IT Services Providers Manage Utilization for Performance

Transcription

1 IT Services Providers Manage Utilization for Performance Vendor Analysis Abstract: Utilization is recovering from a long slump that afflicted most types and sizes of IT services provider. However, the recently reported numbers are not as positive as they first seem. By Lewis Clark Recommendations Track utilization rates by service line, practice or region and respond with resource reallocation and skills development as appropriate. Integrate demand management and supply management; watch for changes in the sales pipeline that signal variations in the number and types of people required to deliver the work. Whenever utilization rates increase, whether because of a demand spike or a reduction in force, be alert for indicators of job stress and burnout, such as higher turnover or slipping service quality. Build delivery models that can sustain higher utilization, such as solution centers that cut down on travel to client sites, and improve efficiency in training and project coordination. Publication Date:19 February 2003

2 2 IT Services Providers Manage Utilization for Performance The Number at the Juncture of Finance and Operations For any IT services provider with a labor-intensive service portfolio, the utilization rate is the crux of its performance and viability. Utilization is related to a host of other metrics, such as gross margins, billing rates, engagement or contract size, and revenue and profitability, as well as the company's delivery model and human resources (HR) functions. Because labor costs are such a large component of some service lines, achieving healthy margins is difficult without high utilization. But "high" is a moving target, adjusted for trade-offs with other variables. Financial metrics are usually complementary. For example, under present market conditions, in which vendors are under intense pricing pressure, an increasing utilization rate can mitigate a decline in average billing rates. If the two rates decline together, though, it may signal a mismatch between the company's resources and market opportunity. Utilization differences among practices or regions are a major consideration in hiring, training and reallocating personnel. Even more than a fulcrum of performance management, utilization symbolizes the ongoing tension between the financial and people sides of the business. When demand is strong, managers are tempted to keep staff on client work as much as possible, even if it means skimping on professional development and risking burnout. In a softer market, vendors may allow "billability" to slip for a while because they are reluctant to undertake mass layoffs. Human capital is the core asset in this type of business, and it can take a long time to rebuild. But when utilization rates remain persistently low, as happened recently across the industry, vendors may sail perilously close to the financial brink. Utilization Trends Among IT Service Providers With these trade-offs in mind, Gartner Dataquest examines some trends that emerge from recent vendor research. Utilization is recovering from a long slump that afflicted most types and sizes of IT services provider. However, the recently reported numbers are not as positive as they first seem. For background information on study methodologies and participants, please refer to other Gartner Dataquest research: "IT Services Financial Metrics Analysis" (ITST-WW-FR-0101) "Applying Performance Metrics and Benchmarking to the IT Services Organization" (ITST-WW-FR-0102) Figure 1 shows the trend from 1999 through 2002 for two broad brackets of IT services vendors. The large and midsize group (more than $100 million in services revenue) had suffered a decline in utilization rates from 1999 through 2001, although they still outperformed the smaller vendors.

3 3 Figure 1 Long-Term Trend in Utilization Rates by Company Size Utilization Rate (Percent) Jun-01 Jun IT Services Revenue <$100M IT Services Revenue >$100M Note: 2002 data are from a vendor survey other than the 1999 through 2001 survey. Source: Gartner Dataquest (February 2003) The disparity mainly reflects differences in growth rates and target markets. The host of companies chasing the e-business brass ring was concentrated among smaller players. Their rapid hiring held down utilization because of the high ratio of new employees, who had to mesh their skills with the company's needs as well as get up to speed on internal processes (submitting expense reports, navigating the byways of HR and so on). Then, when the brass ring proved tarnished a few years later, the same companies were left with overcapacity in personnel. In a separate survey in mid-2002, both size groups reported dramatic increases. However, changes in the vendor landscape mean that the recent numbers are not as good as they seem. Companies with subpar utilization rates had workforce reductions, so the improvement in this metric reflects decreased supply rather than stronger demand. Many of the weakest IT services providers went bankrupt or were acquired. This "survivor bias" in the data is compounded by a reporting bias: Survey participants with poor numbers are less likely to disclose them. Therefore the recent survey results, for both size groups, probably overstate true industry averages by several percentage points. Figure 2 shows the comparison by vendor type for the mid-2002 survey respondents. Outsourcers far outperformed other categories of IT services provider in 2001; they actually increased their lead in 2002 with an improvement in utilization rates of nearly 6 percentage points.

4 4 IT Services Providers Manage Utilization for Performance Figure 2 Improvement in Utilization Rates by Company Type (Percent) Outsourcing Service Provider Comprehensive Service Provider Project-Based Service Provider Services Arm of Technology Vendor Jul-02 Jul Average Utilization Rate (Percent) Source: Gartner Dataquest (February 2003) The wide gap represents both differences among business models and market conditions that favor outsourcing. Demand for these services is on a recurring basis through multiyear contracts, providing the vendors with a relatively predictable stream of revenue and workload. This enables outsourcers to plan around an optimal utilization rate, which depends on their circumstances, strategy and management philosophy. In contrast, for project work such as consulting, applications development and systems integration, market demand remains erratic and weak overall. Technology vendors, which are struggling to revive sales of high-margin software or to gain market share in hardware, may lean on their IT services divisions to sacrifice some billable hours to support product revenue targets. Variations in Calculating Utilization Utilization rate is the percentage of time that billable resources are performing revenue-producing work. Although this seems straightforward, the way it is calculated can vary according to the following factors:

5 Thebasenumberofhoursperyearusedinthecalculation.Surprisingly, there is no accepted standard, although the most common denominator is 2,080 hours (40 hours per week times 52 weeks). Using this base and excluding vacation, holiday and training time a realistic upper limit for the utilization rate is about 85 percent. If a vendor calculates the rate on a 1,920-hour base instead, its reported utilization rate will be about 5 or 6 percentage points higher than with 2,080 hours. The "realization rate," which is the percentage of reported billable hours that in fact are billed and collected from clients. With some exceptions, such as pro bono work that the company may want to record as billable for the employee's sake, this rate should approach 100 percent. Anything lower usually reflects a lack of discipline in reporting and accounting procedures. The types of resources that are counted. This factor can make a difference of several percentage points in the reported utilization rate. Figure 3 shows the results of a survey question that asked IT services providers which types of resources they include when calculating utilization rate. Most respondents count their core delivery people systems and software specialists as well as the program or project managers who direct client engagements. Relatively few respondents count staff in product support or sales roles. (Note: This survey did not include vendors that specialize in hardware or software support.) Practices vary when it comes to business strategy or process specialists, whose role may be more in relationship management or service development than in front-line delivery. Figure 3 Types of Resources Included in Calculating Utilization Rate 5 IT Systems or Software Specialists Program or Project Managers Business Strategy or Process Specialists Product Support Technicians Business Development or Account Managers Others Percentage of Respondents Source: Gartner Dataquest (February 2003)

6 6 IT Services Providers Manage Utilization for Performance Other Performance Metrics That Interact With Utilization IT services providers are well aware of the pervasive effects of utilization rate. In a survey question about factors that affect profitability, respondents named two top metrics that are closely related: HR productivity and add-on business (in other words, contract expansion or follow-on projects). Productivity is sometimes mistakenly confused with utilization, but the former is a measure of output per hour, and the latter is the percentage of total available hours billed. Together they cause a multiplier effect on revenue and profit. Add-on business is a good way to sustain high utilization, to the extent that personnel can carry over an assignment into the new contract. Looking at different functional areas of a services business, specific metrics affect utilization or are affected by it in various ways. Figure 4 shows some of these relationships at different utilization levels. (The numbers here correspond to the arrows in the figure.) Sales metrics 1. Repeat business (contract expansion or follow-on projects) helps minimize downtime between assignments and reduces the number of nonbillable hours normally required for the vendor and client to establish a working relationship. 2. If the hit ratio suddenly increases, as may happen if Sales closes a lot of business toward the end of a quarter, it will cause upward pressure on utilization. 3. Monitoring the sales pipeline can help reduce short-term fluctuations in utilization, if people with the required skill sets are available soon after a deal closes. 4. If the company has a short-term decrease in utilization levels, it may temporarily reassign billable resources to sales support. This will effectively raise average customer acquisition costs unless the additional sales activity generates new accounts. Financial metrics 5. A long-term increase in utilization levels will enable the company to grow revenue faster than head count. The ratio of these two numbers, or "growth efficiency," shows the scalability of the business model. 6. To track margin contribution at a granular level, managers need to know how utilization varies by service line or practice. 7. A long-term decrease in utilization can escalate the company's burn rate to levels that threaten its cash position, unless the staffing model is adjusted to compensate. 8. A company's implied billing rate, which can be useful for competitive comparison or financial analysis, is inversely related to its utilization rate (for a given level of revenue per professional).

7 7 Resource metrics 9. If workers put in excessive numbers of client hours for too long, they risk burnout, resulting in higher attrition rates. 10. In the event of a sudden rise in utilization, a company may need to ramp up its new-hire rate to maintain sufficient staffing levels. 11. Fluctuating utilization levels may yield an uneven flow of intellectual capital that is difficult for the company to capture if resources that normally would be responsible for knowledge management are instead moving directly from one client assignment to another. 12. To deploy resources where they will be most effective, managers need to anticipate variations in utilization by service line. Delivery metrics 13. Boosting the amount of repeatable content in its solution offerings can help a company raise utilization levels, provided that people spend less nonbillable time on devising one-off solutions for clients. 14. Short-term fluctuations in utilization can make resource availability and project timelines unpredictable, therefore hurting on-time delivery performance. 15. If utilization remains low for a long time, a company may redeploy billable resources to develop new services or improve systems efficiency, in hopes of restoring its future revenue and profitability. Many of the linkages described here mediate the effect of utilization on revenue and profits. For example, redeploying billable resources into sales support or internal systems development is only a short-term solution. Endemic low utilization rates will result in low gross margins or outright losses. Increasing utilization can support revenue gains, but only up to a practical maximum "billability" level and not as a long-term strategy.

8 8 IT Services Providers Manage Utilization for Performance Figure 4 Interactions Among Utilization and Other Performance Metrics Sales Personnel Sales Metrics Repeat Business 1. Lower Downtime and Startup Time Utilization Level Sustained High 9. Burnout Resource Metrics Attrition Hit Ratio Sales Pipeline Acquisition Cost Financial Metrics Revenue Growth Profitability Cash Flow Billing Rate 2. Sales Closures 3. Resources on Deck 4. "Growth Efficiency" 5. Reassign to Sales 6. Margin Contribution 7. Burn Rate 8. Inverse Relationship Long-Term Increase Sudden Rise Short-Term Fluctuation Variation by Service Line Sudden Drop Long-Term Decrease Sustained Low 10. Hiring Ramp-Up 11. Uneven Production 12. Repeatable Solutions 13. Skills Balancing 14. Unpredictable Timelines 15. Reassign Billable Head Count Recruiting Intellectual Capital Resourcing Delivery Metrics Repeatability On-Time Performance Service Development Systems Effectiveness Accounting Quality Assurance Source: Gartner Dataquest (February 2003)

9 Staffing Actions to Improve Utilization Rates In addition to layoffs and workforce attrition, companies can give a temporary boost to their utilization numbers by deferring new hiring. Doing so, though, may have unintended effects on leverageability (usually described in terms of the company's pyramid structure). Since most new employees fill in the base of the pyramid, a hiring slowdown can thin out their ranks until the base no longer supports the upper tiers. In practice, this means there are not enough low-level skills, such as software deployment or systems administration, to carry out the work that moreexperienced people design and sell. Some companies are using a hiring slowdown to effect a shift in their leverage model. Proportionately more work is going to offshore resources, whether to subcontractors or the company's development centers in other countries. This transition is tricky because, in the interim, there have to be enough onshore resources to maintain continuity in ongoing client work. Companies risk too slow a ramp-up in offshore hiring or too high a ratio of managers and partners for their ideal leverage structure. Either the lower or upper levels of the pyramid could end up underutilized, affecting the performance of the company as a whole. 9 Gartner Dataquest Perspective Many IT services providers have recently improved their utilization rates, which would be a good sign if demand-driven. Instead, these numbers are set against an industry backdrop of continued slow sales, layoff announcements, business closures and consolidation motivated by survival rather than expansion. At this juncture, vendors may be boosting utilization simply because they are taking the painful and necessary steps to conserve cash and get their financial house in order. In the long term, industrywide trends are likely to raise utilization rates in IT services. Because of the secular shift toward IT management and business process outsourcing, with their attendant longer contracts and thinner margins, vendors will find it both feasible and necessary to minimize slack time among their workforce. While this boost in efficiency should benefit both buyers and sellers of IT services, it means a higher bar for vendors to hurdle. Key Issue What are the most important market metrics and benchmarks for IT services companies or organizations?

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