Not only do you need to monitor and report on the right performance metrics for your firm, but you also have to explain what these numbers mean to your people.
It’s one thing to track and report on the right metrics, and then share those performance numbers with your people. But not everyone understands WHY those numbers are so important.
Knowing the “why” is critical if you want your people to drive those numbers in the right direction. Following is a review of a couple performance metrics AEC firms (and the “C” stands for consulting in this case – not construction) regularly use, how they can be manipulated, and why they are so critical.
- Utilization. Utilization is defined as raw direct labor (in dollars) divided by total raw labor cost. It is expressed as a percentage, and serves as a measure of how much time your people are spending on projects that clients are theoretically paying for versus how much time they are spending on other stuff that clients are not paying for. When utilization is low, it can mean any number of different problems exist. There could be too many people working on client projects that the company has. That can mean the firm needs to lay off some people or quickly get more work that clients will pay for. But those aren’t the only reasons utilization can be low. It could also be low because the firm has too many other things that employees are required to do – activities that are not paid for by their clients. Too many internal meetings, for example, can drive utilization down. Too much bureaucracy can also drive it down, such as cumbersome time sheet and expense reporting, or overly difficult forecasting or manpower allocation systems that take too much work to maintain. Vacation, sick leave, and sabbatical policies can also be too liberal and drive down utilization. People may not have enough time in the day to charge to actual projects by the time they do everything else that is required of them. Management could also be contributing to the low utilization problem if their culture and practice says higher-paid people only manage other people and don’t work on and charge their time to projects. That will drive utilization down disproportionately, because those people have higher salaries than the average employee and add to the denominator in the utilization equation more quickly than a lower-paid person would. In any case, hammering on utilization rates is something most companies in this business either regularly do, will do in the future, or have done in the past. Some companies even post this information on individuals for everyone to see. The problem with “utilization shaming“ is twofold. First, not every employee is in a position to do anything about their own workload of billable projects to charge their time to. And secondly, while hammering on utilization continuously can give you a temporary burst of higher utilization, it can also lead to lower labor multipliers because individuals who don’t want to look bad simply charge their time to what should be billable projects, whether or not they are actually accomplishing anything that advances the project. That’s just gaming the system to look good as individuals, but doesn’t help the firm at all.
- Labor multiplier. Labor multiplier is defined as net service revenue divided by direct raw labor. The important aspect of labor multiplier is that it’s a reflection of what clients really think the services your firm provides are worth. That drives the numerator in the equation up. But it is also a reflection of how good of a job management is doing with organizing projects and getting people into the best roles they can relative to their cost versus what clients will pay for those people’s time. And, it is a reflection of the firm’s marketing, selling and negotiation skills, and savvy related to the contracts they are able to get their clients to sign. The problem with management over-emphasizing labor multiplier is that it, too, can be easily manipulated by intelligent employees and project managers. To increase it, all one has to do is work on a job but not charge their time to it. This practice is known as “protecting the multiplier.” Of course, it is a fundamentally dishonest thing to do, but that doesn’t mean it doesn’t happen regularly in firms in our industry. There have been extreme examples from the past of companies whose top management insisted that no project would fall below a certain labor multiplier number or the axe would fall on the manager. They got the labor multiplier numbers they insisted on but also tended to see their utilization numbers decline, so the net effect of their multiplier “push” was zero. It looked like they got paid well for their time but didn’t do enough of it (low utilIzation).
- Revenue factor. This number is defined as net service revenue divided by total raw labor, whether that labor is billable or not. While not tracked and discussed nearly as often as utilization and labor multiplier data, it is, in my opinion, the most important number of these three to understand. It shows what kind of revenue a firm can bring in relative to the cost of its biggest expense – labor. It’s sort of like a selling price versus cost of goods sold number in a manufacturing business. It’s much more difficult to manipulate than utilization or labor multiplier, because costs are what they are (you can get that from payroll) and revenue is what it is. The one way it is subject to manipulation is when management is able to decide how much revenue is earned on a particular project for a given period of time. Sometimes large, complex projects are billed to clients at various percentage of completion milestones, and those milestones are not always easily identifiable. So, if an individual PM “decides” a project is 35 percent complete, 35 percent of the revenue for that project is recognized and counted. If it is months later when top management figures out the project was really only 25 percent complete at that time because 75 percent of the work was yet to be done to finish it, the revenue factor will then take a hit. But if project managers are over-accruing revenue on new projects by then, the manipulation may not be so evident. The game continues until there are not enough new jobs to over-accrue revenue on, and then a day of reckoning occurs. Still, in spite of this potential problem, tracking/reporting/reviewing revenue factor is, in my opinion, super-critical. And although I have said it before, I will tell you again: I was taught the wisdom of tracking and reporting revenue factor from the late, great David Robertson, whom I worked with as a consultant back in the early ‘90s when he was at that time CFO at RS&H in Jacksonville, Florida. Theirs was a fantastic story of an incredible financial turnaround of the company that was buying itself back from a publicly-traded company. But that is a story for another day!
The bottom line is this – not only do you need to monitor and report on the right performance metrics for your firm, but you also have to explain what these numbers mean to each of your people AND be on the lookout for manipulation if you want the exercise to be fruitful. It’s important stuff if you want your firm to be successful over the long haul!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at email@example.com.Click here to read this week's issue of The Zweig Letter.