Consulting Metrics 101 and the Real Cost of Soda
The following is an excerpt from an email I sent to DeveloperTown in October 2015.
Over the last five years, we've looked at a lot of numbers. Things like profit contribution by employee, profit contribution by client, individual point delivery, and the value of profit sharing units. To be clear, all of those are now deprecated. :) While we had some crazy things we measured, we learned a lot of with of them.
Sometimes we learned what not to do. For fun, ask Chris Wingate or Chris Scales to explain the first DeveloperTown compensation package sometime. You'll see "fun with numbers" hard at work. I have some killer spreadsheets on my computer. They are almost works of art.
I don't actually regret any of those experiments. We learned a ton in the early years. And we're still learning. Figuring out what metrics are meaningful indicators for your business and for performance is really difficult and nuanced. I'm sure we don't have it right yet. But I feel like we're closer?
Most firms look at three basic numbers: utilization, realization, and efficiency.
Definition: Percentage of billable hours for a person in a given period of time.
Example: Larry works 32 hours on NewCo, and 10 hours on ZombieTown. Larry is 80% utilized. You'll notice by that math, it's possible for someone to be more than 100% utilized. You divide by the expected billable hours, not the total hours actually worked.
Definition: Before you define realization, you need to define Fee Capacity. A person's fee capacity is the amount of revenue you would expect to collect for that resource if they hit their target utilization at their target bill rate. Realization is a percentage determined by dividing the revenue the person actually earned, divided by their fee capacity.
Example: Larry works 38 hours on NewCo, and 4 hours on ZombieTown. Larry's fee capacity is 40 hours times $150 per hour; or $6,000. Larry bills at $135 on the NewCo project, so at 38 hours he would bill $5,130. So his realization for that week is 86%.
You'll notice that in both of metrics, the person doing the work can't always control those numbers. In some cases, people don't have billable work. For example, if we have a sales gap, we keep people on "the bench." We don't have a history of layoffs when times get hard. Realization is also difficult, because you don't set your bill rate for clients. That's the sales guy's job. And it's not your call if some of your hours get discounted because of a bigger macro issue with the client. Or what happens if the project is fix-bid?
So what can you control?
Definition: Efficiency is a lot like utilization, but instead of being based on a fixed unit (like a 40 hour week), it's based on how much billable work has been allocated to you. So efficiency is the ratio of hours billed to billable work available/allocated.
Example: Larry has been allocated 50% to NewCo and 25% to OldCo. He doesn't have billable work allocated for the last 25%. He logs 32 billable hours that week. His efficiency is 32/30, or 107%.
While you have more control over efficiency, it's still not perfect. Why isn't efficiencythe killer consulting metric? Because sometimes the work isn't that cut and dry. We might allocate 20 hours to Matt for a project, but he might legitimately finish the work in 8 hours. Does that mean he did something wrong by not billing the other 12 hours? Of course not. You only want to bill the time if that's there's real work to do.
All of those numbers are more nuanced than I've presented them. But you get the idea. These numbers are great feedback tools for consulting companies.
So how are we doing as a firm?
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Why share the novel?
We are a consulting company. We're a bit of a special consulting company, but still a consulting company. (And hopefully not like Harvest math is "special.") I think understanding these numbers are important. These numbers drive our DT economy.
I remember attending a meeting at Liberty Mutual where they listed off what various items costed in terms of insurance policies sold. Coffee for the company for a week? That's 437 policies sold. A 30 min team meeting with 6 attendees? 567 policies. (Those numbers are completely made up. I can't remember.) But the idea of doing that math was super impactful to me. It completely re-centered me on the core business of the company. I was really thankful they had done that exercise.
So, here at DT?
Cost of a new house for an employee? 173 billable hours.
Cost of a team kickoff dinner for a new client? 10 billable hours.
Cost of 3rd party accounting so far this year at DT? 432 billable hours.
Cost of coffee and soda each month here at DeveloperTown? 27 billable hours.
Cost of domain names so far this year? 10 billable hours.
Cost of building out a new deck on the Monon side of the building next summer so everyone can sit outside and soak up some rays while working? 500 billable hours.
Cost of cleaning the bathrooms each month? 33 billable hours.
Cost of Harvest? 94 billable hours. Or perhaps 90? Or perhaps 102?
Cost of Daryn losing a fantasy football matchup any give week? Priceless.
(For those playing at home, all that math assumes 30% profitability on an hour billed. You don't apply the full rate to the client, just what DT would net on that hour worked. I'm ignoring the possible double-dip on overhead calculated into the profitability ratio. It's not perfect math... but you get the idea.)
It's a great way of looking at the costs of our firm. Because that's how we pay for things. This is the fuel that our engine runs on.
We are not expecting anyone to start tracking individual utilization, realization, and efficiency. As a leadership team, we don't really look at these numbers on an individual basis unless there are concerns. They are great heuristics and top-level metrics to assess the health of the business. They are also great tools for long-term planning.
Have a great weekend. And a huge thank you to everyone coming in tomorrow to help with the house move.