Uncovering Project-Specific Profitability

What problem did you tackle?

A government contractor servicing the healthcare industry wanted to get a better grasp around the costs that went into the services being delivered to build confidence that she was bidding competitively in her proposals without eroding margins.

In time and material engagements, this was straightforward: each hour was billed at an hourly rate that’s a multiplier on wages, and each expense was marked up or passed through dollar for dollar, depending on the contract.

However, for fixed-fee engagements, the potential for profitability became less clear as prices needed to be determined ahead of time based on estimates instead of actuals. Depending on the performance of the team servicing the engagement, projects could end up being less profitable (or not profitable), and the company lacked visibility into this.

How did Norman Professional Services craft a solution?

Though the company had been using timekeeping internally tagged to projects and internal work, leadership had not associated that data to assess project profitability over time. NPS suggested analyzing timekeeping data once it was verified through the payroll process, noting the amount of hours assigned to each project, by person.

With each person assigned a salary or hourly wage, it was simple arithmetic to calculate the fraction of each person’s payroll that was attributable to each project. On a monthly basis, NPS created a report that assigned an approximate cost of labor to each project, and comparing it to the billing issued for the same period.

What was the positive impact?

The company is now able to identify which projects are experiencing higher profitability. This could be a signal for which clients or types of service delivery offers higher margins. When the company deducts the cost of labor from the total billing, they get a more accurate picture of their Gross Profit: the high-level profit metric that accounts for costs that are directly associated with service delivery.

In circumstances where projects were not meeting profit expectations (or even generating a loss the more they worked on it!), the company felt equipped to address this with their clients to discuss shifted expectations from the start of the contract (including scope creep), to prepare to renegotiate for fees that accommodated more acceptable margins at renewal, or to gracefully exit the engagement following conclusion and keeping lessons learned in mind.

An additional byproduct of paying attention to timekeeping data at the person level, company leadership also gained insights into the time spent on non-billable, internal work, on a person-by-person basis. In some cases, there were resources whose fraction of time spent on billable work (also known as employee utilization) was lower than they expected. This triggered an internal investigation of extraneous internal tasks and meetings that are stealing away client delivery resources’ time from doing what they do best.

What’s next?

When calculating gross profit, the above approach provides most of the picture. However, including non-employee subconsultants that are included in the work and invoices also contribute to the consideration for gross profit. Other direct costs, expenses that are unique to the project, may not necessarily be passed through in invoicing, especially in fixed fee engagements. A deeper look into their expense documentation processes will help incorporate that level of data for more granular insights into gross profit.

Additionally, to aid in future contract bidding, the company wishes to craft bids on contracts that not only are profitable after considering cost of labor, but also account for the indirect costs of being in business. Above the direct labor rate, the approach of adding in the cost of employee benefits, overhead costs, and general/administrative costs (and the desired level of profit) gets the company to its wrap rate. This better informs how much the company has to charge to reach a target net profit.

NPS can address this indirect expense consideration with the company through its budgeting process, reviewing historical expenses, confirming current recurring spend, and projecting when these expenses will occur. When totaling up all indirect costs (including the portion of wages that is dedicated to nonbillable work), the company can approximate the additional cost per hour to assess their wrap rate and its competitiveness in the market. If it’s not competitive, then an internal look to cut down costs will be necessary to regain competitiveness.