Utilization rates vs Realization rates
Every Professional Services Organization should keep a close eye on its utilization metric. It is a good way to understand how productive is an individual or a team.
Here is how you calculate utilization rates:
Add up all the billable hours in a period divided by the total workable hours of this period. For example, if an employee has recorded 30 billable hours over a week, and say the workable hours in a week is 40 hours in your firm, then the utilization rate is 30 / 40 = 75%
Now, this method is not always accurate because:
- An employee can work more than 40 hours per week
- It doesn’t provide any information on how the non-billable time was spent
So here comes the realization rate:
Add up all the billable hours in a period and divide by the total number of hours recorded by the employee (billable + non-billable).
The realization rate provides the right billable performance of this employee, whatever number of hours he has spent over the period. And if you are using the right software to track time, you will be able to better understand how your employees are using their time:
There are many reasons to record non-billable hours in a Professional Services Organization: the employee can be working on a commercial proposal or working on an internal project. In both cases, it is important to have metrics about his non-billable time, because it would be a mistake to see that his realization rate is low and jump to conclusions that his time is not optimized. In many cases, commercial activities and internal projects have high returns.
Make sure that you are using a software that helps you track time accurately, and follow-up your team’s productive performance.
Recording precisely and looking at the right reporting is the first step. The next step is to optimize your resources, and this will be the topic of another post.
In Stafiz, we like to show a very useful KPI: we call it the production rate
It takes everything into account (past and future time, expenses) and tells you if you can anticipate to over perform or under perform the project. Here’s how we calculate it:
Project fees / [Actual and future labor time spent on the project x Daily rates]
Of course the denominator takes into account the different daily rates of each member involved in the project.
So, if you have sold the project at the exact value of the time planned for each team member, multiplied by their daily rate, you plan to realize a Production rate of 100%.
Let’s take an example: You have sold a project $100 000, and plan to have a junior working 60 days at $1000/day, a senior working 20 days at $1500/day and a director working 5 days at $2000/day: (60 x 1000 + 20 x 1500 + 5 x 2000 = 100 000). So in your plan, the production rate is at 100%.
But, let’s say you are a month in the project, and now you anticipate that the junior will spend 70 days, the senior 25 days, and the director 6 days. Now, the value of your production is (70 x 1000 + 25 x 1500 + 6 x 2000 = 119 500). So the production rate is = 83.7%
It doesn’t mean that your margin is negative, because your daily rates may include a significant margin compared to the real cost of your collaborator. But it means that you are under performing compared to your initial plan, by 16.3%.
You need to find ways to speed up the project or justify a price increase to your client.
It also happens that over the course of a project, your client may ask for additional work. In this case, you need to review the initial plan, adjust the fixed-fee sold, and take it into account in your performance analysis. In Stafiz, you can do it by adding as many new “production plans” as necessary.
There are many reasons why a project becomes unprofitable: commercial activity costs have been underestimated, expenses have not been included in the margin calculation or you are just stuck on the project and spend more time. In some cases it will be the opposite, and you will end up much more profitable than planned. The most critical aspect of all this, is to ANTICIPATE. You need to have the reporting tools to have real-time visibility over your project financials. It will help you set the appropriate bidding price, and it will help you have enough time to react and take decisions to speed-up the project or reduce costs when you still can.
What else are you guys looking at?