It’s the million-dollar question for consultants and professional service firms (PSFs) alike: How can we more easily maintain and increase our profit margins?
In the real word, generating profit takes a lot of time, investment, and practice. Increasing your margins isn’t always as simple as adding more clients, doubling your rate, or simply working more hours—there are nearly countless factors that go into improving profit margins for consulting services business.
That’s why, in today's post, we’re going to take the mystery and confusion out of things by:
1. Walking you through the formula for accurately measuring your profit margin
2. Identifying the 4 variables you must know—and how to use them—to maintain a healthy margin
3. Outlining 8 actionable tactics for maximizing profit margin for consulting services and beyond
Understanding Profit Margin
But what is a good profit margin? If sales are the lifeblood of your business, profit is the pulse.
Knowing your profit margin will tell you whether your business is flourishing or in need of some serious first aid.
Tracking your profit margin helps you:
- Identify what’s stopping you from growing
- Set realistic financial goals
- Resolve issues around price and scale
- Secure loans when you want to scale
Without this information, it’s pretty much impossible to tell if your business is profitable or not.
So, let’s take a look at how you can measure this all-important metric.
How to Measure Your Profit Margin
According to Inc.com: “Most professional service firms have operating profit margins from 25-40 percent. This means that out of every dollar of revenue, 25-40 cents drops to their bottom line as pre-tax profits.”
Now, this isn’t a hard and fast rule. The number can vary depending on the market you’re in, but it’s a good starting point.
As a business owner, it’s always good to know how to calculate the numbers yourself.
Here’s a simple formula to calculate gross profit margin for a consulting business:
Want an example?
Let’s say Tiffany provides SEO services to B2B companies.
She’s currently generating $5,000 a month, but her expenses total $3,000 a month. After expenses, she’s netting $2,000 a month.
In this case, Tiffany’s gross profit margin is 40%.
Here’s the math: [( $5,000 - $3,000) / 5,000] x 100% = 40%
By comparing the planned and actual profit margins, your chief administrators can get a holistic view of the company's operational results. From there you can begin to optimize performance to get the margins you want.
How to Maintain Consistent Profit Margins in a PSF
When it comes to profitability in professional service firms, there are three variables that, for the most part, will determine your fate: Capacity utilization, pricing, and overhead.
Let’s take a look at how to work with each of these factors to maintain a strong profit margin.
Keep an Eye on Capacity Utilization
Have you ever wondered how much time your office is wasting on things like email, unplanned drop ins from coworkers, and even regular meetings?
Measured as a percentage, capacity utilization helps you compare your potential output to your actual output to understand how much productivity you’re getting from your firm.
To measure your capacity utilization rate, use this formula: (actual output / potential output) x 100% = capacity utilization rate
To get a handle on what capacity utilization looks like, let’s take a look at Juan’s web design business.
Juan is currently designing 4 websites a month—that’s his actual output. However, he’s done some number crunching and believes he can reasonably design up to 7 websites a month without working overtime—that’s his potential output.
Right now, Juan’s capacity utilization rate is 57%.
Here’s how we got there: ( 4 / 7) x 100% = 57%Now Juan knows that he’s only utilizing a little over half of his usable time and can decide how many more projects he wants to take on to grow his profit.
By calculating your capacity utilization rate, you can begin to understand the true productivity of your firm and optimize as needed.
However, don’t get too caught up on utilization. It’s an important metric for service firms, but it could end up hurting your business if you begin to zero in on it. When measuring utilization, it’s important to keep an eye on the big picture.
The idea behind utilization is that firms have a basic volume of available capacity. The logic that follows is that if you can maximize that capacity, you can maximize your profit.
But real life doesn’t work like that.
Maximum utilization can lead to unnecessary strain on your support staff and, in turn, translate to tension between your company and customers. Ultimately, utilization will never hit 100 percent, so it’s important to keep your other metrics in mind.
To do this, you need to determine what your principal value is. By evaluating how you differentiate from your competitors, you can identify more relevant benchmarks than simply measuring utilization.
Firms that favor connecting via customer intimacy often see higher rates of happiness from both their employees and customers.
Focusing on team metrics such as velocity can help reduce strain on your talent as well as deliver a better product without the micromanagement associated with utilization metrics.
That doesn’t mean that you need to drop utilization completely, however. Just think of it as more of a guideline than a goal.
Find Your Pricing Sweet Spot
One of the most obvious factors in your profit margin is pricing.
For many service firms, the ideal pricing solution falls within a certain sweet spot—essentially, between what the general market will bear and what your specific client base is willing to pay.
There are a multitude of factors to consider when it comes to pricing and even more strategies for arriving at the final numbers. If you’re just looking for somewhere to start, we like the “2-5-3 Method.”
This one quick question can help you determine whether you’ve nailed your pricing or not: Considering market rates, are your competitors generating more profit than you—or performing the same?
If you’re all in the same boat, you have a strategic or a pricing problem. Utilize transparency when it comes to costs and profits to convince clients that the product is worth the price you’re selling it at. But if they’re doing better than you, then odds are you have a cost problem that’s driving up your pricing.
Here’s what to do about that.
Understand Your Overhead Costs
Overhead costs are the enemy of profit. They can typically be broken down into three categories:
- Support Staff: Costs related to your staff that aren’t directly tied to a specific project are all good examples. They can include salary, benefits, and training for support employees.
- Materials: Any material used to provide a service or benefit to all of your clients affects your bottom line. For example, the software you use to service clients counts as an overhead cost.
- Indirect Costs: Items necessary for the business to run, but not used directly to service clients, are another form of overhead. This manifests in the form of software, utilities, and furniture, among other things.
To gauge the true measure of your overhead costs, avoid measuring as a percentage of fees. Instead, measure your ratio of support staff to professional staff to get a more accurate look at the data.
Try Cost Accounting
Cost accounting is another great way to measure and increase profit margins.
Typically done by collecting, analyzing, and recording data; it can forecast different scenarios and guide future action.
Cost accounting systems allow professional service firms to maximize operating efficiencies by providing informed cost information. This information can then be used to track costs for common activities, such as the cost of creating a service or how prices will affect your profit margin.
Maintaining awareness around certain profitability metrics such as project performance, utilization of resources, and working capital are an integral part of effective project management.
However, maintaining that awareness is easier said than done.
Challenges with Resourcing
One of the biggest problems you’ll face in gathering accurate metrics is the resourcing challenges.
The internet has given companies infinite resources—but it’s also given them infinite headaches.
External engagement teams, scaling issues, and remote employees all contribute to the difficulty of maintaining a real-time view of what’s going on in your business.
The solution: Unifying resource management through the use of tools and technology such as smart meeting management software allows management to retain control of resources without succumbing to the pressures of scope creep.
Challenges with Financial Management
If you are using a Frankenstein mashup of different systems that aren’t meant to integrate, get ready for a logistics nightmare.
Creating a real-time view of your business is more complex because it extends to finances.
Even the simple act of billing a client can quickly become a monumental task when your systems aren’t working together.
And if your accounting team doesn’t have access to project details like billable hours, they’re in for a lengthy series of phone calls, emails, and meetings.
And that ruins your profit margins.
Fortunately, you can avoid this problem by linking financial management systems on a unified platform.
In fact, unified management systems have become so beneficial that 91 percent of businesses with 10 or more employees have made the switch to complete CRM solutions. This heightened visibility means your finance team can make more informed decisions autonomously, while giving management tighter control of financial decisions.
8 Tactics to Increase Profit Margins on Professional Services Projects
Like the many tributaries that make up great rivers, managing profit margins on your different professional services projects will lead to greater impact on your overall profitability.
Time management, standardization across rates, optimization, experimentation, and estimates all flow into profit margin—neglect or cut any of them off, and you could be looking at a drought!
Here are several tactics you can implement to maximize profit margins on professional services projects.
1. Produce Reliable Estimates
This isn’t the Wild West—you can’t just go in guns blazin’.
What you can do is create a standardized process for developing project estimates.
Producing reliable estimates starts with laying down your groundwork. By creating a baseline and setting your targets, your team has actionable goals they can work towards.
Measuring your margins by client, project, and service line will give you insight into where your focus should be. From there, you can set clear goals and assignments for your team and get a better idea of the costs that will be incurred.
A standardized process can do wonders for your bottom line. You’ll be better prepared to handle the ever-changing nature of service projects, resulting in a more balanced budget.
2. Identify Your Weak Spots
Revenue is important, but costs are a major focus as well. By identifying weak spots in your finances, you can see what you should concentrate on. Often, this will start with reducing delivery costs.
Make the most of your talent by reducing the ratio of senior to junior consultants on engagements and manage sub-contractors efficiently. By balancing capacity with demand, you can reduce the amount of time spent on delivering your services and use those time savings to further your goals.
Once you’ve identified the weak spots in your delivery process, you can leverage that information to manage your overheads. A 30 percent investment in overhead is common, so defining actions that help you reach that target can get you closer to your profit goals.
3. Manage Your Time
There are only 24 hours in a day, making time your most valuable commodity.
Unfortunately, you’re not always making the most of it.
Circumvent this problem with a strict timesheet entry process. Maintaining a daily timesheet log can boost resource management and provide more accurate billing information.
4. Optimize Your Meetings to Increase Productivity
Meetings are often seen as time and energy drains, but they don’t have to be.
In fact, studies have shown that employees who meet regularly actually experience up to a 10 percent increase in productivity due to increased cohesion and more effective nonverbal communication.
So, why do meetings get such a bad rap? More often than not, it’s because we simply aren’t getting the most out of them. Here are some optimization tricks to test out at your next meeting:
- Focus on decisions, not discussions
- Set a time limit
- Use smart meeting management software to organize quickly
- Assign clear responsibilities
5. Review Project Status on a Weekly Basis
When a pilot flies a plane, they constantly adjust to keep it on course against ever-changing winds.
Like the pilot, it’s up to you to keep your employees on track. Help them stay focused by reviewing project status on a weekly basis. Monday mornings are often a prime time for this, since it gives your team a vision of what they need to accomplish for the week. Just make sure they get their morning coffee first!
6. Keep Your PMs in the Loop
Project managers have a tough job. By setting up standardized processes, you can make it easier on them by giving them an idea of what to expect going into a project.
Similarly, creating and distributing weekly reports keeps them on the same page as their teams and stakeholders with regard to project expectations. It’s a win-win for everyone.
7. Standardize Extra Services
Maybe you want to keep a certain client happy, or maybe you underestimated the project. Regardless of the reason, chances are that your project is going to go over budget. Scope creep can be extremely stressful, so stop the problem before it starts.
Establish a standard procedure for approving and billing extra services so that you and your client aren’t caught off-guard when a project goes over budget.
8. Increase Revenue with Experimentation
Sometimes, it’s risky to not take risks.
More revenue begins with articulating your value proposition and getting a clear idea of what it is you’re offering your clients. From there, you can (and should!) experiment—play with your prices, drop services running at a loss, manage your bidding process, and so on. By experimenting, you can optimize your business to maximum profitability.
Becoming a master of maintaining and gaining your profit margin is a big project, but we promise it’s worth it in the end. So while you’re working toward that goal, here’s a helpful shortlist of the most important takeaways to keep in mind from this guide:
- Begin with data. Once you’ve figured out what your current profit margins are, you can begin to set goals for the future.
- Capacity utilization can help you figure out your firm’s true productivity levels, but it isn’t the be-all, end-all. Also consider metrics that focus on productivity and customer intimacy.
- Look to your competitors to assess your pricing. If they’re outperforming you, chances are you have a cost problem.
- Overhead is the mortal enemy of profit. Gain an accurate view of your overhead costs by measuring your ratio of support staff to professional staff.
- Consolidating team efforts on cost accounting systems saves both time and money.
- Increasing profit margins on individual projects will help boost overall profitability.
- Develop standardized procedures to make sure things go smoothly.
- Whatever you do, don’t compromise on customer relationships and overall quality.
Ready to maximize the profit margin for consulting services at your firm? Understanding the pitfalls of planning to maximize meeting productivity is a great place to start. Download our free ebook—Meeting Management: How Much Time Do You Waste?—today to learn why meeting management has become such an issue for modern workplaces, the benefits of solving this issue, and how to become the meeting hero your organization needs.