Metrics-Their Value is in Creating More Questions – Part 3

In our two previous columns, we have discussed Realization, Leverage, Net Income per Partner, Business Generated and Capacity Budgeting™.  We will pick up this column working through a tool we use to determine a reasonable employee ROI by addressing what a firm should expect as a reasonable amount of billings from an employee at a specific staffing level given their current pay (salary plus overtime).  Just like every tool, using it should help you ask better questions, but it doesn’t answer them as there are many variables in play that determine a final statistic or metric.

The tool we use to take a look at employee ROI is “The Billing Worksheet.”

The Billing Worksheet

The Billing Worksheet is one of many tools we use to get a feel for our clients’ performance and compensation issues.  As you read through this explanation, please keep in mind that this is simply a way to begin looking at the ROI provided by each of your people, especially at the lower levels, where the main focus should be on their production as compared to managers and partners, where, for example, their main focus should be on client management, people management, and the like.  What we’re trying to do here is to see if charge rates, pay rates, hours utilized and realization all make sense in a bottom-line context.

The fallacy of how most firms set billing rates for their people is that they take someone’s pay, multiply it by 4 or 5, divide it by 2080 (40 hours a week) or some other number and establish a billing rate.  To us, that formula has decreased substantially in its relevance over the years.  This is because all of our people don’t do the same kind of work and the work itself has built in efficiencies and/or inefficiencies.  For example, consider a firm’s top, highly talented audit managers producing 1,600 hours of billable work, tax managers with similar skill levels producing 1,400 billable hours, and similarly skilled business valuation managers producing 1,100 billable hours.  If they all make about the same amount money, they should have different billing rates to make sure that, at the end of the day, they can return the same ROI expected by the firm.  If everyone has the billing same rate, you have not factored in the natural efficiencies/inefficiencies rooted in the work they are doing.  Using our example above, those audit managers will almost always be the darlings of the firm because they will bill more revenue, but the “one-rate applies to all” philosophy is actually sabotaging the other managers in the firm.  Continuing with our example, let’s consider that the firm does a lot of large audits where the auditors are out of town a great deal.  Doesn’t it make sense that while the auditors are traveling and in the field, almost every minute they work is billable (and therefore, probably earning a lower realization since no one can really deliver eight hours of efficient work every day)?  Now consider the tax managers.  They don’t travel and they typically work on smaller projects.  Because of the start and stop time between each project and the fact that they have so many projects, doesn’t it make sense that they can be working as much as the auditors in this example, but not be able to capture the same amount of billable hours (and because they are not onsite with the clients, their inefficiencies turn into non-charge time and therefore they tend to have a higher realization)?  Finally, think about the business valuation managers.  Because that type of work is often feast or famine, firms often pay to have a specific level of expertise that is sometimes underutilized at various times of the year due to the timing of projects.  For this group, you might find that those managers would be lucky if they can amass more than 1,100 chargeable hours no matter how hard they work.  The point is … everyone should have a fair chance to earn the appropriate ROI for their firm.  And for that same reason, people that work in multiple areas of the firm, we believe, should have multiple billing rates; with each rate appropriate for the type of work they are doing.  Remember, charge hours is one variable, realization is another, the billing rate is a third, but in the end, we believe it is all about total expected billable dollars.  Therefore, you have to consider what is reasonable given the work being done for each of those variables.  We use the billing worksheet to help assess where changes need to be made.

For this discussion, we are going to use some assumed numbers to illustrate the process we use with the Billing Worksheet.  The numbers in the illustration simply are sample numbers used to illustrate concepts, so please don’t get hung up on them if they are out of line with your marketplace or expectations.

As introduced above, the Billing Worksheet focuses on five variables:

1. Charge hours,
2. Billing rates,
3. Realization,
4. Annual salary, and
5. Multiplier

Manager Example: Billing Rate Analysis

In this example, you can see that we’ve chosen a manager with 1,500 actual charge hours from the prior year, whose billing rate is $125 an hour with 90% realization.  He or she is being paid $90,000 a year in our example here.  This pay figure typically is simply the base pay plus overtime pay.  It does not include performance bonuses/benefits such as health insurance, life insurance, retirement plan, profit-sharing and the like.

In this illustration, we use 2.5 (two-and-a-half times) as a multiplier.  We multiply this times the compensation paid to determine what the expected billed revenues should be from this person.  In this sample case, 1,500 actual hours billed times the actual hourly rate of $125 an hour, reduced to 90% actual realization, comes up to $168,750 actual net production generated by this $90,000 a year person (before other bonuses and benefits).  Now, compare that performance to our expected “return on investment” calculation.  In this case, with a salary of $90,000 and a 2.5 multiplier, it indicates that a reasonable ROI for the firm with someone making that amount of money should result in net production of $225,000.  This means that when you compare our expected ROI against the actual performance of this manager, we’re looking at a $56,250 shortfall in billings for this person.  That’s $56,250 of profit that could have gone to the partners or invested in the firm which is lost forever.  (In other words, $225,000 (expected ROI) less actual production of $168,750 (hours times rate time realization), creates a shortfall of $56,250).

Now, let’s take a look at some of the questions this information should bring to the surface.  Could you make up this difference by making that person more chargeable at their current billing rate and realization?  Theoretically you could, but based on the spreadsheet, you’d need to get 2,000 charge hours out of them and that is not realistic unless you want the manager to pad his or her hours.  The problem is that if the manager pads hours, then the 90% realization rate wouldn’t be attainable, so he or she will still be under-performing.  However, if this person isn’t well trained, then improving their skills through training could be the fix for the realization.

If we back into it, what this model points out is that your actual multiplier for this manager is currently 1.88 times salary, quite a bit off from the 2.5 times salary for estimated revenues that we used earlier.  If you would decide to stay with the lower multiplier here, then you would be saying that given the work this person is doing (because of its other value to the firm, like taking care of great referral sources, etc.) you would be willing to accept a lower ROI on their work.

Think about it.  Using $90,000 for base pay, you’ll still need to cover payroll taxes, insurance, other fringes, plus some share of overhead, and then what’s left, if anything, goes to the partners.  So, think about what an extremely low multiplier will actually be doing to the bottom line with respect to this employee and the contribution to operations.  It will actually be taking money away from the partners or areas that need additional investment within the firm.  Of course, there could be circumstances where this currently level of ROI could make sense and even be profitable for a specific employee doing a specific job.  For example, consider an auditor that works on some select non-profit clients.  These clients could have been offered special pricing as a marketing choice of the firm to position themselves to be in front of prominent people in their community (this is not an excuse for poor performing non-profit work, it is just an example of a situation that should be managed and limited—and your firm needs to actively capitalize on being in front of these folks).  In this case, especially if you know the employee managing that non-profit work is an excellent performer, you may choose to make his or her multiplier 1.5 or some other lower than normal number for that position because you know the reason for the lower billings is due to your firm’s strategic choice and therefore you are willing to make less of an ROI on this employee (or better said, you recognize that you are making a fair return using a lower multiplier because of the discount on fees you have passed onto the client).

As an alternative to status quo or increasing charge hours in this illustration, you could get back to the appropriate ROI on this manager by bumping their billing rate up to a rounded $170 an hour.  This would provide a reasonable ROI for the partners.  Now, you may be thinking that the market won’t bear that rate though.  If the market won’t bear that hourly billing rate for this person, then what we find is that the market also won’t demand that you pay this person at the salary you are currently paying either.  We have not seen a situation where a firm had to pay high dollars for staff, but their market would only pay low dollars for the work.  If that is the scenario you believe you are operating under, to us, that doesn’t make sense.  In rural markets, people cost less, and fees are less.  In large cities, people get paid more, but the market also allows for those salaries to be passed on through relatively higher fees.

The next question to ask yourself is, how efficient are your work processes?  And how well trained are your people if your overall efficiency is off?  And of course, whose fault is it if the people aren’t adequately trained?  It all goes back to what you value as a firm and what you’re willing to pay for.

So, you have four variables to consider.

1. Are you paying this person the right amount? This is the least flexible value, but it could impact how you offer future raises and bonuses.
2. Are you using a billing rate that makes sense with what you are paying this person? Often, the biggest part of the problem lies in this variable.
3. Next, you have to ask if this person is efficient doing their work. Often, this is a combination of training opportunities and getting partners and everyone else into the routine of delegating work as they should be doing, and
4. Are you getting a reasonable amount of charge hours? Often, this is a combination of performance expectations, poor delegation from partners, managing the pipeline and scheduling, etc.

Many times, this billing worksheet points out a number of problems the firm needs to address simultaneously in order for you to create a reasonable return on your people investment.  In other words, most firms want to put all of the blame on poorly performing people and projects when in fact much of the problem lies in poorly performing partners and managers not selling the work at the proper levels, not delegating the work appropriately, and not training those below them how to do the work.

On another note, we’d like to address a common objection we often hear when we suggest that you need to raise staff and manager rates.  And that is, “Our partners only charge—fill in the blank here, say $225 an hour, for example—so how can we charge that manager out at $170 an hour?  The answer is far simpler that it first appears.  In most cases, based on our experience, the partners aren’t charging high enough rates to justify what they make either.  You want billing gaps between each level of person within your firm.  If the rates for partners were where they should be, it will be easier not only to bill appropriately for managers, but also to move some of the work off the partners’ plates to their people because the clients would see a true price differential between partner rates and the managers’ rates and so on, down the line.  You may have heard us say this before, but whenever you raise rates, you rarely see enough client attrition to offset dollars earned from the new, increased billing rates.  In fact, you usually end up net ahead, even with client attrition.  If you do lose a client or two, it just means that you have more time to devote to managing the business, working with the remaining good clients, and developing your people, all of which will pay far greater dividends to you in the long run.

In summary, the odds are that by utilizing and completing this worksheet, you’re going to find out that there are several people whose billing rates don’t make sense, because billing rates should be a function of pay, not position.  You also likely will find out that several of your people who you have considered to be billing stars are actually not really out-performing some of your average people when you take into account pay differences.  And finally, it is not uncommon for our firms to find, based on the way they are utilizing some of their part-timers (they tend to involve part-timers in too many non-chargeable activities), that part-timers are killing them profitability-wise.

Multipliers

Now, at this point in the conversation, the next questions we get is, “What multiplier should I use?”  There are no set-in-stone rates or range of multipliers that you need to use, but a starting place might be the list that we show below:

3.25 – 3.50 for paraprofessionals
3.00 – 3.25 for staff
2.75 – 3.00 for seniors
2.50 – 2.75 for technical managers
2.25 – 2.50 for supervisory managers
2.00 – 2.25 for principals

You can see that multipliers range all the way from less than 2.0 for a principal, on up to 3.5 or so for a bookkeeper or paraprofessional staff.  These ranges are based on surveys we’ve done of client firms.  Certainly, some use higher and a few may use lower multiples, but these ranges are a good starting place for anyone interested in doing this analysis we just reviewed with you.

Now, keep in mind, if this is your first time going through this analysis, consider starting at or near the lower end of the range or perhaps even a tad under the low end, and then easing into the changes over a year or two as you go forward.  In other words, if you find that you need to raise your rates, you should not feel compelled to do it all in one year.  Try to start moving them up so that over the course of two to three years, they’re up to the right place.  Don’t try to make up for ten years of previous, unprofitable practices by trying to fix it all at once.

Another point that’s worth reiterating with regard to the use of this Billing Worksheet tool is that it should generate some questions that need to be asked.  When you find out somebody’s not performing based on their numbers and a reasonable multiplier, it’s time to then ask the question, “Why?  Is it just them?  Is it how we’re interacting with them?  Is it how we’re assigning work to them?  Is it the fact that we’ve got them tied up in a bunch of administrative duties?”  Don’t jump to conclusions.  Remember, the fish stinks at the head so once you uncover a problem, recognize that the partner and manager group are very likely playing a large role in perpetuating the problem, especially when the problem is recurring or is seen across numerous people.

In Conclusion:

For those who want a downloadable copy of the Billing Worksheet, just visit our website at www.successioninstitute.com, register (it doesn’t cost you a thing), and search for Billing Worksheet – General and you can download it.This concludes our three-part series on metrics.  Obviously, there are many more metrics to consider.  But the bottom line is … use them as management tools ONLY as they are great at creating questions in your mind to answer, but taken as a number at face value, they often provide misinformation or motivate people to jump to erroneous conclusions.