Small Consultancies Need Analytic-Driven Management Approach

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1 Research Brief Small Consultancies Need Analytic-Driven Management Approach Abstract: Consultancies of all sizes are increasingly using analytic models, business intelligence and enhanced visualization techniques to manage the business to improve their competitiveness and effectiveness. By Alex Soejarto and Lewis Clark Recommendations Start with an understanding of the DuPont model for services as a basis for measuring business performance. Choose an analytic framework that fits the management style and business model of the company. Consider the effects of information presentation and visualization on the ability of managers to communicate effectively. Publication Date:27 February 2003

2 2 Small Consultancies Need Analytic-Driven Management Approach Broad and Competitive Market The broad base of the pyramid in the IT services industry is a large group of little-known Tier 4 companies of less than $100 million in revenue. These midtier companies tend to be small (50 to 1,000 associates), operate locally, have close relationships with a tight group of clients, and concentrate on labor-based professional services such as consulting and systems integration. In the past, the partners or other managers of these companies have run the business informally, based on relationships and intuition. And as private companies, they have avoided external pressures from investors and analysts. However, because of increasing competition, many midtier companies within this group are adopting more-rigorous management practices. Practices These practices include tighter fiscal controls, formal service development processes, robust methodologies for service delivery and explicit risk/reward provisions in client contracts. Reasons for these changes include: Closer scrutiny of IT budgets and project outcomes on the part of clients Broader geographic reach or vertical market extension that brings smaller companies increasingly into each other's turf Competition with Tier 1 and Tier 2 IT services providers that are moving into the midmarket or bidding on smaller contracts More intensive use of technology to improve service delivery and streamline back-office processes An influx of managers who have left larger companies, bringing bigcompany discipline into established smaller companies or startups Characteristics The characteristics of these midtier companies lead them to apply a different set of performance metrics with associated software tools than larger IT services providers. Characteristics include: Profitability Because many midtier companies are privately held, often with a partnership structure, they tend to use different margin or profit metrics (for example, profits per partner instead of gross margins by service line). Labor efficiency The concentration of labor-based services means that metrics for utilization and resourcing are paramount, while other factors such as R&D or infrastructure for service delivery tend to be less important. Local operations For companies that operate mainly out of branch offices that have a high degree of autonomy and mainly a local clientele, headquarters need metrics for exception reporting that can identify laggards or best practices among diverse offices.

3 Project oversight In the staff augmentation or contract work parts of their business, midtier companies have less influence over the planning and execution of IT projects. Performance measures for this type of work must account for the client's role in project management and servicelevel requirements. Real time Winning in competitive bid situations requires the ability to commit resources based on a client's preferred timetable. Understanding resource availability as well as project profitability is essential. A sharper focus on key performance indicators (KPIs) or key metrics will entail several changes for these midtier companies. First, choose an adequate profit model and gather the appropriate information. Second, the analytic framework must represent changing or expanding practices and gaps in performance. Finally, some means of visualizing the results should be tailored for people in different roles. It is important to note that historically, midtier companies attempted to develop their own proprietary models and tools. Today, standard sets are available, for example from project portfolio management (PPM) software, to facilitate a metrics-based approach. 3 Choosing a Model The trend to use dashboards, scorecards, analytics and business intelligence to relay company information to business managers is picking up steam. This method is as critical in professional services as any product-based company. Filtering through the mass of information that is regularly collected is a challenge and choosing a model is a first step. The Analytic Methodology Taking a cue from product-based industries, the DuPont model is a logical foundation for analyzing the profit of a company. Much has been written about its applicability to professional services. Though return on equity is an important measure in the product-based world, in professional services the more appropriate metric is profit (return) per unit. Describing profits on a per-unit basis allows flexibility in analyzing the company based on units such as services offering, geographic location or partner contribution. The three components that determine profit per unit are shown in Figure 1. Leverage This is often referred to as skills mix or consultant experience and represents the type of model the company employ such as "pyramid" or "diamond" structure. Productivity Fees generated by consultants as a result of utilization. This captures the effectiveness of the staff in delivering services to the client. Margin The percentage gap between revenue and expense is an efficiency measure for the use of available resources in capturing value for the company.

4 4 Small Consultancies Need Analytic-Driven Management Approach Figure 1 Profit Model for Services Profit (ROE) Margin Productivity Leverage Profit Partners Profit Fees Fees Consultants Consultants Partners ROE = return on equity Source: Gartner Dataquest (February 2003) Two basic resource inputs are required to calculate the profitability: head count (billable staff) and hours billed. In addition, several financial inputs, such as selling expense, fees and bill rate, are required. PPM/service process optimization (SPO) applications support this model. Managing and Monitoring Performance measurement and assessment can be a consistent discipline year in and year out. The discipline requires well-honed practices of gathering metrics and applying them. To execute, a set of industry standard models is necessary. As a schema to represent the relationships among different types of performance metrics, this Perspective will use a variation of the Gartner Business Performance Framework (see Figure 2). Gartner developed this framework as an assessment or diagnostic tool for various kinds of IT initiatives and business processes. The framework is based on the fundamental elements of demand management, supply management and support services. The variation shown in Figure 2 adapts some of the categories and metrics for IT services providers. The metrics in each cell are only examples; actual performance measures will vary by type of vendor and service line.

5 Figure 2 Example of Metrics-Based Reference Model: Gartner Business Performance Framework 5 Demand Management Market Responsiveness Percentage of Revenue From New Services Sales Effectiveness Average Acquisition Cost Service Development Time to Profitability Supply Management Customer Responsiveness Percentage of Jobs Sole-Sourced Alliance Effectiveness Lead-Generation Rate Operational Efficiency Percentage of Work Done at Client Site Support Services Human Resources Voluntary Turnover Rate IT Effectiveness Revenue/Head Count Growth Finance and Regulatory Compliance With Standards Source: Gartner Dataquest (February 2003) Cost analysis must adhere to principles that include all significant visible, hidden, one-time and recurring costs. Benefits must be modeled against a framework of business metrics that represent the controllable and quantifiable activities of the company. These can be internally developed or based on an available reference model. Direct benefits must be modeled against the measurements they are expected to improve, along with impacts to other areas of the enterprise's operations that can be affected positively or negatively. These business metrics are key to the analysis because they become the "living" part of the business assessment. Even for benchmarks that are in wide use, a range of optimal values can exist for different professional services organizations. Companies must understand their relative performance to correct any weaknesses and overtake competitors. The work they do for clients factors into the process, in relation to applying principles of change management as well as relying on the client as a source of feedback. Metrics should be geared to the most-critical numbers for a particular company, such as utilization rate or service-level performance. However, the optimal value or target range may change depending on client needs, market conditions and competitive dynamics. Benchmark references can be drawn not only from the known peer group, but also from companies in nearby parts of the market that could be future competitors. People in all roles of the services organization must have access to metrics so that they can take the initiative. While the numbers themselves are useful for exception reporting, to create an alert that one performance is outside an acceptable range, individual attention can lead to action that anticipates and prevents the problem. Client metrics are so crucial that

6 6 Small Consultancies Need Analytic-Driven Management Approach they should be available even to people who are not in customer-facing roles. Ultimately, a collection of metrics can be calculated that provides an accurate status of the business. The top metrics that must be assessed in any financial model are presented here: Revenue Bill rates Billable hours Gross margin Number of billable consultants Consultant utilization Revenue per billable consultant Billable consultant distribution Top five customer concentration Taking a "profit per unit" approach to analyzing the business is appropriate for a smaller services company. Particularly when taking a "profit per partner" approach, accountability can be established against a budget. Being able to take action on these measures quickly is imperative in an increasingly competitive market. PPM applications gather these data points. Assessing Total Capacity and Pinpointing Shortfalls The Gartner Business Performance Framework helps to locate specific performance indicators within broad functional areas of the organization. To derive something practical for professional services from this generalized model listed in the previous section, it is useful to take a complementary top-down approach. This aspect of the analysis looks at different layers of the business model for their contribution to financial performance. It uses a sequence of guiding questions: Delivery capacity What is a maximum potential revenue or profit that the company can attain? Shortfall How much of this capacity goes unused at anytime or on a particular engagement? Direct costs How efficient is the company at generating revenue in relation to its variable cost base? Indirect costs What is a practical minimum amount of overhead for the company's size, scope and growth plans? Bottom line What is the actual income per partner or revenue per professional for the company? In an hourly model, total delivery capacity is derived directly from the number of billable professionals, hours available and charge rates.

7 7 Depending on the company's operational model, it may be appropriate to calculate capacity by practice, by local office or for the company as a whole. The usual metric for shortfall or unused capacity is the company's utilization rate. The ability to match available skills to paying contracts is key. Other factors that can influence shortfall are hindrances in deploying people among different locations, or delays in hiring or training new employees. Direct costs relate inversely to the billing markup rate. If variable costs are too high, the company's operating margins suffer. This is why professional services companies pay close attention to their leverage model: typically a pyramid with a few highly paid partners and a broader base of lessexperienced professionals. In theory, indirect costs are fixed costs, but, in practice, they tend to creep up along with the company's revenue growth. These include the traditional general and administrative line items such as rent, support staff and supplies. Many professional services companies are becoming increasingly dependent on technology for service delivery, so this is a growing expense item. For the partners in a privately held company, the bottom line is the amount of income per partner that the business generates. An alternative is to track revenue per professional, a common measure of productivity among publicly traded services companies. This top-down approach is useful for budgeting, tracking current expense ratios and comparing annualized performance to historical levels. It provides a base set of data to monitor and manage performance throughout the organization. Professional services companies use an increasingly refined set of performance metrics, aided by analytic and visualization tools as discussed in the next section. Choose a Visualization Model Once the business establishes an analytic methodology, the next step is to present the information in a usable format within a proper context. Here is where business intelligence functionality comes in: Visualizing the information in an intuitive way is important for managers to quickly interpret the results. A visualization tool matched to the organization's philosophy increases management responsiveness when turning data to knowledge and then action. Data Data are presented in recognizable formats (charts, tables) that are common among managers to serve as a communication medium. Knowledge An intuitive model is used as the context of the information. By wrapping the information within a model, data are not only exchanged, but knowledge sharing is encouraged as stories of the state of the business become easier to relate. Gaps in performance allow an assessment of operational efficiency.

8 8 Small Consultancies Need Analytic-Driven Management Approach Action With knowledge sharing comes the ability to take action. Often, a criticism of metrics and models is that they create "analysis paralysis." But ensuring that the information is actionable avoids overanalysis of any one point in time. Understanding how current company performance compares with historic performance or current annual budget or a forecast of the business is a necessary component to have for proper action. Moving data to action is the goal of a visualization tool and associated model. Combining the three elements of analytic methodology, visualization tool and comparative components provides a complete picture of the financial performance of the company or units (service line, geographic location, and partner) within the company. Such an accessible form of information sharing allows greater efficiency in monitoring operations, meaning reduced labor costs, reduced latency in information access and increased ability to react to the business all critical factors in the success of smaller services companies. Gartner Dataquest Perspective It is imperative for all companies in IT services to develop a metrics-driven management approach to compete effectively. Though the temptation is high to develop a novel approach, Gartner Dataquest recommends using a model, such as the DuPont model for services, because it has been vetted for a wide variety of service company business models. In choosing a framework to drive the business, managers should exercise judgement to choose a framework that complements their style and business model. Although the Gartner Business Performance Framework is useful in putting a context to how the business is doing, it is by no means the only framework available. Other proprietary approaches are available. A final important consideration is the presentation of information. An intuitive presentation style facilitates knowledge sharing and confidence in decision making. To obtain full benefit of this metrics-based approach, services companies must seriously consider the use of PPM/SPO. This applications suite is designed to capture and present the appropriate data to manage the delivery of services. Without PPM/SPO, the resources required in time and money as well as skills and expertise are high when compared with the availability and functionality of these applications. Key Issue What is the impact of new technologies on consultants and systems integrators?

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