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The Utilisation Paradox – how to pay your people more but charge your customers less while increasing profit

This fundamentally simple proposition will forever change the way you think about the contribution of people to your service business. Whilst it...

The Utilisation Paradox

An article by Len Norman, Director of Conquest Consulting Pty Ltd and inventor of Skillspeak, a revolutionary skills management tool aimed at “creating experts”9D. Reaping business benefits by applying the ideas expressed was a design objective of the tool. For further information you may contact the Author at len@conquestconsulting.com.au originally written in 2000A0- re-issued 2010.

Conventional Wisdom

People are your most valuable resource. Right?

People certainly carry significant wealth creation capability. This is achieved by current staff applying their skills. The methods and procedures employed, however, represent the accumulated knowledge of all previous staff since the inception of the business. Even though business leverage is a desirable aim reducing the direct dependence on people to create profit, we are a long way from the day when the importance of people in a business is absolutely diminished.

So people are valuable but what about cost?

People cost should not be an issue in a well-managed business with a stable flow of revenue, especially if there is a strong repeat business component. The labour cost is undeniably high but given a reasonably consistent flow of work, staff will usually be able to produce enough revenue to cover their cost plus a fair contribution to profit. Still, all organisations need to manage the output of their staff to avoid scenarios where some are able to coast while others make up the shortfall. The usual measure applied is individual employee utilisation.

How does the utilisation measure work?

If the business is in the services sector, it is possible the skills of people are the direct product offered to clients. Examples are consulting, legal and accounting firms, IT Services, professions and personal services. In these organisations, billable utilisation is managed to healthy levels. Organisations can offer fixed price quotes for its services or sell secondary products, the results of the application of staff skills. In these cases utilisation rates are managed to minimum standard levels consistent with pricing policy.

Surely it is best to drive utilisation as high as possible?

The higher the utilisation of staff, the more return will flow to the business from employing that labour. This certainly represents the traditional accounting view of business. Elaborate time recording or labour claiming systems have been developed to help control utilisation. Nobody would deny getting more from staff will initially add to profitability on a fixed salary bill. Indeed, competitive pricing pressures have forced organisations to drive up utilisation rates to almost unhealthy levels with break-evens up in the high 80 percents or even in some extreme cases, the low 90 percents.

The first signs of the wheels falling off? Outsourcing.

Imagine an internal services group providing its labour and skills fully funded by the business. In other words, the employees in this service department are on the payroll. Examples may be, Pay Office, Purchasing, Legal Services etc. In the interests of cost reduction, utilisation rates are driven as high as possible and practicable. When no further saving can be gained, you guessed it? The outsourcing card is played. After outsourcing, the organisation can pay for services on a usage basis allowing costs to be controlled more tightly. The assumption of course is that the outsourcing organisation can manage the delivery of services at a more competitive rate. Through having critical mass and the opportunity to specialise, this may be true for a time. Eventually though, these organisations too must find the correct levels of utilisation to drive profit.

Challenging the Wisdom

A professional workforce will deteriorate and diminish in value if not maintained by personal development. This will reduce the organisation’s wealth creation capability over time. Also, the greater the dependency on leading-edge skills, the faster the decay or the shorter the half-life. This is real and widely acknowledged even if not necessarily reflected in the books of account. To those people conceding the death of “jobs for life”9D, this may not seem to be a major concern because they have a firm belief they can recruit needed skills without developing them in-house from scratch. Of course, this is short-term thinking and the natural ebbs and flows of the labour market will have such organisations critically short of needed skills and at the mercy of the supply market.

So even within a desire to utilise staff with the highest possible billable percentage, a successful business must allow minimum levels of personal development to ensure its people remain current and relevant to markets it chooses to serve. To do this, they need to make a dollar investment in the cost of training and allow time during working hours for the development to take place. It may not be simply attendance at training events, but could well be reading technical journals to learn how their art is being furthered worldwide. Surely, this must challenge the concept of every hour spent at work being potentially billable.

How has it been managed in the past?

If a business is experiencing severe price competition in its market, the natural response has been to squeeze more billable time from staff for basically the same salary. This has pushed break-even utilisation rates up as high as the low 90s% in some organisations. It is frequently found to be in the 80s% for many pure service companies. When this occurs, the symptoms are unmistakable and immediate. Some of these observable outcomes are:

– People enrol on training but do not appear

– Cancellation of places on courses, if submitted at all, are too late for substitute placements

– Staff work overtime and through breaks in order to win back enough time to take all of their annual leave

-A0″Next Available”9D is the main criterion used to select staff for new work assignments as opposed to the far healthier E2??Best QualifiedE2?9D

– An “ll ands to the wheel”environment develops, where people are asked to cover work for one another regardless of whether they possess the necessary skills

– Everybody is working harder and it is becoming less fun to come to workA0- few are working smarter

– Demand for sick leave rises but is not taken because of work pressures, so people bring their bugs to work

– There is a marked slowdown in repeat business

– Customer letters of complaint increase in frequency

The answer is to reduce the break-even billable percentage

I can hear the accountants roar their disapproval at this point but the more objective reader will follow the logic and embrace a new wisdom9D.

If current break-even billable utilisation is 90%, an increase in billing rate (whether internal or external) of 50% will effectively reduce the break-even to 60%. Those who are students of mathematical queuing theory, will know that a resource loaded 60% delivers a far more manageable queue. This is evidenced by shorter waiting times, easier resource scheduling, wider customer choice, more thorough preparation and close-out of service tasks resulting in fewer mistakes.

Of course, the trick is to get the end client to accept a direct service priced up to 50% per hour higher or an end service or product where internal charge-out rates represent a 50% higher charge per hour for labour employed. To justify this premium labour rate, the service must ultimately be valued more highly by the client. Several factors will now work to ensure this is the case. These include:

Staff are able to become more expert in their work by:

(a) being better trained for it directly

(b) being selected based on a superior skills match

(c) having more time to stay current with the latest methods used in their industry even contributing to research in many cases

Because work is now being done in all cases by relative experts, fewer hours will be billed for any given piece of work

The delivery risk of projects is greatly reduced

Delivered products incorporate a greater level of applied workmanship and will be far more reliable

Staff deliver quality results on a “right first time”9D basis

Will there be a strategic advantage for the organisation?

Once a business can justify and lock in premium labour rates, it no longer needs to respond to pricing pressures from competitors. It enables a shift from commodity pricing to quality of service competition. This is a far healthier arrangement.

It should be noted at this point that a move to set a low break-even does not impose any assumed actual operating level of utilisation. A lower break-even point facilitates greater levels of profit in that if management choose to operate at higher levels, profit is enhanced during that period. However, there is just no room to move from a 90% break-even.

What happens to the price paid by clients? The Paradox.

When this strategy is perfectly executed and becomes part of the established operating style of a business, prices will actually fall. This is based on several interesting effects:

Experts use fewer hours to get the same or better quality result

With a 60% break-even point, staff can be more selective in the hours they bill to particular projects rather than billing everything just to meet the target

Individual staff begin to specialise in their work and develop productive techniques driving costs down even further

Repeat business is encouraged and project establishment costs are reduced for follow-on work

A new beginning for E2??jobs for lifeE2?9D

There is no natural reason why there has been a shift in employee thinking which is killing off the idea of E2??jobs for lifeE2?9D. It is all in the recent experience and in particular a result of the way companies have treated their staff. Some bad business planning decisions and sudden economic downturns have made people question the idea of employment loyalty. If the company can let an employee go in order to re-balance profit, why should the employee resist a move elsewhere, often at an increased pay rate? The answer lies in all that has been identified above.

There are three very significant factors controlling an individualE2??s decision to leave an organisation and become an attrition statistic. These are:

Do I get to work on challenging and interesting assignments making best use of my skills? i.e. Am I appreciated?

How much development and career assistance do I get here?

What do they pay me?

If the answer to each question is “I’m doing the best I can on these points right here”9D, attrition will be controlled.

By embracing the principle of premium pricing per hour worked coupled with a personal development investment strategy, these three factors are eminently achievable. The result is that staff will either not leave or at least delay a decision to leave. There will be no natural reason to leave once all three of these criteria are met.

Any service company able to sustain a renewed “jobs for life”9D mentality will be the winners in their industry in this new millenium. Their employees will not be able to afford to leave them.

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