Service Business Woes

Take utilization, for example, one metric many companies zero in on. Will a utilization rate of more than 75 percent ensure profitability of services? Surprisingly, it may not.

Many VARs understand the concept of utilization rates and attempt to manage their service departments by maximizing the utilization rates for their engineers and technicians. Most VARs also understand the importance of the billing rate. However, the utilization rate and the billing rate do not always tell the whole story when it comes to profitability. Another little-known metric, the realization rate, is just as important when it comes to maximizing service department profitability.

All three measurements,utilization, billing and realization rates,are interrelated. When combined, they give you total revenue generated by your billable resources. The following formula can be used to understand this relationship: B x (U x 2080) x R = Revenue.

In this formula, B is the standard billing rate, U is the utilization rate and R is the realization rate.

Utilization is defined as the percentage of hours an engineer bills compared with a standard base of 2,080 hours (52 weeks at 40 hours per week). For example, if an engineer works 1,248 hours out of 2,080 their utilization rate will be 60 percent based on standard hours (1,248 divided into 2,080). Many VARs include as part of the utilization calculation work performed by the engineer that is not billable. That may be work performed on the internal network, for example. Although this is productive work, it should not count toward utilization. In general, you should target a minimum utilization rate of 67 percent.

The billing rate is the rate charged to the client. A good rule of thumb is the standard billing rate for dispatched engineers should be five times their hourly salary. As an example, if an engineer makes $50,000 per year, their hourly salary should be $24 ($50,000 divided by 2,080 hours.) Therefore, their standard billing rate should be $120 ($24 times 5). Keep in mind this is for a dispatched engineer, not an engineer that is outsourced to your client on a full-time basis. Different metrics are used if you run a staffing model. In addition, the actual billing rate may vary from the standard billing rate due to competitive pressures.

Realization is the ratio that ties utilization and billing rates to actual revenue produced. The realization rate is the percentage of dollars generated to the total dollars that should have been generated. We suggest that the realization rate needs to be 90 percent or more. To understand how that works, let's say you have an engineer who earns $50,000 per year and his standard billing rate is $120 per hour. He works 1,400 hours out of 2,080 per year giving you a utilization rate of 67 percent (1,400/2,080 = 67.3 percent). Thus, he should produce $168,000 in total revenue for the year ($120 x 1,400 hours). That seldom is the case, due to myriad factors. If he only produces $126,000, his realization rate is 75 percent, calculated by dividing $126,000 into $168,0000.

The realization rate can be less than 100 percent for many reasons. One common example occurs with rework. Say an engineer was dispatched on-site for eight hours to complete a $1,000 billable project. The work was not done to the client's satisfaction, resulting in the VAR's having to send another engineer out a few days later. That might mean spending another eight hours to redo the project, none of which, typically, is

billable. Yet, both engineers record eight hours of billable time (16 total billable hours), which contributes to each of their

utilization rates. However, their combined realization rate is only 50 percent.

Another common example is a $5,000 fixed-priced project, estimated to take 40 hours. If the project takes 60 hours, then 60 hours will count toward an engineer's utilization rate. However, the realization will only be 66 percent. Other factors that can negatively affect the realization rate include discounted billing rates, travel time, poor pricing policies, bad debt and poor work quality that results in giving a client "credit" for additional work.

Realization, utilization and billing rates are only three of a total of some 16 factors that can affect your service profitability. But thoroughly understanding those three can help you better manage your service departments, especially as the economy improves.