Calculating a Break Even Rate

What problem did you tackle?

A sustainability architecture firm wanted a better way to understand if the bill rates assigned by staff level were actually profitable. Previously, a multiplier on wages based on billable throughput was used. However, that created unreasonable swings in rates that caused junior client facing staff to have bill rates that felt too low, low-utilization staff to have bill rates that felt too high, and a bunch of other considerations in between.

On the whole, the results seemed to match up close enough to averages that were shared in industry publications to be acceptable. But what was missing was a better understanding of how her company’s overhead (including the non-billable component of her team’s wages) could be folded into her team’s bill rates for future contracts.

How did Norman Professional Services craft a solution?

The company already had employee wage data and expectations around billable utilization, thanks to their existing employee performance review process. From that, it was simple to calculate the portion of wages that is not attributable to billable work and therefore should be considered overhead.

Add on top of that all other expenses that the company took on that weren’t directly billed back to clients: insurance, business licenses, office space rent, marketing, professional services (like NPS!), and even regular outings to keep employees engaged in a positive company culture. Those expenses are also overhead, and their cost should be contemplated for the company’s stated (or implied) bill rates to clients as well.

Combined, those pieces of overhead made up the total non-billable burden to be added on top of wages to at least break even, let alone make a profit. The utilization expectation by team member allowed the team to calculate the total number of expected billable hours that each staff member contributed to the pool of total service delivery that should cover that overhead. Dividing the overhead by hours yielded a total dollar per hour on top of wages that should be overhead.

By adding the overhead dollar per hour to each staff member’s extrapolated hourly wage, NPS obtained each team member’s break even bill rate. Initially, this number was pretty high, and that was because the pool of available billable hours was smaller than typical due to some changes to the team. The way to address this was to add more billable hours by going on a hiring push, which was in line with the company’s objectives to seek out talent that aligned with areas they wanted to grow their service delivery. Now that the organization brought on two new people, the total billable hour pool increased to bring the overhead spread back down to a more acceptable level.

What was the positive impact?

The company gained visibility on how their non-billable component of wages also influences the total overhead of the organization, particularly as it takes on individuals who are more likely to be internal-facing, rather than client-facing. Additionally, discussions with the owner helped reinforce how the addition of more service-delivery-focused talent into the org helped to “spread the wealth” when it comes to the overhead expenses. Provided the work was on the way, this strategy allowed the company to price themselves more competitively while still striving for target profit margins that brought them closer to being in line with the industry at both the top and bottom lines.

By using the approach of adding overhead to wages to arrive at breakeven, the client could confidently walk into contract negotiations knowing what rates she wished to command in order to obtain the profits she was looking for. And she also knew what would cause them to turn around and walk away because the project would not make enough (or any!) profit, so she and her team can spend their time working on contracts that are more in line with their business goals.

What’s next?

The spreadsheet was also built with a flexibility to allow for future hires to be forecasted (and have their hours add to the billable hour pool). So as the organization grows and seeks out additional talent to service its clients, they can experiment to see how additional hires affect that additional overhead rate for each staff member, real and in the flesh today as well as those they hope to hire in the future.

Recently, the company also worked with Norman Professional Services to reorganize the way it segments its revenue internally, based on project type and skillset, and has begun to map out the timing of projects from signed contracts to better anticipate what talent is needed when. With clarity on internal cost rates beyond just wages, NPS can work with the company to identify the more profitable revenue segments and the clients driving that profitability. Armed with this information, the client will be able to identify characteristics of those high-profitability contracts and seek out more of the same.