Consulting Industry: Stop measuring Utilization! Its putting us out of business.

On Oct. 24, 1861, after 112 days of construction, Western Union completed the first transcontinental telegraph, rendering the 18-month-old Pony Express obsolete. Two days later on Oct 26th, the Pony Express shut down. Records indicate that the Pony Express was at 100% utilization the day it closed business.

Measuring utilization has moved many Professional Services Firms (PSFs) to be stuck in the middle. It is hurting their culture, their medium & long run profitability, their ability to serve their customers, their overall talent experience, and their focus on creating value. PSFs need to move to profitability & velocity metrics; Profitability: measuring profitability by industry, service line, and product and; Velocity: measuring the efficiency of how teams work to deliver units of value.

This is inspired by Tim Williams' popular “An Obituary for the Billable Hour”, Tim discussed the perils of the numerator (measuring billable hours), I will focus my discussion on the perils of managing to the denominator (available billable hours), the metric itself, how it is mismatched with how customers buy; and suggest alternate KPIs to align value with the organization performance framework. 

I have been in professional services my entire career, starting out in a small independent, that grew to a large independent, as an independent consultant, as a founder of a PSF that we sold to a large PSF, and recently left a leadership role in a large PSF. My discipline would be described as information management (ie: architecture, data and analytics) and business performance management.

This is a point of view; I am hoping to see if we can shape our collective thinking with feedback from others. I expect there will be folks that disagree. Please share it & comment to help us form a more complete picture, this is just the starting point on how we can address what I consider to be a fundamental bust in the business model of industry that is full of some of my closest friends & colleagues, and some of the most intelligent people I have ever met.

Ok, if I still have you. Let’s dig in.

Utilization, Value, and Organization

Modern disruption has complicated firms that still manage utilization. Customers are insourcing consulting talent, customers are able to source strategic guidelines using reputable crowdsourcing collaboration sites, and most firms’ proprietary intellectual capital is undifferentiated from the competition, so in a forward-looking age of infinitely accessible intellectual capital, and an infinite (and flexible) talent pool, borrowing from Simon Sinek, it isn’t what you do anymore, it’s how you do it, that differentiates competitors from one another. 

Utilization

Professional services firms (PSFs) use utilization as one of the core metrics to measure performance of their practice across service lines and geographies. Utilization is calculated based on the premise that a firm has a volume of available capacity, and maximizing that capacity will maximize profit. 

The formula for utilization is generally:

 (hours billed) / (hours available to bill)

some firms deduct vacation, training or sick time from the denominator. 

A typical professional services employee is available from 2100 – 2200 hours per year. So A well regarded utilization of 80% is roughly 1700 billable hours in a year (42 weeks), and you haven’t done any training, taken vacation, worked on a pursuit, researched anything, or attended a single internal meeting yet.

Utilization has been around as long as ‘the billable hour’, and worked well when most engagements were a function of maximizing the profit from available Human capital. In order to lever up or down profit you hire or reduce FTE’s in your workforce (utilization X FTE). Consequently, many firms measure Utilizations and FTE’s. If you know Utilization, FTE’s & average rate, you can ballpark the profitability of a firm. Hence why many firms manage in order: 1.Utilization 2. # of FTE’s & 3. Average Rate. 

Measuring Utilization and inputs is aligned with the thinking that their are scarce resources and opportunities available (hours, FTEs, Clients, Projects), and its in maximizing the utility of these scarce elements that profit is maximized. Measuring value and outputs is aligned with the thinking that there is an abundance of elements and its in maximizing adding value for these elements that profit is maximized. We are in an age of abundance.

Value

Michael Treacy and Fred Wiersema outline 3 value disciplines in their HBR classic “Customer Intimacy & other value disciplines” they outline that firms have 3 choices to deliver value to customers, 1. Customer Intimacy, 2. Product Leadership, 3. Operational Excellence.

Customer intimacy means targeting markets and industries then customizing your services/products offerings to match the demands customers. Companies that choose customer intimacy have deep industry knowledge, treasure & measure the whole life profitability of the customer/industry, and work to build tremendous loyalty within the customer. They value trust in the relationship, listen and work in partnership with their customers to bring value added innovative products and solutions to the market. Classic examples is Nordstrom’s and in the big data era, great examples could be Netflix, Facebook or Amazon.

Product Leadership means striving to produce innovative products and services that serve a defined market need. Successful product leaders are creative in understanding the problem; are organized to iterate, experiment & ship their ideas quickly; relentlessly cannibalize their current products/solutions or revenue streams in order to push the market with new products and solutions (See Shawn Kanungo’s talk on hyper cannibalization at https://youtu.be/c-5FbNjeX-w for more on this third point). The examples here are Apple, Samsung, 3M.

Operational Excellence firms approach the production and delivery of products and services strategically. They lead in price and convenience. Companies pursuing operational excellence are obsessive in minimizing costs, and optimize business processes. Think of the modern manufacturer, Wallmart, and ExxonMobile.

How does utilization align with these value disciplines?

Customer Intimacy

If you follow the PSF industry, you know we take pride in our focus on building trust and relationships with our customers. We educate ourselves on the art of empathy, questioning, listening and partnership. In his books ‘How to manage a professional services firm’ and ‘Trusted Advisor’ David Maister positions that customer intimacy is the only path to success for a professional services organization. So, we hone our skills on emotional EQ, sensing, and emotional connection, we understand how to target the limbic vs. the neo cortex, we are strategic in our relationship & power maps, we know who calls the shots, and who are the influencers, we make a point to double down on relationships. Customers make their choices on who they most trust, and since “People buy from People they trust”, we work to own those relationships. 

This would suggest that Customer Intimacy is the principal value discipline for PSFs, the rub is that if I am being measured on the utilization of my resources (the denominator), I haven’t truly suspended self-interest and I am just doing all of that training to move my agenda, not create value. This is why customers often feel like their PSF contact isn’t being authentic in their questions or genuine in their concern for the customer’s success—because if they have a utilization metric in their scorecard—it’s impossible.

Product Leadership

Living through the disruption impact in professional services in the last 4 years, it’s become (thankfully) evident that customers are moving from larger projects to smaller, iterative cycles. In doing this, customers have matured in their ability to assess their own problems and source their own solutions.  In the era where every solution and methodology is ‘googleable’, it isn’t the solutions that differentiate any longer, it’s determining what question to ask that has become the most valuable part of the process (not what you do, but how you do it). Given this lack of differentiation, open information, and crowdsourcing platforms, customers are now able to source solutions to their problems across multiple platforms. It is now less costly to procure 3-4 different solutions for legal, tax, code, strategy or design problems than it would be to procure a single solution form a PSF partner. Customers can review the solutions and pick the winner, leaving the PSF’s either on the sidelines or left to orchestrate the multiple solutions into an integrated solution.

Technology is not left on the sidelines, with every major software platform moving to a Platform as a Service (PaaS) model, we are witnessing a further reflection of Apple’s App Store business model in technology solutions. Where it used to be commonplace for a system integrator to configure, code, & customize solutions (and bill a ton of hours to do it!), now we are seeing a movement to apps. Where a customer can now activate and de-activate capabilities in their enterprise platform in the same amount of steps as one can install an app on their mobile device.

These apps are service based solutions bundled in to technology products, these products are built by the crowd, maintained by the crowd & substitute effort that otherwise would have been delivered by billable hours. This substitution of inputs will eliminate entire service lines in some PSFs as customers will no longer require to solve their solution with hour based effort, they will be able to just ‘turn it on’, and if they don’t like how it works, they can just ‘turn it off’, much the same way you delete an app you no longer use on your device. 

This shift to buying products, has also lessened the impact of measuring utilization, for a product (by its very nature) is procured because of the output it delivers, not the input required to create the solution/product. Firms that are driven by utilization are motivated to not create products, not create solutions because they are cannibalizing the numerator and the denominator (less billable hours, less FTE’s); even though this is precisely where the market is going, and what customers want to buy. 

If PSFs view themselves as moving towards the product leadership value discipline, they need to drop utilization as a metric as none of the investments and cultural buy in required to develop these products will have a positive impact on utilization, even though those products will be the anchor for profitability for PSFs in the near to medium term. 

Operational Excellence

An Operational Excellence value discipline is at the opposite spectrum of a firm that manages utilization. For the reasons outlined in ‘An obituary to the billable hour’, it discourages innovation, efficiency, sharing and investment. It is erosional to the value delivered to the customer, reinforces self-interest, and drives down price (reducing profitability). The bigger (and less obvious) issue lies in how PSFs compete & the talent experience for the people that drive firm profit. 

Behaviourally, if I am measured by utilization, I will make sure that my people are utilized even if they are not the most skilled or best fit for the role, in an inefficient allocation of resources, either increasing the effort (and cost) to deliver the same standard of work, or decreasing the standard of work; negatively impacting both the talent or the customer.

Pursuing OpEx for PSF requires investment in collaboration, knowledge warehouses, standardized processes and measurement; all things that would improve the talent experience (its not what you do, but how you do it). All of this investment is oriented to delivering faster, less consumption of resources, greater value to the customer, and a better talent experience. A firm measuring utilization will disregard these investments as they are counter to the firm and their personal objective, to keep my staff doing billable work, rewarding self-interest and inefficiency. 

So what to measure?

Firms need to determine what is their principal value discipline (how they differentiate), and then develop their own cascading metrics that reward that value discipline.

For discussion, let’s assume large firms will pursue Customer Intimacy; they have large pools of resources, relationships, multiple service lines and multiple industries. Let’s also assume that smaller firms will principally pursue product leadership as they have a smaller set of homogenous resources, typically one or two service lines, and one or two industries. Smallest firms or start-ups may choose to follow a single industry, with a single product. For either large or small firms, if the principal value discipline is customer intimacy, the second will be product leadership & vice versa. Both large and small firms will have Operational Excellence as their third value discipline. 

With the utilization metric dropped from the performance measurement fabric, firms will have to orient themselves, and make investment decisions based on new principals, and points of view. I’ll play out a couple of examples, but there a number of metrics that are market and flow oriented that can provide the backbone for the required shift.

Large Firms/Customer Intimacy

Following a customer intimacy model implies an immediate orientation towards industry/region and customer profitability metrics. The organizational hierarchy should reflect industry orientation and the firm should choose a leadership position in industries with the most profit potential for the products the firm has to offer. They should be known for their depth in their industry, understanding the problems, buying cycle, relationships and be a trusted authority on the industry direction.

When the industry is in a down cycle or contracting, the customer intimate firm doesn’t flinch, it invests in the industry, teaching & leading the industry in innovation and best practices in how to manage through the downturn. If the firm is global, it redeploys mobile talent to other regions that are not feeling the contraction. The firm suspends self-interest and works as a whole to serve the one.

This firm will measure itself with cascading metrics that start with industry, to region, and then to customer. The firm will understand the full profitability of a customer, all time & charges will be allocated to a customer or developing the industry. The firm is not distracted and chooses to focus on serving the industry and the customer. Full profitability implies that all costs oriented to serving a customer are booked to the client code. Firms have visibility to the costs of sales for that customer/industry and learns from these costs in order to optimize the cost of acquiring new work. There are no ghosted hours or orphan expenses, all costs roll up to the account leader & that person is accountable to manage the customer like a financial statement (P&L, Balance Sheet, Cash Flow). But this Financial statement is a little different, because it needs to reflect the long-term nature of the relationship, it should reflect a rolling 5 year summary to identify not only growing opportunities, but also accumulated ‘retained earnings’ that can be used to invest in the customer. The concept is to reinforce and reward long term customer partnership.

Small Firms/Product Leadership

Product leadership oriented firms leverage their solution or product across multiple industries or regions. The success of their solutions is measured in terms of the suite of products that they offer. Small firms can choose customer intimacy as a discipline, choosing that will find themselves outsourcing the work to multiple vendors due to the breadth of the problems.

Organizationally, they will be organized by product category verticals, and profitability will roll up accordingly. These firms go to market with a message relating to the functional or regional problem they solve, and how their solution differentiates against other competing products or solutions. They will educate the market on the problem & match their solution to the problem. As profitability is baked into the price of the product, these firms are oriented around sales metrics; units sold/shipped, revenue, and attach to complimentary products. The customer experience is consistent & reliable. As there is relatively little investment in customers, profitability at the customer level is not as important as sales & marketing targets by region by product category. 

Velocity

PSFs are often selected for work that they do not have the capacity or the capability to realize. As discussed earlier, capability is now infinitely sourced via internet search, products and crowdsourcing; capacity is still a gap. Customers need to source effort & experience for big transformations or implementations. Customers are most interested in outcomes & delivery, & firms need a metric that rewards accelerating efficiencies. 

Velocity is a metric born out of the agile movement & can be applied across a number of non-agile or project instances, one of the key elements of Velocity is that it is a team metric, not an individual metric. Teams that increase their velocity are delivering more with the same or less resources. This is good for the customer, and good for the firm. Measuring velocity can be a significant change in firm culture, rather than having individual or group utilization, now we have a measure that motivates collective thinking about outputs instead of individual thinking about inputs.

PSFs that choose to eventually compete on velocity are able to demonstrate to their the value of working as team, neutralizing the competitive impact of independent contractors and other firms that work as an assembly of individuals.

Velocity is measured by setting time blocks on productivity schedules, and estimating the effort to deliver work in that time block. Effort is estimated in terms of effort ‘points’ and a team measures their ability to finish delivery in that set period of time. As teams begin to measure their delivery velocity, they have a medium to seek and reward improvement. What’s interesting about measuring velocity, is that teams are forced to a deeper understanding of the scope of work to be delivered, are collectively accountable for delivery, and learn how to estimate and track effort. As outputs are now the focus, waste is quickly eliminated from the process, profitability, quality, and employee engagement increase.

So what if we don't change?

Not changing will create a tremendous amount of tension between the PSF, the customer & your talent. Challenging profitability, relevancy, and the talent experience.

Imagine the task of building a fountain in a backyard. There are three competitors on the bid, Firm A is a utilization oriented firm, Firm B is customer intimacy, output oriented firm, measuring velocity and profitability. Firm C is a product leadership firm, measuring sales by street.

If Firm A wins the work, the tasks will be to move a pile of rocks from the street to the back yard, then build the fountain. They will be happy to assign 10 resources to the task and achieve full utilization. The resources may not be the best fit, and the duration might be longer than expected, and the quality might not be as high as possible, but the firm would be happy—all of their people are billing. The budget to the customer isn’t well defined, the quality is subjective, and time to deliver is dependent on many external factors ie: weather. Firm A’s profit is eroding as they can only complete one job at a time. To be competitive, they need to price the job to compete with the other firms, driving down earnings, investment and limiting funds available to pay staff competitive wages.

Firm B uses a hauler (technology) to haul the stones, the job is completed faster, employees are happier (and not as sore!) and the customer receives a beautiful custom fountain. The customer looks at Firm A and shake their head as they are no longer relevant in their usage of technology. The employees of Firm A are shaking their head as they find the work of hauling stones menial, repetitive, and out dated. They begin talking to the team of Firm B and start looking for jobs as they don’t want to waste the summer hauling rocks. There is less variability in the budget, the timeline is tighter because of technology, and the team of 3 can focus on the custom elements of the fountain. Firm B’s profits are limited to usage of the technology and the team of 3, but they can do 3X more work than Firm A because they changed their focus on outputs & delivery efficiency.

Firm C sells pre-cast fountains in 5 models with one price.

Relative to their competitors, Firm C has exponential revenue potential, so they can price their fountains at a quarter of what it took Firm A & Firm B to deliver the fountain. Yes they had to invest in standardizing the product offering, a factory & distribution, and because of this they have predictable profitability for each job, they can forecast with better accuracy and slowly (or suddenly) put Firms A & B out of business.

Firms A&B didn't see that coming, nor did the Pony Express.

This is happening to Professional Services Firms that lead with utilization. The structural change that has impacted the market, requires a structural response to the configuration of the economic and structural model. The desire to manage to an obsolete metric will render these firms themselves obsolete. 

For the benefit of your customers, your talent, your relevancy and your profitability, 2017 is the year to change, lets drop Utilization & never speak of it again.