Tag Archives: per diem

Professional Value, Fun with Math

Our lives intersect with professionals. They plan for us, design for us, operate on us, and give us their advice. Our communities are strongly influenced by their ideas:

of legality, of health, of our future.

The fundamental role of the professional is quite simple, although not easy.

To profess.

To affirm openly; declare or claim;

To teach, to claim knowledge of;

To enunciate through recommendations in a consistent and unbiased way certain principles and beliefs upon which we should act. It is a role of leadership within our community, and that is why accountants, architects, engineers, doctors, and lawyers, among other professions, must submit to extensive training and adhere to public standards in return for permission to offer services in these fields.

The meaning of “professional” moves about somewhat. Its contrast with “amateur” (as seen through the 5 lenses of the Olympic looking glass) has turned the professional into “someone paid for it” rather than one who works from purer motives. It is also viewed synonymously with “expert”. “Trust the professional!”

Without in any way denigrating the professional athlete, or any skilled tradesman, the professional has a distinct calling: one who advises action upon principles that she “professes”; and who takes a view of the issues from the public and client point of view, rather than a self-serving one.

Modern professionals occupy a wide variety of positions both publicly and privately, but many are organised into firms of private consultancies offering service for fee. It is here that livelihood and principles find a most uncomfortable intersection: “the billable hour”. Lawyers know full-well its tyranny, and clients its exasperation. The billable hour is rough justice indeed, and in some instances no justice at all.

Here’s the dilemma. Can a consultant truly be paid on the basis of the effect of recommendations, “the success of the project”, when the advice must be implemented by others in an unpredictable world? Whether acted upon or not, advice and ideas have value. This is in part the famous “$1 for showing you the spot to hit, $9,999 for knowing where it is” invoice.

But on the flipside, can a professional make a living by valuing only his or her time, each tenth or quarter of an hour generating a billing, regardless of the relation of that time to the service provided? The slower the service, the higher the bill?

How is a client’s best interest served if fees paid relate inversely to productivity?

To the latter 20th Century, many professions worked from agreed schedules of rates established for different kinds of service ($X as a reasonable fee for this task or that). This rubric of fee crumbled, however, in the face of concerns over monopoly and anti-trust legislation. Professionals turned increasingly to other yardsticks, and especially to formulae relating their remuneration to their time.

But as we often sense, there are problems with the time approach. While apprenticing many years ago at a large architectural firm, I discovered that team leaders knew very well that the firm’s senior partners must never be allowed to work on the project. Why not? Their billable rates would quickly ruin the time-based internal budget. Strange that the experience of the partners would lead to inefficiency, you say? Well, let’s take a look at the mechanics of the “billable hour”, the “hourly rate”, and how they are calculated.

Bear with me mathematically! How is an hourly rate usually calculated in the consulting world?

Working 37.5 hours a week gives 1950 potential hours of earning per year (regardless that professionals may work many more hours than that). A base salary of $75,000 plus a $50,000 overhead amount (for benefits, insurance, leadership, marketing, administration, office rent, technology, furnishings, supplies, training, and a further 20% on the subtotal for firm profit and insurance against unpaid bills) means that each hour must earn $64 to recoup the $125,000. Yes?

A mid-level professional earning that wage, working pretty much full time on billable projects for his firm, still spends some time away from that productivitiy. Perhaps 4% vacation, 3% sickness, 8% non-billable office duties and training, totaling 15% of her time. That means further that each “billable” hour (that is, an hour spent on work that will result in a productive bill to the client or project) must generate more revenue, to account for the non-billable (the 15%).

That brings us to $75.40 (64 divided by .85, ok?). From the client’s point of view so far, so good, because the bill a client receives is still linked to services that benefit his project (that is, it receives the attention of a trained, healthy and productive employee).

Now, here’s where things get interesting. In theory a rise in salary, a car allowance, other perks and items reward the more productive professional. Right? That is, the Jack earning $120,000 a year and costing $67,500 in overhead to the firm, should be accomplishing the same tasks as the aforementioned staff in less time. In fact, work that cost $125,000 from the junior should cost the same from the senior. Since the senior costs $187,500 a year, it follows that the $125,000 of work would get done in 2/3 of a year!

The client receives the same fee request for the same service. Well done. Where the greater project experience or project-smarts of senior staff identify solutions sooner, or craft better solutions, the system still works to the benefit of the client, even though the same hourly rate calculation for the senior fellow yields a billing rate of $113 per hour.

For some items that senior staff do, however, the higher productivity is so obviously not true that clients should be careful in their consulting contracts to specify that tasks best done by more junior employees should be charged at their junior rates. The senior partner likely uses the photocopier more slowly than her assistant, not more quickly.

Well we’ve done ok so far, and the money to value equation seems to be holding. Where might things start to stray?

Well, it’s that management thing. Where senior staff’s wages and overhead (the calculation of their worth to the firm) are more related to their management abilities and responsibilities, or their marketing connections, than their project-smarts, the billing rate calculation leaves reality behind.

So far, we’ve assumed that the senior professional is working on projects 85% of the time. But once in a management role, that same wage, overhead, and profit cost of the previous example ($187,500 per year) must be covered by perhaps only 50-60% of this professional’s working hours, since he is involved in many non-billable internal tasks (hiring the others, for instance). Additionally, his wage level is not related to productivity when he is working on the billable file, since his skills in the trenches may not outshine others earning less, through less use and less familiarity with the file. The client, however, is now paying $190 an hour for somewhere between $75 and $113 of productivity on the project (187,500 divided by 1950 divided by .5 for 50% billable hours).

That is why in the context of mega-consulting firms carrying large hierarchies, project managers often work to keep senior staff away from their projects and clients. They’re trying to get the job done efficiently, either on fixed budgets that can be side-swiped by the partners’ rates, or in an effort to avoid severely higher billings for the same services.

In a world of professional services where the work is often 10% inspiration and 90% perspiration, there is no doubt of the value of senior professionals at key points. Their judgement creates effective solutions for clients, saving hours and money. For these insights they are worth the high billable rate. When they involve themselves in the other 90% of the job, however, their rates do clients a grave disservice unless their productivity is 100% higher for tasks regularly performed by other staff, or unless the billing rates acknowledge the relationship between productivity and consultant billings.

Worse still, some firms have business models with billing for overhead and profit (including the cost of carrying a high-priced management hierarchy and rents in a toney part of town) at TWICE the cost of project wages, or even more. My examples above assume only once the cost (75k wage, 50k overhead, 25k to cover non-billable hours). At these higher levels of overhead, the junior professional bills about $115 an hour instead of $75. That’s a 50% higher bill for the same trained professional producing the same work!

And that more senior professional?

  • with larger responsibilities to the firm that aren’t related to your project, and
  • fewer billable hours to cover the firm’s $360,000 annual expectations?
  • producing an item of work that could efficiently be done by someone more junior?
  • $370 per hour.

At these rates one begins to wonder what priorities are being “professed”.

So next time you are presented with a proposal for time-based billing from a professional, ask him or her to break it down for you. Where does the money go? For productivity on your project? Or overhead? For trained staff to spend time efficiently creating solutions for you, or carpet in the boardroom?