plus specific ways to improve in services, marketing, sales, delivery and support.
by august j. aquila
price it right
accounting firms focus on top-line revenue or net profit. but are they focusing on what really matters?
more: tomorrow’s leader in 9 bullet points | checklist: 18 essential steps to effective billing | how to get partners to accept a new pricing philosophy | 12 pricing factors beyond cost | 13 questions about providing value | how to shift from production to marketing orientation
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profitable businesses involve more than just selling more products and services to increase revenues. there is an old joke in the retail business: a salesperson tells the manager that they are losing $1 on every shirt they sell. the manager says, “don’t worry, we can make it up in volume.”
even though your firm may have a sizeable client base and predictable income streams, the firm may not be sustainable. how can this be?
one reason could be the gross margin. a deeper understanding of gross profit margins should aid in choosing the services on which the firm owners need to focus. the current economic environment should cause even the most astute managing partner to examine the gross margins on their services.
accounting 101
i think everyone would agree that if there is no profit, there is no firm. the most important unit of measure in a professional services firm, then, is profit. to keep it simple, we can say that profit is a factor of several variables – billing rates, hours billed, direct labor cost, sales, general and administrative expenses. think of it this way:
billing rates times hours billed = revenue
direct labor costs times hours = direct cost
revenue less direct cost = gross margin
gross margin less sales, general and administrative cost = profit
gross margin in a service firm
unlike product companies, a professional services firm has labor for its key cost of goods sold.
each service has a different gross margin and unless you know the gross margin for the various services you offer, it is impossible to maximize your firm’s profitability. ultimately, improving the firm’s performance comes down to understanding and taking action to improve and maintain your gross margin level.
in professional services firms, gross margin can vary widely from service to service. at one time, accountants used to say that one-third of revenue went to employee compensation, one-third to overhead and one-third to profits. if that were the case, firms were looking to have a gross margin of 66.6 percent. the first thing you want to do is to establish a realistic gross margin target if your firm is going to stretch itself to grow. then, start evaluating the business functions that have impact on your gross margin.
in 1997, david maister in “managing the professional service firm” presented his profit per partner formula, which remains highly relevant today:
profit /partner = profits/fees × fees/hours × hours/staff × staff/partners
= (margin) × (value) × (utilization) × (leverage)
because many of the above variables can be manipulated, maister noted that firms “should hold each practice (or partner) accountable for a profit per partner target and let the practice (or partner) figure out the best mixture on margin, productivity and leverage necessary to achieve this goal.”
as maister noted in 1997 and is still the case today, few firms use net profit per partner as their main method for regular reporting of practice economics.
improving gross margin
analyzing your current gross margin should reveal areas for improvement. you may have identified new issues or ongoing ones, which never seem to go away. either way, you have to implement changes that will be sustainable and not overly cumbersome. where do you start?
the section below presents a number of ways to improve or maintain gross margin either directly or indirectly. some are quick fixes, while others will be more difficult to operationalize. select the ones that appear to meet your needs, prioritize the list and begin implementing them.
for most companies the importance of gross margin is well understood. the challenge is operationalizing all areas that impact it – making the time to review all sales opportunities and delivery projects, evaluating and enhancing internal processes, providing relevant education for sales and delivery, etc. these efforts can seem overwhelming. if you cannot do some of it because of time constraints or not having some of the knowledge, get help from a consultant.
managing your gross margin is that important. can you afford not to?
ways to improve gross profit
services
impact on gm: having unique and value-added offerings enables you to charge more of a premium for your services. also, the more you sell of these services, the more efficient you become at delivery. both the increased revenue and controlled delivery costs will favorably impact your gross margin.
start by asking these questions:
- is there a real need for our current offerings?
- how long will that need last?
- are our offerings unique to the technology, industry and/or business area, allowing us to price them accordingly?
- are our offerings repeatable or scalable, enabling efficient delivery of services?
marketing
impact on gm: targeting the right the markets (i.e., geography, industry, companies, buyers, influencers, etc.) for your services is essential, followed by creating awareness and demand for these offerings. having prospective clients want your services will enable you to value-price your work for them.
start by asking these questions:
- do our service offerings align with our marketplace?
- are our target clients aware of how our services can benefit them?
- do current clients know about our other services?
- are our marketing campaigns focused on selling our differentiated offerings?
- are we generating enough qualified leads for the business we want?
sales
impact on gm: qualifying and pursing the right opportunities increases your probability of winning deals and enables your sales team to work more efficiently. these should result in shorter sales cycles, a better contracted backlog of business, and higher booked margin per project.
start by asking these questions:
- do we manage the sales pipeline to ensure our team is focused on selling the right services versus selling anything?
- is sales management working with finance to periodically review and set rates and guidelines for pricing and discounts in order to reach or maintain our targeted gross margin level?
- do we revise our project estimating assumptions and guidelines based on actual project outcomes or do we risk repeating history based on potentially flawed or outdated assumptions?
- are we monitoring client negotiations to ensure concessions or compromises (scope, time frame, pricing, etc.) have the least possible impact on gross margin or do we at least understand the impact we agree to?
- does our sales incentive program drive the results needed to achieve company revenue and margin goals?
service delivery
impact on gm: having good project management and a delivery methodology and tools that are followed on a consistent basis should enhance project quality and efficiency, helping to control costs. resulting project margins should be on target; unplanned fee write-offs should be minimal, if any; and ultimately, client satisfaction should be high.
start by asking these questions:
- is our project manager controlling the scope of work and corresponding fees with client involvement?
- are all components of the project being monitored and corrective actions taken as necessary?
- budgets and overall time frames
- efficiency of work being done
- quality of work/rework
- charging/billing all time incurred and allowable
- personnel issues that could cause problems or delays
- are we managing client expectations to avoid project issues and delays and to optimize the relationship?
support services
impact on gm: internal business operations have an indirect, yet important influence on revenue and costs affecting gross margin. for example, untimely turnover of delivery personnel can create inefficiencies on projects resulting in delays and cost overruns, which will reduce gross margin and possibly impact client satisfaction.
start by asking these questions:
- do we have a staff retention program in place or at least enough proactive focus on this area?
- are we managing billability/utilization to minimize bench costs and maximize services revenue?
- are we providing up-to-date project tools and it services to improve delivery quality and efficiency?
- do we ensure accurate and timely billing of fees and expenses to avoid client issues and potential revenue write-offs?