There’s perhaps no topic more important for consulting firms than improving profits. Because of this, we recently ran two 30-minute webinars on improving margins. This week, we’re looking at questions asked during the first of these, which explored how to put margins at the center of your business.
If 20% EBIT is a good target for a consulting firm, would a firm achieving 40% EBIT be viewed as considerably more valuable?
At face value, a 40% margin business might appear more valuable, but it depends on whether the buyer considers this sustainable.
Some will interpret a margin of this size as indication that the firm has under invested in itself and will discount this. Because of this, we typically recommend that 50% of revenue be spent on the delivery of your services and 30% should be allocated for overheads – such as selling or marketing the business, admin costs or recruitment or IT fees – leaving the remaining 20% for EBIT.
Firm owners might be wise to consider investing any EBIT above 20-25% into growing the top-line instead.
We have long-term contracts with our clients and these prevent us from increasing our prices. How can we drive up margin with these clients?
If you can’t increase prices then the best way to improve margins is to deliver the same work at a lower cost, which is often best achieved by delegating work away from senior consultants where possible.
While this inability to increase prices is a problem with long-term contracts, it isn’t always a bad-thing. Buyers might consider a firm with these types of contract more valuable because revenue is more predictable. So they can be a good way to grow equity value, but you do of course have to get good prices locked in at the very beginning.
We find it very difficult to get our senior people to delegate to more junior staff. What do you advise?
This is a very common problem because consultants love consulting and it can be difficult to convince them to stop.
Here are some key steps you can take:
- Make senior people responsible for delivering margin on engagements. This means allocating costs and, obviously, senior people cost more than junior people. Also, incentivize senior people to do this well. If utilization is used as the primary driver of reward then it’s little wonder that project managers do not delegate and keep too much of the delivery work for themselves. So, consider using margin as the reward mechanism instead.
- When the project plan is created it has to be done in such a way as to deliver the target margin. This process needs to be carefully defined with exception criteria (such as the use of more senior staff) needing to be formally signed off.
- Finally, senior people need to ask themselves how much value they are creating in the business for every hour they spend delivering services, and how much more value they could create if they spent that hour selling more business or developing IP for their colleagues to use.
If you are preparing to sell your consulting firm and would like to discuss your plans, please get in touch.
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