How to run a more profitable services team
People who run professional services teams often optimize systems to aim at the wrong metrics. By aiming at more useful metrics, you can change the results and have a healthier business.
In a project-oriented professional services team, profit is the result of completing work within a fixed time period, and having revenue associated with that work be greater than your costs.
How much money do I need to make?
My conversations with colleagues who run services teams often leads to billable efficiency, or out of the hours that you pay someone to be at work, how many of those hours can be billed to a client? Every agency has their own numbers, but for most small to medium teams (15–75 people) a reasonable target is 65%. It’s not too great a stretch, but if you have mid-market rates and pay mid-market salaries, you should be sufficiently profitable at that percentage.
Large firms with executive salaries and vertical management structures probably need to aim for a target above 80%, while smaller firms (15 people or under) with fewer non-billable team members can probably get away with 50% or lower and still pay salaries and bills.
I’d guess that most humans would look at numbers like this and start to build systems to try to control that percentage as a key business metric. However, that’s a mistake because billable efficiency is a lag metric.
Lead versus lag metrics
When you’re measuring anything in business, a skill to invest in is the ability to detect whether something is a lead or a lag metric. A lag metric like profit is the outcome of a number of other systems working properly. A lead metric is something you can and should directly influence.
You can’t aim directly at profit and expect to control it, because it’s a lag metric. But other systems contain lead metrics that you and your team can directly influence. You can measure client satisfaction with effective account meetings or touchpoints (please don’t use NPS). You can measure your work management system (i.e. time tracking) and your quality (through a measurable test strategy). You can even measure your market reach through search engine ranking.
Ensuring that the things you can directly influence are healthy (lead metrics) is how you produce lag metrics like profit. Billable efficiency is definitely a lag metric, because you can only really measure it after the work has been completed. I was in a group of agency owners talking about this; one person was fretting about their low billable efficiency and how they needed to increase it. Someone else asked the astute question: “Is the the problem that you have so much work to do but your team can’t get it all done because they’re doing non-billable work instead?” No surprise, the problem was a low supply of billable work, so aiming directly at the lag metric was futile. They needed to focus on work coming into the pipeline first, and if other systems were also working, then the results should be higher billable efficiency.
The basics of service team finances
Imagine you run a services team. We’ll keep it simple, you’ve got 10 people who each make $60,000/year and that accounts for ~70% of your total expenses, so your annual cost to run your business is roughly $860,000, or ~$72,000 per month. That’s your cost of services. 9 of your people are billable, and 1 is purely administration. You run various projects and they typically cost $50,000 and take 2 months to deliver, so you need 4 projects running concurrently to hit $100,000 in revenue each month (that’s a 39% profit margin which is excellent in this industry!). You charge $150/hour so there are ~330 planned work hours in each $50,000 project and you need your services team to deliver 660 billable work hours each month to hit that $100,000 goal. Your 9 people are expected to work 220 days per year (accounting for 10 statutory holidays, 20 days of vacation, and 10 days of sick time) at 7.5 hours per day, which gives you 137.5 hours per team member per month, or 1237.5 total working capacity for all 9. That means that your billable efficiency target is 53%. Congrats! If you have a steady supply of the right kind of work, you have a very profitable services business. Can we trade jobs?
The problem for most teams that grow past 15 people is that you start to add overhead, which puts pressure on the system. When you have a 20-person team, you could have 4 people that are not billable (sales, HR/admin, managers). Also, your salary and overhead costs will increase. Why? Because past 15 people, they no longer work for YOU they work for YOUR COMPANY and they’ll expect more from the company than they expect from you. Ask anyone who’s passed that number. With higher costs (let’s say everyone wants to make $70,000 now, that salaries account for 65% of your expenses, and that you have 16 billable team members out of 20) you now have a monthly cost of $180,000 and 2,200 hours per month of total capacity. To hit that tasty 39% profit margin by generating $295,000 in revenue, you’d need to bill 1967 hours at $150/hour, or almost a 90% billable efficiency! So you settle for a more achievable 20% profit target which comes with a 68% billable efficiency. That’s a bit more intimidating than 53%.
If your experience is like most, you’ll also stumble into the following frustrations:
- Projects never line up nicely like Tetris blocks, so you’ll always have either too much work, too little work, or work that doesn’t quite match your team’s capabilities.
- People make mistakes a LOT, and in a growing company there are fewer systems in place to ensure quality — 10 people can eyeball it, but 20 people need checks and balances that you haven’t built yet. You have to put in extra hours to make up for mistakes or to build those systems.
- People come and go during growth, and that means hiring, onboarding, training, and up to 3 months per person before they really start to produce like someone who’s experienced.
- Your initial reaction to untrained people, lack of formal systems, quality issues, and project overruns will be to start hiring more managers or project managers, which further increases your costs without necessarily adding more revenue capacity.
- You’ll react by increasing your rates, which will work if you are in very high demand, but more likely it will start to reduce your competitiveness, driving away existing clients and making it harder to win new work.
- You’ll focus on time tracking to make sure you’re capturing every possible hour, but with that extra focus, your team will become aggressive with putting their time, even learning and meeting time, against client budgets. In no time you’ll find that you’re running out of project budget before you complete the work due to overreporting. You’ll frustrate your clients or have to do free work to get to end of job.
I won’t say relax since that’s impossible now, but also don’t feel too much failure. Unless you’ve done this before, this is normal. But it’s the problem to solve if you want to grow. Remember that 10-person team? So much easier to run and more resilient to market changes.
If you’re like most people in this business, you’re going to lie awake at night thinking about that elusive 68% billable efficiency that will give you your 20% margin. Why is 20% an important target? Well, if you’re like most businesses then you pay your people as they do the work, and invoice clients after the end of the month, then clients pay somewhere between 30–45 days after they get the invoice. That means that for up to a 75-day period you’re financing your business and your clients’ projects. And 75 days is 20% of 365. So if you don’t hit a 20% profit margin, then you are running your business on bank credit and never have cash in the bank when you need it to pay for office renovations, a team retreat, or that sweet dividend that you deserve.
Can I lose money and still make money?
Billable efficiency is a good lag indicator of health. You can calculate it at the end of each month and get a sense of how you did, but once you know what it is, it’s already too late to influence it.
I think that two better metrics to focus on are:
- The total amount of revenue booked in a month, and
- Your team’s ability to complete the work associated with that revenue.
Here’s how you can lose money on a project, but still make money. If you are the 20 person company and you’ve booked $200,000 of great work in a month, you’re probably feeling OK. You’re profitable, but still financing the business since you’re below that 20% threshold. Your team needs to be 61% efficient that month (1333 billable hours out of 2200), which gives you flexibility and resilience.
A client shows up with a large but straightforward project and a $25,000 budget. You know you need 250 hours to do the project, which appears to be a net loss on the project. But you do have that available capacity on your team, and you know that you can likely complete the work within that calendar month since it’s not complex.
To do the existing work (1333h) and the new work (250h) you’ll need to hit a 72% billable efficiency. It feels achievable so you commit to the project at a fixed price. Your team completes the work, and you’ve now generated $225,000 of revenue in a month, bringing your profit margin up to 20% even though that project was a loss.
The converse is even easier to imagine. You can run one $50,000 project in a month and be highly profitable in isolation, but since your total revenue is far below your cost of $180,000, you’re profitable on the project, but losing money as a business.
In reality, you’re going to have a wide variety of projects, with different challenges, client expectations, and team members. It’s complex. And the more you stare straight at that billable efficiency, the more impotent you’ll feel as a leader. You cannot will or command your team to hit a lag metric, since it’s not something under anyone’s direct influence.
Build a service team around lead metrics
Instead of aiming for untouchable lag metrics, aim for lead metrics you can influence.
The most important lead metric is, do you have enough revenue booked in a given time period, and a month is a good convention to follow since it’s how your accountant, the tax department, and lenders will evaluate your financial health. You can build a solid revenue planning tool in Excel or Google Sheets in an afternoon, or use one of the many web-based software tools designed for this purpose. You can build a secondary set of lead metrics into any sales pipeline tools that you use — how much new work are you quoting on in a time period? — what percentage of that work do you win historically? This will start to become your long term planning tool, and after 1–2 years of using these metrics, you’ll start to see the patterns in your business.
The second lead metric is, can your team complete the work associated with that revenue? Clients will appear to buy time, but they actually expect something other than time to be delivered. This is where a pure time and materials model can be challenging. You can hit 80% of a project budget but only be at 50% of what the client expects.
The skill you need to build into your team is the ability to keep project invoicing and project completion locked together. You can achieve this in many ways, including:
- Hire strong negotiators (project managers) who can manage client expectations or increase budget. The risk will be finding and retaining these people.
- Build your projects around milestones where you only get paid when you complete each piece of work. The risk will be getting to the end of a month and not being done — you’ll have a revenue hit you didn’t plan for, and the extension will impact your work capacity in the following month.
- Go pure Scrum where clients pay for time without any fixed deliverables. This offloads the risk to the client, but your risk is that fewer clients will agree to a Scrum contract, and those that do will secretly build expectations about project outcomes which you then have to manage.
- The best way is the approach you choose to build: invest in team thinking, management systems, and communication tools. You don’t buy this off the shelf, you grow it organically within your team. It takes time and change management.
We run our shop on Kanban, which is in the agile family, but provides us more flexibility for the consultative nature of our work. We’re continually working to provide our team better tools and skills for work planning and management, so that they can make better decisions. It’s a journey, not a destination.
By rebuilding the way you think about your business around these two lead metrics, you can stop chasing billable efficiency, which is a false metric to chase. It’s the result of doing other things right.
In a project-oriented professional services team, profit is the result of completing work within a fixed time period, and having revenue associated with that work be greater than your costs. Chasing lag metrics like billable efficiency won’t get you there.