- Measuring the Health of Consulting Businesses
Measuring the Health of Consulting Businesses
Investor Steve Anderson, who has successfully built and sold two IT services companies, and advises many others, lays out the steps he takes to assess and improve the performance of professional services businesses. He goes into specifics about his process and explains why companies often underperform.
For him, a big ingredient in the secret sauce is for the management team to make sure that they have time to step back and look at where the company is headed.
“A company needs to have goals, it needs to have a strategy and it needs to measure how it is doing against that.”
Being totally focused on solving today’s problems is likely to lead to a business not fulfilling its potential. “The management team needs to delegate so they can focus on driving the business forward.”
Steve Anderson – Growth is hard
Doug D’Argenio: Welcome to the PS Insights podcast series sponsored by Kimble Applications. Professional services organizations strive for efficiency, success, and growth. This series is intended to provide key insights on how to achieve this from industry leaders.
Steve Brooks: Hello, my name is Steve Brooks, and today I’m talking to Steve Anderson about measuring the health of consulting businesses. Steve has worked in professional services for more than 30 years. He has helped found two successful companies during his career. He has also worked at larger multi-nationals, including Oracle and Hitachi Consulting. He founded and is a director of Capitalised Partners, which operates as an investor to technology companies. He is a non-exec director of five companies in that portfolio, and is always looking for the next opportunity.
Steve as non-executive director of several professional services organizations, how do you tell how an organization is running well?
Steve Anderson: The first thing that I like to look at it is what information a company has, that’s often an indicator, incredibly, a lot don’t have very much. I’ve come across one which didn’t even produce monthly management accounts. Most do, however, and the first thing to look at is the management accounts and the key financial measures, the revenue, gross margin, net margin, and how these are trending. Is the company growing, are these values good? Once you’ve looked at those, then you need to think about how could performance be improved. If it’s good and if it’s not good, why isn’t it good? What’s causing the problem? What are the other things that you need to look at next?
Steve Brooks: When you say look at other things, why don’t management accounts tell you the whole story, what else is there to get?
Steve Anderson: Management accounts are at a fairly high level, they look at the overall performance of the company. Don’t go into the granular detail of where there might be things going well and things going badly. You also want to look at things which impact on the performance of the business. In a professional services organization, the first two things I would look at are utilization and average rate. They give you an indication on the utilization side of whether the company is meeting its potential. So is the utilization at a level that you would expect it to be in a professional services organization. If it’s too low, obviously need to find more work and get people busy. Equally, if it’s too high, is the company wearing its people out, they’re going to burn out at some stage.
Steve Brooks: What is a good level of utilization, also is that utilization on purely commercial work, or should you consider other factors like training and things like that?
Steve Anderson: What I think is important in measuring performance is to get a definition of utilization that a company is happy with. I always focus just on billable utilization. Other utilization is obviously important but doesn’t pay the bills at the end of the day. So, I would say a utilization level of 70% is something I would think see as a healthy level. Anything below 60%, there are issues and the company is probably struggling. Anything above about 75% and it’s going to be difficult to sustain on a long-term basis.
Steve Brooks: You talk about utilization, but that’s in the past generally. What about measures for the future and how do you categorize those or what’s important?
Steve Anderson: In terms of looking at the future, utilization is also important there, making sure that you’re forecasting ahead. It’s a difficult thing for businesses to do, but you need to know what your people are going to be doing, at least for the next month, and ideally for the next three months going forwards. And that forecast utilization gives you an idea of how healthy the business is going to be.
There are a number of other things that you need to look at which give you both shorter, and longer-term indication of how the business is going to perform. On the sales side. What’s your backlog of business? How much signed contract work have you got? That’s a little different to forecasting utilization, because the backlog of work could stretch over a long period, particularly if you’re delivering managed services. And what’s your sales pipeline? How much opportunity have you got to sell new business? Typically, you would want to have something like two times revenue coverage for the next quarter in your sales pipeline, so you can see twice as much business as you need to close to continue to drive the growth.
Steve Brooks: You mentioned you need two times revenue. Are there any tricks or tips you can give to ensure that pipeline is actually accurate? After all, sometimes sales people do inflate figures.
Steve Anderson: Yes, it’s a difficult thing to do. I think it’s so difficult, it’s not really worth trying to do it. You might go through and say, okay, looking at this pipeline, talk to the sales people, make a judgement over whether the opportunity is real and whether you can see an event at the client, which means that the business might close in the next quarter. If you can’t see an event driving that closure, then it’s likely to slip. And I think the sales pipelines are always slipping. The danger that you have when you’re looking at a sales pipeline through a salesman’s eyes is if it’s the same opportunity and it’s slipped once or twice but is still then likely to close, then that’s looking fairly good and as long as there’s something coming up which you think it might close is good. If you see the opportunities in the pipeline changing on a regular basis, so there’s a really good opportunity then that disappears and is replaced by another really good opportunity, I’m always skeptical about that. You want some continuity there.
Think the other thing about sales pipeline is how much of it is in your current clients and how much of it is in new clients. Current clients are much more predictable and you can win the business much more easily and you expect a higher closure rate than you can on new clients, where there’ll be more competition for that business.
Steve Brooks: It sounds like it’s getting quite complex because surely, you’ve got a forward-looking pipeline that you think is actually quite strong. What point do you make the decision to ramp up the people or to ensure you’ve got the right amount of resources to cover those clients?
Steve Anderson: It’s a difficult decision to make. I don’t think there’s any magic formula for it. It’s always possible if you win something which is a much larger project to use contract staff on a temporary basis to up your head count. Cause, if you win something which requires you to increase your head count by 25%, you don’t want to recruit all those people on a permanent basis, because it’s unlikely that you can sustain that, unless you’ve got a very long contract. It’s better to say increase your head by 10% and use the other 15% use contractors to meet it.
Steve Brooks: Are there any other risks you think need to be highlighted at this point in terms of when you’re looking at those kind of forward measurements?
Steve Anderson: We talked there about the sales pipeline and about forecasts. Also need to think about some other things which might give you an indication of potential future problems. If you’re looking at growth, then what’s your recruitment pipeline looking like? Are you interviewing enough people to be able to recruit when you need to? And how’s your staff morale? Are you looking after people properly? Are you giving them the right review process, the right career path that they’re likely to stay with you? If you lose people, then that’s going to damage your ability to deliver.
Cash is always important as well for smaller businesses. If you are not producing cash, then you’re going to go out of business. You’ve always got to have a look at that and see how it’s going. And you’ve got to look, I think, at existing projects and not how they are progressing. I always say that the most dangerous thing for a consulting business is a project going wrong, because that can destroy your profits for a month or two without you noticing it happening. A lot of companies when they look at particularly fixed price projects don’t estimate properly how much effort needs to go in to finish those projects. They will potentially just recognize revenue based on the time spent during the project, get towards the end, find they’ve run out of revenue and haven’t finished the project, and spend a month or two having to do work getting no revenue for it. People have to look on a regular basis at how a project’s progressing and recognize revenue on the right basis.
Steve Brooks: I take it you’ve got some personal experience of that not happening in some of the companies you’ve seen in terms of companies not looking at their measurements. What kind of examples have you seen of that?
Steve Anderson: There are companies that I’ve worked with where I’ve seen they haven’t estimated the amount of effort required on a fixed price project correctly. Every month they will either recognize revenue on a time materials basis, even though it’s a fixed price project, just based on the amount of work that they’ve spent on the project, or they’ll estimate the time remaining is equal to the time spent minus the time they estimated in the first place. In either of those cases, the project runs out of revenue. So, they get to the stage where they think, we’ve got no revenue left, but there’s still two months work left to do on the project, and they have to look very carefully at how they can fund that.
Steve Brooks: Is that often an endemic issue within those companies, so it’s not just one project that’s run like that, it’s across the whole board, and they just need to change the whole organizational methodology?
Steve Anderson: Yes. Quite often a company will be focused on sales and growing their revenue by selling more business and delivering more business. Not have sufficient focus on delivering their existing projects. Depends where the founders of the company come from in terms of their background. If they come from a sales background, they’re focused on growth, have great relationships with customers, win new business, but are at danger of a project going wrong. If someone comes from a delivery background, then they’re more conservative, perhaps less successful in sales, but will make sure they deliver successfully and win new business at existing clients. I think what companies need to look to introduce there is monitoring of projects, so project managers reporting regularly on progress and the operations director looking at those reports, not taking them at their word, but delving into the detail, questioning the project managers, and recognising revenue based on the percentage of a project which is complete, rather than the amount of work done.
Steve Brooks: You wrote a paper on balanced scorecards as a tool that can be used by businesses to understand where they’re going, what they’re doing. Why are those so good, why are they so important to businesses?
Steve Anderson: Think it’s very easy for businesses to look at the easily measured things within their business, so measuring the financial performance, measuring things such as utilization and average rate, measuring project profitability. Those are important in terms of the operational running of the business and how successful it’s going to be, but a company has to have goals in terms of what it wants to achieve. Needs to have a strategy of where it wants to get to, and needs to measure how it’s doing against its strategic goals. Cause it’s all too easy to say, “This is today’s problem that we want to solve,” but if we decided to go in to a new area, introduce a new service line, or to strategically address a new market sector, then there need to be some measures about what’s being done there, otherwise it gets forgotten. Also, looking at some of the measures around employees and customers.
There’s one company that I worked at where they found that the attrition rate amongst employees was increasing, and this was damaging their ability to grow. Based on exit interviews done with employees, they found that actually, the employees were happy with the work they were doing, they were getting challenging projects, but couldn’t see their careers progressing. So, the company knew that it needed strategically to introduce an employee review process and a career path, which people could understand how their careers could progress, that they could do that within the company and didn’t have to leave to do that. And by introducing, focusing that as a strategic goal communicated throughout the company and then implemented, they managed to reduce the attrition rate from 20% down to less than 10%.
Steve Brooks: You mentioned customers one of the measurements. What kind of measurements do you put on customers?
Steve Anderson: Customer satisfaction is obviously an obvious one to use, and I think is in an important one, to ask customers how satisfied they are with the service that you’re delivering for them. If you’re delivering managed services within your organization, then to make sure that you’re meeting any agreements you’ve got over service levels. But then you can also measure customer performance in terms of the amount of repeat business that you’re getting with customers. Are you winning new projects with existing customers? Are they providing references for you? will they let you write white papers about the projects that you’ve done for them? All of those things are indicators of how the customer is satisfied with what you’re doing. Customers like to talk about themselves, so if they are willing to allow references and allow white papers, that’s an indication that they’re happy with what you’re doing, and you’re likely to win more business with them.
Steve Brooks: Is that enough though? You talk about customer advocacy programmes, you’re talking about measuring customer satisfaction. Should you spend more time with customers asking them and getting down to the detail of what’s going well, what’s not going well? How much can you expect from customers in terms of feedback?
Steve Anderson: You’re right, that customers will sometimes not give you feedback, and particularly if they’re not happy, they’ll not give you feedback, cause they don’t want to give you negative information. I think that it’s important to spend as much time with customers as you can. It’s not necessarily looking for feedback, but maybe talking about a customer’s business, the success of a customer’s business, rather than the success of what you’re doing for that customer. Cause if you’re able to understand a customer’s problems, then they’re much more likely to come to you as an advisor, rather than just look at you as a supplier. I think the answer is spend as much time with customers as you can, because that’s likely to improve things for you.
Steve Brooks: You’re not advocating value-based pricing though?
Steve Anderson: Value based pricing is a really difficult thing, because it depends on really understanding the customer’s business and also the performance of people outside of your control, which is always a difficult thing. You have to put in so many caveats to make sure that you’re not too dependent on things you can’t control, it ends up being self-defeating. Strategic management consultancies it’s easier, because they get much closer to the customer strategy. If you’re delivering IT systems, then I think you’re too far away from the control centers of a customer’s business to be able to do that.
Steve Brooks: Growth is hard. What happens when things go wrong?
Steve Anderson: If I talk about a company that I worked with, they’d been stuck in a rut for probably about three years with revenue flat. They wanted to grow, they wanted to show that they were a successful growing company, potentially look for an exit. I came in and looked at what they were doing. First obvious thing was that the management team didn’t meet with each other on a monthly basis to discuss how they should run the business and they didn’t have any shared management information. So, first thing to do was to have some management information so the management can share and understand between them the performance of the business and decide together where they should focus. Next thing that they looked at after that having had some management information was the profitability of the clients they’d got. They’d got some large clients, but a long tail of smaller clients who weren’t profitable for the business. So, they needed to look at focusing on winning more larger clients to improve profitability, and then increase the rates or stop doing work with the smaller less profitable clients.
Next stage after that, was to look at their strategic initiatives. They had about 10 strategic initiatives, which is far too many. I said you can have three at the most. By doing that, they cut down the number of initiatives, in fact, they focused on one for a period of 18 months, which was growing business intelligence practice around their ERP business. They successfully grew that to 25 people by focusing on it and not trying to do other things.
The next thing they did and the most common thing for underperformance of professional services organizations in my view is the management didn’t have enough time to think about what the business should be doing, where it should be going. They weren’t delegating enough to people within their teams. So, they needed to have a management structure which allowed them to delegate, allowed the people who they were delegating to understand what was expected of them and then to create more time for the management to focus on how to drive the business forwards.
All of these things aren’t complicated in their own right, and actually if you look at them, you might think they’re fairly straightforward and obvious, but unless you step back and look at them, you tend not to make the changes, because you haven’t got time to think about them. In this company, making these changes after a period of three years successfully back on a growth curve, after three years their revenue was twice what it had been three years before, and then they successfully found a buyer. It’s a really great outcome.
Steve Brooks: We’ve talked about doing different measurements. How important are systems in this whole thing in terms of should your accountants be producing you Excel spreadsheets ad infinitum or should you rely more on systems? And can systems help in terms of the accuracy of your pipeline for example?
Steve Anderson: I think it’s not just around pipeline, but in terms of measuring the performance of a business. It used to be 10 years ago, the finance department would produce the management accounts and they would also spend a lot of time producing spreadsheets based on time sheets submitted, based on client performance, and all of the other information. That used to take probably two to three weeks before you could get the information of what had happened historically. When you look at that information, if you just look at utilization as an example, then the factors which affect that might be the number of days in the month, the size of projects you’ve got, the amount of pre-sales work going on, the time of the year, so how many holidays are happening, whether it’s Christmas when billable work is always lower.
Then looking across different projects that you’ve got going on, utilization might be high on some projects, but then you’ve got others where perhaps you’re putting in a lot of work and not getting very much money back for it. There are a lot of factors involved, and as you continue to drill down, there’s more and more places. I think that, what that’s resulted in is people relying now more on systems. Those who use systems to monitor this tend to have much better information and be able to grow faster because they can make better decisions based on the information coming out of that. And there are a number of professional services automation suites of software available which cover this now, which 10 years ago didn’t exist at all.
Steve Brooks: If I’m running a professional services business, what are the next three things I should think about or do having learned some of these measurement techniques?
Steve Anderson: It depends what the issues are. By issues, just because you’re being successful doesn’t mean there aren’t issues hidden there and things you can’t improve. I think the things to do are to look at where your organization can perform better by drilling down into the detail of performance across different projects. To make sure you’ve got your head up and are looking forwards in terms of what the sales pipeline is looking like and then to actually take action based on some of the information you’ve got. If your sales pipeline for business that you expect to close in six months time is on a downward trend, then do some marketing now, start to think about what service offerings you can produce and how you can differentiate yourself from your competition. Because for sales, you’ve got to look six months ahead in terms of improving things. If you’ve found one of your projects isn’t performing, then drill down into the detail of why it’s not performing and take action. For example, get one of your best people onto the project to get it back on track. Because if you don’t take action, things are going to continue to get worse. They won’t get better.
Steve Brooks: Thank you, Steve.
You’ve been listening to one of a series of podcasts dedicated to sharing best practices for professional services organizations. These can be found on www.kimbleapps.com.