Unit economics are critical to understanding how your business will scale. They tell you which levers to pull to improve performance. There has been a lot of good work on unit economics for subscription businesses (see for example David Skok on SaaS Metrics 2.0). Entrepreneurs and investors are focused on understanding and optimizing these numbers. At professional services businesses, we are not yet quite as focused. Maybe because professional services is above all a people business. But understanding the unit economics of professional services is critical to the future.
So what are the unit economics of professional services teams?
Not a unit metric, as it depends on performance across projects, but still critical, is the utilization ratio.
It costs money to win work, and you want to win the right work. The right work is the projects you have the people with the skills available to perform. And where you have some sort of differentiation so that you have an edge on the competition.
Marketing and sales costs are obvious components of the cost of winning work. But most professional services companies will also put together teams to win important projects, and these teams are generally staffed by billable staff. These are expensive teams as they are being paid for these sales efforts and they are not being billed on other projects. Ouch. But you can’t win a major project without this investment. Most companies do not track this cost properly, it is Cost of Team + Gross Profit on Foregone Revenue x Utilization Ratio.
To win work professional services companies must also be continually upgrading their capabilities. Investment in new capabilities should be considered a cost of winning business and not an overhead. (OK, companies that actually invest in developing new frameworks and tools could treat these as analogous to product development).
Time to revenue
Once you win the work you have to deliver something before you can recognize any revenue. (See Services Revenue Recognition). To do this you have to build the right team quickly and get it to work. Any mistakes in identifying the skills needed or delays in getting the team in place will delay revenues (and annoy clients).
Another common reason for delay is unclear requirements. When a project is transferred from sales to the delivery team information is often lost and what seemed clear to the sales team is ambiguous or even wrong to the delivery team. One way to prevent this is to make sure you have the right skills on both the sales and delivery team.
A project can meet all of its deliverables and all of the client’s goals and still lose money. What are the keys to ensuring project profitability?
Make sure you have a team with the right skills. This is critical to making sure that the deliverables are clearly understood, change orders are managed and rework is minimized. Skills go beyond the technical skills needed. Business and communication skills are also essential.
Deliver the Work
The baseline for professional services is to deliver the work contracted. You have to meet the project requirements. But this is not enough.
The project team has to help the client meet its goals and ensure that it meet’s the company’s own goals. And no project is truly successful if it does not meet the team’s own goals.
The goal of a professional services company should be to sharpen differentiation and to win repeat business. A project that does not contribute to repeat business is a lost opportunity.
The secret to winning repeat business is to develop relationships and to build a shared understanding of complementary skills. As a professional services company you are hired because you have some skills that your client is short on. The most important of these are the skills that complement those of your clients, where the combination is more than the sum of its parts.
One of the keys to running a profitable professional services company is to optimize (not maximize) utilization rates. Simply put, an individual’s utilization rate is the percentage of hours worked (or paid) that are billed. Most firms aim for utilization rate of 70% (for specialist firms) to 80-90% (for generalist firms).
Good scheduling is the key to utilization ratios, but I have seen too many companies focus on upping utilization rates without regards to balancing the skills on project teams. The best approach to utilization optimization is to make sure you are taking advantage of the skills of all your people and getting the right balance on each team.