Client Profitability vs. Practice Profitability
January 24, 2014
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This post is for dummies covering few business terms which I am dabbling with these days. Thoughts below are primarily related to software services, but I think they would be of help to any service industry.
Having ran a startup earlier, I have always cared for margins which is necessary for the healthy growth of the business. Before getting into a customer engagement getting your margins or simply put profits right is very important, for both fixed bid and T&M (Time and Materials) projects. Apart from resource costs, you also need to take into consideration other costs like T&E (Travel and Expenses) and call them out separately.
Keeping above in mind, the profits you derive out of a given customer project is called Customer or Client Profitability (CP) – usually measured in terms of percentage. So, is good CP all what a company should care for? Answer is, of course not. While you might have a high CP it’s still possible that the overall company or practice is making loss. Let’s see how.
The common reason for discrepancy here is overlooking the fixed costs. For instance, you are going to incur salary costs irrespective of whether your resources are allocated (billable) to a project or not (e.g. project you signed up for got over in 5 months) and you will have to still pay rent, infrastructure bills, etc. All of these expenses fall under the larger category called SG&A (Selling, General and Administrative Expenses) which includes advertisement, sales, taxes, training, corporate functions, etc. In short, the Practice Profitability (PP) is not a sum of various CPs; rather it’s Sum of CPs minus SG&A.
It should be clear by now that the only way you can grow your business is increment CP without proportionally increasing SG&A; i.e. do more with less. Most of the budget planning exercises in corporate companies is around this agenda. One way to achieve this is move away from RFR (Resource following Revenue) to non-linear revenue models, shifting the focus from services to products.
Hope this was useful in putting these terms into the right perspective.