Economics of Professional Services 7 - sensitivity issues in time based charging

Having established basic parameters for normal time based charging in previous posts, we can now look at some of the variables likely to affect outcomes and the way they should be handled for planning purposes.

The first variable is treatment of write-offs/write-ups.

A write-off arises when time spent cannot be recovered, whereas write-ups involve billings beyond the direct time involved. The first reduces average fees, the second increases average fees.

Both write-offs and write-ups are of particular importance in fixed price jobs.The higher the proportion of work derived from fixed price contracts, the greater the attention that must be paid to unders and overs.

Sensible business development therefore requires a conscious approach to the measurement and management of both write-offs and write-ups.

The second variable is the size and management of workload fluctuations.

Calculation of time and charge targets is based on time available in a period. Fluctuating workloads can play havoc with such calculations in creating alternative periods of under and over capacity. To the degree that extra resources have to be bought in during peak periods or jobs foregone, then either costs are increased or revenue reduced.

The degree of problem will vary from business to business. In all cases, a conscious management policy should be adopted to minimise the impact of workload fluctuations.

The options here include:

• expanding working hours to cope. This approach is more feasible where planning has been based on eight hour days and reasonable billings targets, since this creates short term overflow capacity.
• reducing revenue and profit targets to match internal resources more closely to peak workloads. This approach can make a lot of sense if combined with a policy of concentrating on higher yield work, deliberately weeding out lower yield work.
• carefully scheduling both charge and non-charge activities to maximise the value of available time: developmental activities can be defined in advance to be carried out in low charge periods; work on jobs can be started in advance of formal start dates; alternatively, work on specific assignments can be slowed down.
• deliberately outsourcing work, using rises and falls in use of external resources to protect internal resources from the impact of workload fluctuations. Under this approach, targets are set in such a way as to fully utilise core resources, with work beyond this point outsourced.
• The critical question here is the likely scale of workload fluctuations. To illustrate by example, the full utilisation of internal resources at all times may be associated with workload peaks of up to 160 per cent of capacity, with an average of 30 per cent. In this case, marketing targets would be set at 130 per cent of internal capacity, while resource planning and costing would include allowance for maximum use of external resources of 60 per cent of internal capacity for defined periods.
• deliberately managing marketing activities to try to generate a more even work flow. One of the features of workload fluctuations is the way they can be entrenched by the production/marketing cycle. In high work load periods marketing declines, leading to a fall in new work. As work falls, marketing increases, leading to a subsequent new work peak, again marked by low marketing. Thus workload fluctuations lead to marketing fluctuations which in turn lead to workload fluctuations.

The third variable is the composition of work.

All jobs contain a mixture of activities. Because market rates vary with type of work, so the real return from the job will vary with the mix of activities contained within it.

Large consulting practices mix and match varying levels of charge staff to take this mix into account. Among other things, this allows partners and other high level staff to achieve high personal charge rates since they can concentrate their time on high billable activities.

The independent does not normally have this luxury, personally completing all the different mix of activities relating to the job. This factor alone is sufficient to explain the normal difference in personal billings between independents and equivalent capability partners in major firms.

As the composition of work changes, so returns will vary. It is therefore very important to be aware of both the activity composition of particular jobs and changing types of activity over time.

Most independents handle this problem on one of three ways.

• they ignore it entirely, simply quoting whatever price they consider necessary to get the job regardless of daily or hourly charge rates. In this context, many independents do not have in fact have standard charge rates. This approach nearly always leads to below average returns
• they apply a standard charge rate to the time involved in all jobs regardless of activity mix. This approach gives better results in that the return on specific jobs is more certain. However, it is likely to lead to over and under bidding. The first means loss of work, the second loss of profits
• they concentrate on relatively uniform work types related to their capabilities, thus effectively minimising the problem.

In practice, the best way of managing the problem depends upon the particular business but is likely to involve:

• analysis of the changing patterns of work to determine the mix involved. Without this, the practice is flying blind.
• a measure of concentration on particular types of work.
• a deliberate policy of subcontracting work, concentrating internal resources on higher level activities.

Most independents feel that they are too close to the line to follow the third option, subcontracting. This may be true, but comes at a price. Using another consultant, a casual or a shared resource allows the independent to concentrate not just on higher level production, but also on business development and marketing, thus growing the business. It also builds longer term capabilities. The alternative approach can lock the independent into a vicious, low yield, cycle.

The composition of work also affects the ability to vary charge rates.

Calculation of charge rates allows for down, business development and marketing time. Because larger long term jobs reduce the need for marketing time, rates can be reduced without affecting the bottom line.

To illustrate by example, postulate a $1000 daily charge rate with a 60 per cent charge target. This combination means an average daily yield across the whole year of $600 per day. The same consultant working full time on an assignment for an extended period can charge out at around $600 per day instead of $1000 and still generate the same fees.

Introductory post. Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

Economics of Professional Services 6 - use of associates

Most small firms use associates or other subcontractors to fill capability gaps and to leverage performance.

The costs associated with subcontractors represent a disbursement, the costs directly involved in doing a job. From the perspective of the individual business, the critical questions are:

• the impact of subcontractors on net fees, fees remaining after disbursements.
• the way subcontractors are to be treated for business planning purposes.

Answers to both questions depend upon the role subcontractors are to play in the business and the precise financial relationship between the subcontractor and the business.

Traditionally, small consultants use subcontractors as an add-on to gain specific jobs. Because the focus is on net fees to the practice from their own time, subcontractor issues are generally ignored. The sub-contractor is paid their standard rate, the client is charged that rate.

The Ndarala model is different in that it is specifically based, among other things. on cross-selling and work sharing. If the model is to work, marketing targets have to be increased to cover not just direct net fees but also a specific minimum allowance for work to be placed with other Genesis members.

The exact impact of this upon the business plan and firm economics depends upon the nature of subcontractor relationships. Note here:

• the firm gaining the work has to receive a return from its marketing efforts. This has to come either from cost recovery or from cross selling
• time, costs and risks are involved in managing other people in a job. As a simple example, if sixty per cent of work is subcontracted, then the prime firm bears 100 per cent of the risk for 40 per cent of the work. A reward has to be received for these risks and costs.

In the Ndarala case we have tried to accommodate these issues through an internal system of fee discounts - generally twenty per cent - combined with marketing commissions on work brought in of up to twenty per cent.

In theory, this should allow a practice to build a solid business based around the conscious use of fellow Ndarala professionals. While this has encouraged cooperation, it has not delivered the results we originally hoped for for two main reasons:

• First, management of associates is a business and management skill in itself, one that has to be consciously acquired. From experience, while most independent professionals do have project management skills, they lack management skills. Mind you, that is not unique to them!
• Secondly, building a business around the conscious use of associates or other subcontractors requires a shift in business thinking. Without this, associates will always remain an add-on.

I make this point based on our own experience because I find that many professionals are still interested in leveraging their returns from the use of others. So they do need to think through the issues.

The contracting firms themselves that have extended their reach in recent years are themselves an example of leverage. Generally they take a far higher proportion of the fee charged to the client - up to two thirds - but they also find the work and take care of the paper work, something that can be very attractive.

So associates can work in increasing your yield, but you need to think the issues through.

Introductory post. Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

Why Lightbulb Works - a case study in business blogging

Photo: Noric Dilanchian.

Ndarala member practice, Dilanchian Lawyers & Consultants of Sydney, has used it general web site and especially its blog to great effect. Noric Dilanchian supplied Des Walsh with a brief statement on the role of the Dilanchian blog. I am repeating it here because it is an interesting case study.

The Post

The Lightbulb blog on our http://www.dilanchian.com.au/ website is 12 months old. That makes it a new born. Our website is five years old, which makes it ready for primary school. As for some of the writing in the Library section of our blog, it's about 18 years old, which means it is now adult content.

Making the baby blog a success among its siblings has required passionate stories, research notes, investigative reports and other types of writing. In shorthand, we call them posts, like everyone else. The rare post which works to generate client enquiries is heart-felt, has a logical structure, has an edge or smarts or even humour, provides practical advice and keeps it real for the specific audience we have in mind when we select the post's topic, title, style and positioning.

Being topical, controversial and prolific are not necessarily virtues when it comes to generating client enquiries from our Lightbulb blog. The effect of the rare post that works is to both capture and communicate our insights and capability as lawyers and consultants with decades of experience. Those posts engage prospects to explore our blog further. They make them go beyond one page. They make them check out the blog's siblings and read or scan between say 5 to 30 pages of our extensive website.

At a certain point, typically after browsing between 5 to 30 pages, some of our visitors turn into prospective clients when they are moved to call or email us with an enquiry. How we then respond to serve some as new clients, or refer them to others, is an important part of how we benefit from our blog.

Our broader web site content clearly helps our blog greatly. There are many lessons here.

Also essential is our consistent use of all the usual search engine optimisation habits and our regular monthly enewsletter. While digital media has made publishing and communication faster, easier and cheaper, to get to the best form of communication (which I believe to be theatre and conversation, that's particularly because both are interactive) you have to have something worth saying and a voice, ie an ability to communicate in an engaging way.

You have to add to all this your dedicated time, commitment, devotion to maintaining first rate publishing standards, energy and good karma. It's not something you can do on your own. Like all authors, it helps to have colleagues and friends who can help you in research, check your assumptions, and give you regular leads, feedback, technology ideas and editing suggestions.

Despite the huge effort it involves, I have found having a blog a very special experience. As intellectual property and business law specialists, we consider it a vital service to our clients to regularly scan or go over the horizon and report back to our clients to give them advanced guidance, all in language they can understand and media that engages them. A blog has added to the ways we achieve this.

The Economics of Professional Services 5 - normal time based charging

Most professional services businesses derive the majority of their revenue from time based charging. Revenue therefore depends upon the combination of billable hours times the charge out rate achieved per billable hour.

CALCULATING MAXIMUM BILLABLE HOURS

In theory, there are 365 days in a year. In practice, time needs to be taken out for weekends, holidays and illness. This holds, or should hold, even for the sole practitioner.

Deducting this down time, there are around 220 available working days in an ordinary year. With eight working hours per day, this gives a maximum of 1760 working hours in a full year.

Note that the eight hours per day should hold even for the sole practitioner. We work to live, not live to work.

I know that the reality is that many of the big shops work on more hours than this. Yet the real core economics of the practice do revolve around this lower figure.

Not all the 1760 hours is available for charge. Time has to be spent on business development, marketing and administration. The next step, therefore, is to calculate the charge target, the real time available for client specific work.

There is no absolutely correct figure here. However, as a guide:

• within the constraints set by an eight hour day, the sole practitioner is unlikely to be able to achieve more than sixty per cent charge time
• charge targets for junior staff members are generally higher, round eighty per cent
• with partners or team leaders, charge time will be lower because of greater marketing, business development and administrative responsibilities.

Once charge targets have been set for each staff member, total available charge time can be calculated by simply adding the staff totals together.

CALCULATING TARGET AVERAGE CHARGE RATES

Available charge time can now be used to calculate target charge rates.

Each business has to cover its costs plus the desired profit. Proprietor’s income can be counted as either a cost or included in profits.

Both approaches are followed in practice. However, it is generally desirable to make a distinction between:

• the target return for the proprietor’s labour which should be counted as a cost
• the target return on capital which should be profit.

Once costs and target profits have been calculated, target average charge rates can be calculated by dividing available charge hours into target revenue.This gives the average billings per hour that must be achieved if the practice is to achieve its financial targets.

Note that this calculation provides a basic reality check. If the average charge target cannot be achieved, then the whole business plan must be revisited.

CALCULATING INDIVIDUAL CHARGE RATES AND CHARGE TARGETS

Once the average charge target rate has been calculated, it should be broken up by staff member or staff category.

There are no absolute rules governing charge rates. Charge rates vary for different professional categories, for different types of work and by industry and market position.

Once the average charge rate target has been broken up into charge rates for individuals or staff categories, individual billings targets can be calculated by multiplying charge rates by target billable hours.

Once this task is done, we will have calculated:

• available billable hours in total and by staff member and staff category
• revenue targets covering both costs and desired profits
• the average charge rate necessary to achieve target revenues
• the average individual/staff category charge rate necessary to achieve the average
• individual charge targets required to achieve total revenues.

Introductory post. Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

The Economics of Professional Services 4 - sources of income

This next series of posts reviews the normal sources of income open to a consulting practice.and discusses the variables likely to affect those sources of income. It aims to improve business performance by improving understanding of and therefore the capacity to manage the various variables involved.

Our discussion begins with an analysis of normal time based charging since this is the way most practices earn their income.

The chapter then reviews a number of ways of increasing returns on particular jobs:

• multiple charging
• the role of cost recovery in ensuring proper returns
• the use of special levies
• and the way in which structured approaches to intellectual property and productisation can be used to improve returns

Introductory post. Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

The Economics of Professional Services 3 - structure of the guide

This guide provides a basic introduction to the economics of professional services with the aim of providing information for use in business planning and practice development.

The guide draws from a big consulting background. However, the core lessons are just as relevant if not more so for a single person operation since single operators are generally much closer to the margin.

This post itself is meant to provide an overview of the guide. Because of the way that we are presenting this material as a series of blog posts, we will add to this post as we go along.

Introductory post. Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

The Economics of Professional Services 2 - Definitions

This second post simply provides some definitions. We will add to these as we proceed.

Billings

The term billings simply describes the value of work actually billed to the client. These billings will include disbursements if these are to be recovered from the client.

Disbursements

Disbursements are simply the cash-out costs directly involved in doing the job.These may be very small, bus or taxi fares, phone costs. However, in some consulting work they can be very substantial, especially where subcontractors are used.

Financial Flows

These simply definitions provide the basic financial structure for the standard professional services firm.

As we do the work we create WIP. As our future billings, WIP is a key asset of the firm.WIP minus any write downs plus any write ups then translates into billings as we bill the client. So in balance sheet terms the WIP asset has been replaced by accounts receivable. Then as the client pays, accounts receivable become cash.

Gross Fees

Gross fees simply describes the total value of work we have or will bill the client.

Net Fees

Net fees, the amount we actually get for the job, equals gross fees minus disbursements. This is our real income.

Prepayments

Clients may pay us in advance for part of the work.In some cases, law is an example, these may be placed in a trust account and excluded from firm accounts until the funds are drawn down upon billing. In consulting, advance payments may be made upon contract start or on meeting certain milestones to help fund the job. In these cases, the prepayment is formally a liability in an accounting sense, diminishing as work is done and WIP created.

Work in Progress

Work in progress or WIP represents work done but not yet billed. It includes disbursements where these are to be charged to the client.

Write Ups, Write Downs

Actual billings need not equal WIP. When we come to bill, we may find that we cannot bill the client for all the time involved. In this case, we have to write WIP down. In other cases, we may be able to bill more than the time directly involved. In these cases WIP is written up.

As an aside, write downs are not necessarily bad, write ups not necessarily good. A firm without WIP write downs may be undercharging, a firm with write ups over charging. It depends upon the circumstances.

Previous post. Next post.

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

The Economics of Professional Services 1 - preface

It is now eleven years since Ndarala first emerged as a network, while some Ndarala professionals have in fact been in professional practice for more than thirty years. During that time, we have generated a very wide range of material for both clients and ordinary operational purposes.

Understandably, the economics of professional services has been an enduring concern. In this context, some ten years ago I began the preparation of a book on the economics of professional services to draw some of this material together.

While I still hope to complete this at some stage, the daily pressures of life have kept intervening. For that reason, we have decided to run excerpts of some of this material both to make it more broadly accessible and to encourage further work.

As with most of these series, we will use this post as an entry point, adding details of subsequent posts at the bottom.

Comments and questions are very welcome.

Posts in the series

1. Preface - this post
2. Definitions
3. Structure of the guide
4. Sources of income
5. Normal time based charging
6. Use of associates
7. Sensitivity issues in time based charging

Note on copyright

This material is copyright Jim Belshaw. It may be reproduced or quoted with due acknowledgement.

Management Perspectives - Blog perfomance review August 07

Another month, another performance review.

In my July perfomance review I mentioned that blog traffic had been well down because of irregular posting. This has continued to be something of a problem. Still, August traffic was well up from July, September traffic will pass August, so things are heading in the right direction.

Again, the pattern of top entry pages has changed.

After the front page, by far the most popular entry page was the Importance of Demography and Demographic Change - update. This stocktake post drew together various demographic posts as at 10 February 2007.

This was followed with a reasonable lag by Changes in Public Administration and their Impact on Public Policy 1 - Introduction. As the name says, this is the first post in a series and was in fact the lead entry post after the front page in July.

Then further back came five equal posts.

The first was a case study, RANZCO Setting the Standard - Developing Ophthalmic Competencies, looking (as the name said) at the development of ophthalmic competencies.

Then came A New Way of Ranking Universities by Student Experience, a post dealing with the development of a new measure of university rankings. The following post also dealt with higher education - Changes in Higher education - UNSW's Singapore Problems.

The last two equal entry points were both management related, Common Management Problems Series 1 - Dealing with poor performers 2 and the management techniques label.

One interesting feature of the month was the ratio between visitors and page views. Each visitor looked at an average of 1.9 pages. This is quite good.

Finally, and as an afterthought, the following graphic sets out traffic by country.

Personal Networking Strategy in an On-line World

There was an interesting post by Dennis D. McDonald addressing this question: would you benefit from having a personal online networking strategy?

In Dennis's view, a "personal online networking strategy" is a coherent view of how you use various media for communicating and managing relationships with other individuals and groups.

Now I actually wish that I had read this before I gaily sailed forth. Then, a Google search on Belshaw generated less than a thousand hits. Today, there are more than 492,000. Of these, as best I can work out, something over 10,000 link in some way to me.

Now I am not complaining. It's just that when I ventured forth into the on-line world I had no idea so that so many aspects of what I do or think about in both personal and professional life would become so visible. It becomes very hard to hide!

Maybe if I had thought about it, I would have gone a different route. But then, perhaps not. Still, I would have done things in a more conscious way.

I commend Dennis's post to you as a short, simple, introduction to the things that need to be considered.