In this blog post, you’ll learn what professional services firms usually get wrong when it comes to figuring out how to package and price their offerings.
1) No Idea About Their Base Cost Of Labor
First, they have no idea what their base labor costs are.
In other words, they haven't thought about what their average employee salary is.
They haven't divided it by 2,000 hours a year or some approximation like that.
They have no idea.
They haven't thought about whatsoever what the average client costs them on an hourly basis.
2) Failure to Adjust Base Cost of Labor for Actual Utilization Levels
Second, they haven't taken the time to adjust that hourly cost of labor for an actual utilization rate.
Utilization rate is the percentage of your workweek, the percentage of time that's productively billable to clients (versus used for other things like administrative, training, logging in, logging out, breaks, all that other stuff.)
In other words, it's how many hours an average employee can expect to bill in a given week.
And it's typically for most professional services firms, in the 50%, 60%, maybe as much as 75% range at the extreme upper end of the range.
If it's significantly lower than 50%, chances are you're losing money.
If it's significantly higher than 70% to 75% on an extended basis, you're going to burn out your team members.
So it's essential to keep tabs on that.
And that utilization rate is also another critical part of figuring out what you should be charging for your professional services.
So you have your average hourly cost, and then you have to adjust that for the actual utilization rate.
So take your hourly cost and divide it by utilization rate.
3) No Overhead Factored In to Arrive at Effective Hourly Cost
And then next, professional services don't think about their overhead to arrive at an effective hourly rate.
And their overhead is typically in the 20% to 40% range.
It includes the employer's taxes, health insurance, 401K, professional development, telecommunications, IT services, hardware, office real estate. So all of that.
Your effective hourly rate, adjusted for your utilization rate, needs to be adjusted and multiplied to take into account your overhead, which is again is typically going to be in the 20% to 40% range.
4) Failure to Incorporate Target Profitability Into Cost-Based Pricing
And finally, the fourth biggest mistake that most professional services firms are making is they don't incorporate a target amount of profitability into their pricing model.
You're trying to get somewhere in the 20% to 30% range, so that again needs to be added to your effective hourly rates.
Plus, take into account utilization rate, overhead, and some profitability.
So you multiply your effective hourly cost adjusted for utilization rate, adjusted for overhead, and adjusted for target profit.
And then and only then are you starting to get close to having the right kind of pricing model that makes sense on a sustainable basis for your professional services firm.
What have you found most challenging when it comes to arriving at the right kind of pricing model for your own professional services business? Let me know in the comments section below.
Topics:- Managed Service Provider MSP