Why Profitability Matters

Originally published for PSVillage's PS Pulse for professional services executives.

PS Village has been a great source of advice and recommendations, and the best advice I received came a few years ago. I was struggling with balancing the needs to train and develop our professional services team versus the need to keep my team billing in order to ensure high resource utilization.   The advice:  “Take control of your P&L and you will control your destiny”.  I did start to measure and demonstrate the profitability of our services team, and that has transformed our ability to execute.

What About Resource Utilization?

Resource utilization is the metric that we talk about the most.  Fantastic articles have been written in this forum about benchmarking utilization, defining the correct numerator (Billable only?  Non-billable?) and denominator (2080?  Include or exclude vacation?), target utilization by role, etc.   And resource utilization is a great tool – particularly for the individual consultant. If you measure someone on utilization and show them their utilization in real-time, their utilization will increase.  Although utilization is a great driver of consultant productivity, it is rarely the right metric for the PS executive.  The services business has evolved to introduce complexity that a simple utilization metric cannot address.

Evolution of Services Delivery

As customers get more demanding, and as professional services organizations have evolved to creatively address revenue growth opportunities and cost reduction opportunities, the financial terms of a customer engagement are no longer limited to simple hourly billing.

Fixed fees/Packaged Services Offering

When you agree to deliver services for a fixed fee, utilization instantly becomes difficult to define.  Is a consultant given credit for every hour spent on a fixed fee project as though it were a billable hour?  Does every consultant get credit for an equal billing rate?  How do you motivate your team to deliver the project early – with fewer hours – and not penalize their utilization metrics?  None of these questions are easy to answer.  But we can measure the profitability of a fixed fee project and judge the financial success quite easily.  We can furthermore compare the profitability of a fixed fee project to what would have been billed in a time-based billing model.  

And if you can develop a packaged services offering where you gain efficiency in delivery as you execute more projects, you want to realize those financial benefits.   If you provide incentives to consultants that reward them for spending more hours on client facing work, they your utilization metrics might be in conflict with your profitability goals.

Business Development Investment

Building a services business can become complex as your clients become larger.  Effective service delivery becomes much less dependent on an individual project, but more dependent on an overall client relationship.  By measuring project profitability, you can understand which projects help and which ones hurt. Furthermore, you can view client level profitability which might provide insights you had not anticipated – perhaps a project lost money but earned you additional profitable work. You need to understand the value of the customer. Utilization won’t address this question as much as profitability will.

Offshoring/Contractors

Finding cheaper resources to execute the work on a project can greatly reduce the cost of delivery.  Quite often, competition can force you to reduce your billable rate for these resources.  Utilization can enlighten you to how busy these resources are, but you need to understand profitability to fully understand the impact of these offshore resources.  Similarly, hiring contractors can enable you to keep a smaller bench and thus increase employee utilization. But what if those contractors cost more than your employees, how do you measure the impact of contractors on your P&L? Utilization won’t help, you need profitability.

Team Development

Going back to my conversation from a few years ago, the advice was to take control of the P&L.  When a VP of professional services is discussing training with a CFO, it’s unpleasant to answer the question “How will a week of training in March affect our billable utilization for the first quarter?”  The answer is, of course, it will negatively impact utilization.  But if the question from the CFO is instead “Will you hit your Q1 profitability target?” you have a much better chance of saying “yes.”  As a professional services team evolves, you will need to spend time recruiting, training, and team-building – all of which are non-billable, but essential to the long-term success of your team.  If you allow yourself to be subject to the question of “How will this impact utilization?” you have already lost the argument.

Conclusion

“Control your P&L, and you will control your destiny”.  If you are meeting your financial targets, you will have the freedom to invest in your team, and better enable your team for future success.  Furthermore, financial reporting for software companies is evolving to a point where reporting on license revenue separate from services revenue is required, highlighting the need for profitability of your services group (see EITF 08-01) There is still a place for utilization as a metric in your PS organization, in motivating individual contributors and providing a simple benchmark both internal and external to your team. But when it comes to larger business decisions, profitability is far more enlightening and empowering