What is an Effective Hourly Rate at a Professional Services Firm?
If you work in a professional services firm, you are very likely to be familiar with the various performance metrics used to evaluate staff and engagements. Partners, managers, and staff will all consider things like job realization, staff utilization, and job WIP (work-in-progress billings) while performing the duties of their role. While every metric has its own place at a professional services firm, they each tell a different story and have different uses as a result. Today, we are going to discuss a less popular metric for professional services firms: Effective Hourly Rate as a job profitability tool.
What is an effective hourly rate?
The effective hourly rate of a given job is simply the fee charged to the customer divided by the number of hours into the timekeeping system. When calculating the effective hourly rate, there is no distinction between an intern’s hour and a partner’s hour; those differences should show up in the fee in the numerator of the equation. For example: an $12,000 fixed fee engagement that took 40 hours of time has an effective hourly rate of $12,000/40 hours=$300/hour. Most firms build up a budget for a fixed fee engagement based on a standard rate per professional and their estimated hours. This $300 per hour is a mix of every professional on the engagement based on the hours they spent to complete it, hopefully it’s close to the budget!
How is it different from other performance metrics?
Effective Hourly Rate is a simplified tool to measure the firm’s productivity on a standardized scale. By comparing the effective hourly rate to a firm’s standard rates, management can determine which jobs are under or overperforming and they can make adjustments accordingly. Most of the time, the adjustments will fit into two categories:
Reduce the number of hours on an engagement - For fixed fee engagements, this is particularly effective in bringing the effective rate up.
Delegate Work - So that the effective hourly rate is in line with the staff performing the work, or the nature of the work. If a firm normally charges staff level personnel out at $200 per hour, a job that has an effective rate of about $200 per hour is likely to be a good match for those staff level personnel.
Why should my firm use an effective hourly rate to evaluate engagements?
Effective Hourly Rate is an incredible tool for evaluating engagement profitability if you know how to use it. Here are my main reasons to use this tool:
Considers discounts, investment time, and write offs - By simply taking the fee against the hours spent, the metric considers the impact of all the common changes to fees like discounted rates and time write offs. Putting engagements side by side with all these things considered allows for a better analysis of the time spent.
Helps evaluate both fixed fees and variable fees - Different fee structure engagements typically are held to different standards and have different metrics highlighting their performance. Fixed fees are often measured by realization, while variable fees are often measured by their total billings. While each of these approaches has its own merit, using an effective hourly rate helps compare engagements across the two different fee structures.
While it’s not a common metric, the Effective Hourly Rate is a great tool for your professional services firm toolbox that has its uses and has the potential to be a key metric in your firm. Try it out!