living it.
• Metrics are a premium activity. It takes money and staff to generate data. PS organizations want to apply finite resources to the right activities.
• Management teams must make a conscious decision to focus on a tight set of metrics that will provide the most strategic insight into the business.
• To accomplish this objective, managers can use the concept of metric perspectives to assess and prioritize what metrics they will use.
• At a bare minimum, a balanced metrics portfolio contains leading indicators on the health of the business.

Zone 0 Metrics

Now that we have reviewed the framework, let’s take a deeper dive into Zone 0. As previously defined, Zone 0 metrics provide lagging information about the economic health of the professional service business. In other words, metrics in this zone tell you how you how much money you just made--not how much you will make. Also, this zone does not provide specific insight into the operational efficiency of your organization. Are we doing things faster, better, cheaper? Zone 0 is not very helpful answering these questions. Having said all this, the metrics that live in Zone 0 are critical to the continued employment of the management team.

If targets in this Zone 0 are consistently missed, the management team will eventually be replaced. That why this Zone is always a focal point.

Example Metrics
Specifically, which metrics in this critical zone impact employment longevity? There are ten metrics that live in Zone 0. Table 1: Zone 0 Metrics, lists these ten metrics and defines them.

Priorities
In the first column of Table 1, I have documented the three natural priority levels that exist within these ten metrics.

• Priority 1: Total Service Revenues, Operating Profit, Gross Margin. These are the metrics that EVERY service organization tracks. When these three go soft, executives need answers.



• Priority 2: Bill Rate, Rate Realization, Labor Multiplier. These metrics are the next wave most likely to be tracked by management. They provide immediate insight into how profitable you will be for the quarter.



• Priority 3: Revenue per Practice, Profit per Practice, Solution Revenue Solution Margin. These are Zone 0 metrics that many service organizations do not take the time to calculate. Nevertheless, they provide immediate insight into the profitability of specific service lines and provide greater insight into where profitability problems may exist.

Table 2: Zone Metrics Perspectives provides additional data on what these ten metrics can be used to manage. Figure 3: Zone 0 Metrics Graph maps these ten metrics onto the metrics perspective graph.

Figure 3: Zone 0 Metrics Perspective Graph

Deficiencies
Hopefully, by looking at Figure 3, the deficiencies of Zone 0 metrics becomes apparent. There is a natural tendency for the PS management team to fixate itself on Zone 0 metrics. This is understandable. If revenues and profits are falling, jobs are at stake. But if a management team only tracks metrics in Zone 0, they have a seriously flawed metric strategy. These ten metrics will not provide insights in the following areas:

• Future Economic Value: Yes, we just had a good quarter! But what will future profits look like? Zone 0 metrics don't help me here.



• Operational Efficiencies: Revenues and profits do indicate if we are managing the business well or not. However, they do not provide much insight where operational challenges may exist. Margins were off. Why? Were sales costs too high? Did we simply scope the projects poorly? Zone 0 comes up empty when asking these questions.



• External Perspective: Last but not least, the ten metrics in Zone 0 are all important to managers. They are not important to customers. Does a customer really care if margins and profits were down? No. If you are trying to determine how customers feel about you, Zone 0 does not help.

Targets
The most frequent request I receive from management teams is to provide guidance for the following Zone 0 metrics:

• Gross Margin: How much margin should are professional service business be throwing off?



• Operating Profit: What operating profit is reasonable and sustainable for a PS business?



• Bill Rate: Hey, are our bill rates too high (like our sales people keep telling us)?



• Rate Realization: What rate should we be expecting from our consultants? 65%, 75%, 100%?

Over the past three years, I have found the specific targets for these four metrics vary widely from organization to organization, practice to practice, and industry to industry. Gross margins in PS are ranging from 10% to 45%. Operating profits are ranging from -20% to 20%. Realization rates are typically ranging from 50% to 90%. The spectrums are WIDE. Having said this, I do see some pattern recognition.

First of all, actual gross margins are consistently lower than target gross margins. The most common target I see for gross margin is 40%. The actual gross margins in PS are much closer to 25%. Operating profit targets are typically set between 12% - 15%. Actuals are hovering around 10%. I base these observations on the few companies that will publicly report the gross margins and profits of their professional service business and the various companies I have had the privilege to work with directly.

My experiences lead me to the following conclusion: There are no universal targets that make sense for Zone 0 metrics. Target margins and profits should be driven by the specific business model for your professional service organization, NOT some mythical standard that in reality does not exist. For more information on target business models for professional service organizations, please refer to the previously published article The Professional Services Business Model - Fighting the 40/20 Myth.

• When creating a metrics portfolio, is important to consider what the metrics are telling you. The objective is to identify a set of metrics that minimizes any perspective blind spots.



• Zone 0 metrics provide lagging information about the economic health of the professional service business.



• If targets in Zone 0 are consistently missed, the management team will eventually be replaced.



• Zone 0 metrics do not provide insights into critical areas such as future economic performance, operational inefficiencies, or customer satisfaction.



• In the industry, Zone zero metrics are all over the map. There is a wide spectrum of results for these metrics. Industry dynamics, organizational maturity, and service type all impact what a professional service organization can achieve in Zone 0. Universal targets for these metrics does not make sense.

Zone 1 Metrics

Per the earlier definition, Zone 1 metrics provide important insights on the operational efficiencies of your PS business. However, these insights are lagging in nature—not predictive.

If targets in Zone 1 are consistently below industry expectations, PS revenues and profits will continue to disappoint.

Example Metrics
There are at least eight metrics that can logically be placed in Zone 1. Table 1: Zone 1 Metrics, lists these eight metrics and defines them.

Priorities
In the first column of Table 1, I have documented the three priority levels for these eight metrics. These assigned priorities are most likely the opposite priorities most PS managers would assign to these metrics. Let me defend my prioritization:

• Priority 1: Profit per Project, Project Overrun Costs, Cost of Services Delivered, Delivery Labor Costs. All of these metrics inform the management team how much cost is actually involved in delivering their services. When project profitability decreases and project overruns increase, overall PS profitability (Zone 0 metric) will soon be impacted. If delivery labor costs are increasing, profitability will be impacted. In other words, the management team must understand the true and total costs required to deliver the service portfolio. These costs need to be monitored and aggressively managed. If not, the natural tendency is for project costs to become bloated and margins to erode.



• Priority 2: Load Costs, Delivery Overhead Costs. These metrics are the next area management can track to identify potential efficiency improvements. These metrics provide insight into how much overhead the PS organization is carrying to support project delivery. The healthiest project margins will have difficulty covering unnecessary and inflated overhead costs.



• Priority 3: Utilization and Cash Flow. The fact Utilization is placed as a third priority is no doubt controversial. Every PS leader demands that consultant utilization be tracked and accounted for. I agree utilization is a very insightful metric. If consultants are only being utilized 50% - 60% of the time, the business is inefficient and over resourced. However, utilization is one of the most abused metrics available to the management staff. If you tell PS staff you will be tracking utilization, they will be utilized—trust me. The question remains, how beneficial the utilization was. Tracking real project costs and overruns will provide more immediate and potentially more accurate insights into the efficiencies of your business.

Even if deals are being won and top line revenue is growing, you may not be delivering your services portfolio at an optimized level. Zone 1 metrics help answer a very pertinent business question: “How efficient are we as a Professional Services Organization?”

Table 2: Zone 1 Metrics Perspectives provides additional data on what these eight metrics can be used to manage. Figure 3: Zone 1 Metrics Graph maps these eight metrics onto the metrics perspective graph.

Figure 3: Zone 1 Metrics Perspective Graph

Deficiencies
Zone 1 metrics have two significant deficiencies. First of all, the metrics are indeed lagging in nature. Soaring delivery costs or project overruns tell you there is a problem after it has occurred. Secondly, these metrics are very internally focused. As a PS manager, YOU care about utilization rates and delivery load costs. Your clients do not.

Targets
In the previous article on Zone 0 metrics, I discussed the fact that best practice targets for many of these metrics are a slippery slope to stand on. However, there are some reasonable guidelines for two of the Zone 1 metrics:

• Utilization: PS organizations have a tendency to target very high utilization rates. I believe this bias comes from the heritage of traditional professional service organizations such as law firms and accounting firms. In these environments, employees are often expected to bill over forty hours a week to client accounts. I believe PS activity within a product company is a very different environment. I have yet to review a PS organization that was sustaining 100% billable utilization. I do see PS organizations that report 100%+ utilization rates. However, these rates track non-billable activity such as pre-sales calls. For billable utilization activity, I believe there is a natural strike zone that sits between 60% and 85% billable utilization. Less than 60%, and the PS organization cannot financially support itself. Greater than 85%, and no time is left for ongoing staff development.



• Project Overruns: Project overruns occur. It is a fact of life when you are delivering complex technology centered solutions. The question is the order of magnitude. On an ongoing basis, project overruns should average 10% - 25%. If your project costs consistently exceed 25% of the initial estimation, your ability to estimate effort is seriously in question. If you are bidding projects at a fixed price, your ability to be profitable is clearly in jeopardy!

• When creating a metrics portfolio, is important to consider what the metrics are telling you. The objective is to identify a set of metrics that minimizes any perspective blind spots.



• Zone 1 metrics provide lagging information concerning the operational efficiency of the professional service business.



• If targets in Zone 1 are below industry expectations, the PS business will find it difficult to effectively compete in the marketplace. Revenues and profits will eventually be compromised.



• Zone 1 metrics such as utilization and project overruns costs can and should be benchmarked against industry standards.

Zone 2 Metrics

Let's begin the transition to leading metrics by visiting Zone 2. Per the earlier definition, Zone 2 metrics provide leading insights into the operational efficiency of your PS business.

If Zone 2 metrics begin declining, operational efficiency will begin suffering. If operational efficiency drops, reduced margins and profits are sure to follow.

Example Metrics
There are at least ten metrics that can logically be placed in Zone 2. Table 1: Zone 2 Metrics lists these ten metrics and defines them.

Priorities
In the first column of Table 1, each Zone 2 metric is rated by priority level.

• Priority 1:
  Bid and Proposal Costs – This metric is a little tricky. Even though it is a cost metric, and fundamentally speaks to efficiency, it can speak to so much more. We are winning more business! However, if bid costs are going up, something is changing. Are we simply getting sloppy in our bid approach? Are new competitors entering our space? Or, are we chasing business we simply should not be chasing? Review those bid costs now, before your revenues reflect the fact the sales folks were chasing the wrong business.
  
  Channel Mix – How efficiently are we using all of our sales channel options? Are the old partners getting any better at selling the new services? Does everything still get sold through the most expensive channel option we have – direct sales staff? Act to improve the channel mix now, before you are forced to reduce direct sales staff later.
  
  G & A – Are G&A costs creeping up? This often happens in service businesses. If G&A continues to climb as a percentage of total revenues, you are probably spending money to mask other fundamental issues in the business. Take a look at creeping G&A costs now, before the CFO hands you required budget cuts.
  
  Project Completion Ratio – Yes, you track project profitability after the fact. But how about the large projects in play right now? Are the teams meeting commitments on time? Also, this is the first metric we have spoken of that has an external perspective as well. In other words, your customers care how you do here. Are you delivering on your commitments to them? Track project milestones now, before you realize chunks of revenue will be delayed next quarter.
  
  
• Priority 2:
  Research and Development Costs – How much money does PS spend to manage intellectual property and improve delivery methodologies? If this number is becoming too large, profits suffer. If this number becomes too small, you struggle to increase the value you bring to customers. Track how much money is invested in solution development and improvement now, before your solution portfolio becomes stale and unmarketable.
  
  Total Operating Expenses – Many PS organizations are not disciplined in their tracking of Sales Costs vs. Marketing Costs, G&A, etc. To offset this common deficiency, it is recommended that the management team tracks the total amount of money spent to support the business. If PS margins are flat and total operating expenses are growing, there is a problem. Understand total operating expenses now, before there are not enough margin dollars to support them.
  
  Training Costs and Training Days – Like R&D Costs, the concern on Training is centered more around under-investment. Catch severe declines in training investments now, before consultants embarrass your brand six months from now.
  
  
• Priority 3:
  Alliance and Partner Costs – Partners are a critical component to the delivery of most “solutions”. How much money are you investing in identifying, qualifying, and enabling these critical partners? Are you wasteful or under-investing. Spend money certifying your delivery partners today, before they tank a critical engagement tomorrow.
  
  Collateral Costs – How much does PS spend on marketing materials? If it is the largest portion of your service marketing budget, you have a problem—trust me. Reduce marketing material costs now, before you wish you did.
  
  

These Zone 2 metrics provide wonderful perspectives into your business. Once again, no executive will be fired because R&D costs were too low, or Project Completion ratios have slipped by 10%. However, that same executive could be subjected to a very unpleasant business review four quarters down the road, when a poorly differentiated service portfolio and poor project execution has created significant slips in revenues and profits.

Table 2: Zone 2 Metrics Perspectives provides additional data on what these ten metrics can be used to manage. Figure 3: Zone 2 Metrics Graph maps these metrics onto the metrics perspective graph.