Why employee utilization rates are the key to driving profitability

No matter the focus of a services business, you need a profit calculation model for each employee across the organization. This requires a utilization rate.

What is a utilization rate?

Utilization rates are a way to measure the efficiency and productivity of an individual in generating revenue against available bandwidth, divided over a set period of time. In simpler terms, a utilization rate reflects the percentage of an employee’s work hours that can be billed to a client versus their overall availability.

If you don’t know what you have to sell, or how much you can deliver, it’s easy to end up under- or over-utilizing employees. This lack of control can have serious financial and operational repercussions, including dissatisfied customers, missed sales, inflated overhead and more.

There are many factors that go into creating a utilization rate formula that works best for your business. Many areas can impact calculations, and rates can be used in various ways. To make it easier, there are technology solutions that can help services leaders gain this invaluable insight, putting their organizations on the fast-track to greater profitability.

The fact is, if you don’t have target utilization rates, you’re likely not using your workforce correctly.

utilization-rate-formulaIs there a standard utilization rate target or formula for success?

The short answer to this question is no – and there are a number of reasons. Foremost, organizations have different strategies, so (resource) utilization formulas vary.

Take PricewaterhouseCoopers and Deloitte, operators of huge global professional services and consulting networks. Their employees generate revenue through longer-term engagements, often in client settings. These consulting utilization rates would typically be very high because the pipeline of work is full, jobs are specific and the priority is squarely on generating revenue.

Now, consider a smaller services business that is more focused on growth versus profit. To achieve that, they might hire additional people. They might then run a high utilization rate, but not with an emphasis on profitability and billability – the margins might be less because they are attempting to build for the future and are relying on cash reserves for the time being.

Such reasons explain why professional services utilization targets vary. For instance, HubSpot found some agencies aim to target an 85 to 90 percent utilization rate, however the actual average utilization rate is much lower at 60 percent.

Rates vary by type of organization, role, business goals and individual job functions. You could try to benchmark your competitors’ rates for comparison purposes, but it’s most important to know your own organization – and that requires you to evaluate your operations first.

calculate-employee-utilization-rates-1-1-1024x206-1How do you calculate employee utilization rates?

You should set rates for employees that are achievable. You’re looking to determine the actual supply of what you have and how to cost-effectively meet demand. So, while you want to set a baseline to ensure employees are profitable, this shouldn’t be an attempt to reach an inflated sales target. Doing so could lead to employee burnout, which, according to research, causes high job turnover, increased absences and decreased productivity costing U.S. businesses $300 billion annually.

To calculate employee utilization rates correctly, understand that different roles have different rates. As an example, someone with managerial responsibilities wouldn’t have as high a rate as someone working directly on a project. Why? You’d expect them to spend a good amount of their time managing personnel and performing other duties that are not directly billable to a client.

A staffer responsible for overseeing a financial area like accounts payable or someone heading up human resources is probably not generating a lot of billable hours, either. Are they still instrumental to your success? Absolutely. But they shouldn’t have the same utilization rate as a graphic artist or an accountant who spends the bulk of their time on billable client projects. Furthermore, jobs have various monetary values: the hours of an architect can fetch a higher markup than a project manager.

Which brings up a good rule to keep in mind when assessing utilization rates: employees involved in billable client work need to not only cover their own salaries, but also need to allocate a portion to functions that don’t generate revenue. So, a percentage of overhead costs needs to be divided amongst billable employees to ensure profitability for your overall organization.

Determining billable versus non-billable time is also important. Consider time employees spend on personal professional development, in internal company meetings, and on paid time off. These are all important; you certainly want to grow employee skills and don’t want them to be overworked. But if you fail to incorporate non-billable hours from the outset, any calculations will be way off.

So, a basic formula to calculate employee utilization rates looks like this:

  • Begin with 260 working days per year (52 weeks x 5 days).

  • Then deduct the following internal or paid time off activities (you’ll need to adjust to fit your business):

  • Vacation days (say 25 days)

  • Sick days (5 days)

  • Internal activities such as training, off-sites and meetings (15 days)

  • Professional development or conference attendance (10 days)

  • That leaves you with 205 days of billable client work. Divide that by the total 260 working days, and you’re left with a 78 percent target utilization rate.

  • Beyond this, you may deduct other non-billable work activities, such as client prep, reporting, travel, etc., which will further reduce the utilization rate. This is also where you need to factor in each person’s role, as their responsibilities and target rates will differ from each other.

Billability vs. utilization: How can employee billability drive profitability?

All of these factors detailed above need to be used to develop target margins. Those targets should then be reflected in utilization rates at every level of your business. It’s vital to set and be able to analyze these rates in order to establish and grow profit margins.

With this in mind, you should then use these utilization rates to establish billability targets, or the number of billable hours each employee should hit. These should be shared with individual employees, as well as teams, giving everyone realistic goals all can work towards.

What’s more, it’s important that you have visibility into the status of utilization at all times. You need to be able to plan ahead in order to fulfill client work, improve employee bandwidth and make sure the right resources are in place. You don’t want employees to be idle and worried about insufficient work in the pipeline. Nor do you want them overwhelmed and be forced to hire in a way that’s not cost-effective.

You always need to know that enough revenue is being generated and that projects are completed profitably. For that, you need real-time visibility across your organization.

Can tools help raise utilization rates and billability?

If the above sounds like a lot, take heart – there is technology available that can make creating and maintaining utilization rates, margins and profitability a snap.

And these tools were created with your type of business specifically in mind.

Enterprise Resource Planning (ERP) platforms free up everyone in a services business by automating time-consuming tasks in management, sales, finance, operations and project management. They facilitate each step of the quote-to-cash journey. They can raise efficiency and profitability with greater CRM capabilities and finer control over time and costs, invoicing, pricing and cash flow.

User-Roles-Finance-and-OpsSee how VOGSY helps you stay on top of utilization and delivery

An ERP platform can help services leaders set and monitor utilization rates, offering constant visibility along with tools to analyze the past and anticipate the future. The right ERP platform delivers real-time sales, customer, project and utilization metrics. Configurable KPI boards provide fast access to vital data.

As a result, scopes of work are on-target, margins are effectively managed and grown, and the pipeline is accurately forecasted.

Equally important, it gives you a realistic view of employees. You can make sure they’re not getting burnt out and that they have the right resources and skills in place to meet demands. You can empower staff to take ownership of work, ensure that they’ve got projects to tackle and are able to achieve their deliverable targets. Everyone can see what their peers are working on, prepare for what’s ahead and collaborate more effectively.

An ERP solution can give you the data you need to ensure you’re selling the right services at the right margins. And for leaders, that is the key to driving profitability.