How can you make client fee income more predictable and reduce forecast revenue risk?
We don’t want you to be in the position of asking your bank to cover your obligations because a client didn’t pay or because you’ve had a few quiet months. Learn about some tools you can use to avoid contributing to the bank’s profits and instead make your firm stable and more attractive to a potential buyer.
Pat: Welcome to the fourth of 8 Webinars in a series covering each of the levers in Equiteq’s Equity growth wheel. Today we’ll be talking about Quality of Fees. I’m Pat Webb, a Client Growth Director based in Vancouver and I’ll be your host. I’ll be speaking with my colleague, Paul Beaumont, who is in London. We’ll explore the topic together for about 20 minutes then, for a further 10 minutes, I’ll be putting your questions to him. Please post your questions using the control panel on the right hand side of the screen as we go. The question box appears towards the bottom.
At the end of the webinar we will be giving some homework to do which will help you improve the quality of fees that you are earning, so please do hang around right to the end.
So, Paul, perhaps you could begin by telling us what is the most important message about the Quality of Fees lever.
Hi Pat, hello everyone. You probably know the expression, “I never met a dollar I didn’t like” and when you’re a start-up consultancy trying to get work, that’s exactly how it feels: you need all the fees you can get. This lever, however, is all about the need to transition away from this ‘start-up’ mentality so that you consider the quality of fees and not simply the quantity. This is important, not just so that you can grow your business more effectively, but also because potential buyers of your firm will look carefully at the type of work you are winning.
So, in order to grow in a controlled and sustainable way, and in order to attract the right type of buyer for your firm, you have to reduce your risk in fee income and make it predictable. That’s the key message.
Pat: Ok, thank you, Paul. Before we dive down into the detail of this subject, let’s quickly remind ourselves of where Quality of Fee Income fits within the overall context of growing and developing your firm.
Those of you who have heard our previous webinars will be familiar with this diagram; for those of you who are joining us for the first time, the picture represents a high-level view of all the operational issues that a buyer of a consultancy will look at to identify how risky it would be for them to buy your firm. In a 30-minute webinar we’re obviously only going to be able to give you a quick skim through. One of our clients described this model as a way to make sense of the madness. It clarifies all the levers that you need to pull to drive sales and profit and equity growth.
So Paul, can you give us some of the highlights from the Quality of Fees lever?
Paul: Certainly. I’ve already said that the key message here is that you need to reduce your risk in fee income and make it predictable. Why? Because a balanced portfolio of clients with predictable revenue, supported by good cash collection, gives confidence to potential buyers. And, of course, it makes sense for you now, no matter when you intend to sell.
Now, there are three main elements to this lever:
Firstly, reduce risk to revenue forecast
Secondly, manage cash so that growth is not constrained
And thirdly, balance capacity with demand
You can see that the first of these elements contains four recommendations, each of which we will explore:
Focus your services on a limited number of sectors
Engage with a balanced portfolio of clients
Sell more of what you currently do to people you already know
Turn short-term, one-off projects into integrated programmes
Let’s have a look…
In order to focus your services on a limited number of sectors, you should begin with a simple piece of analysis which we call the Service-Market Matrix. Not many consultancies actually do this but it is a very useful diagnosis. Let me explain the structure using this fictitious example. Across the top of the matrix we have the six services that the firm offers and, down the left hand side, you see the market sectors where they operate. They have analysed which services they have delivered to each of their clients, along with how much revenue they have earned from them, and then grouped their clients into sectors. The data in the table, therefore, is simply the revenue earned by each service in each sector.
What’s immediately obvious from the matrix is:
There are a lot of gaps; the revenue is clustered; and there are many sectors. This means that they are probably stretching themselves too thinly (it’s difficult to have domain expertise in every sector and, besides, 4 of the sectors contribute less than 5% of their revenue). They will be much better off concentrating their efforts on a smaller portion of the market. They may also want to consider how many services they can genuinely offer and actually be really good at. The message to this client – at their current stage of growth - would be, less is more.
Pat: Paul, this is a really important piece of analysis and it’s something that we encourage all our clients to do. I’d just like to underline the link to Quality of Fees. One of the secrets to growth is focus because the greater your domain expertise the more value you can add to your clients and the higher fees you can charge. Furthermore, once you establish yourself as the go-to consultancy in your focused area, the more clients will come to you and the more predictable will your revenue be.
So Paul, we’ve discussed the need to focus services and sectors, what are your recommendations for focusing on clients within a sector?
Paul: Well, in a way, the advice is the very opposite, namely: DON’T allow too much concentration! If you have all your eggs in one basket then your business is at risk. We have worked with several businesses where more than 50% of their revenue was with a single client. If, for any reason, they lost the client then, obviously, half their business would disappear. This is not as unusual a situation as you might think, especially for small, growing consultancies, and, as you can imagine, a potential buyer would run scared of acquiring a business with that sort of risk.
Pat: Paul, as you know, I live in the Pacific north-west and in this part of the world Microsoft uses a large number of contractors so there are a lot of small, growing consultancies here. Unfortunately, in July of 2014, Microsoft announced that any contractor that had worked for them continuously for 18 months had to terminate their engagement for 6 months. This resulted in an almighty scramble by these firms to find replacement revenue, and that was no fun.
Paul: I’m sure it wasn’t, Pat. They would have been much better off with a profile more like the one on the right hand part of the screen where their revenue, and risk, was more broadly spread.
Pat: That sounds really good. How would you actually do that?
Paul: Here is a useful tool which will help you and which we actually talked about in our last webinar on the Client Relationship lever. This is the next level of granularity from the Service-Market Matrix: it’s the Service-Client Matrix. It shows the revenue you have earned by service by client. The white spaces in the table represent opportunities to cross-sell your services to people you already know. (For this reason this approach is sometimes called White Space Analysis).
As I mentioned earlier, you want to maintain a balanced portfolio of clients and this tool helps you see at a glance both the opportunities for growing revenue and the risk of any single client dominating your income.
Pat: I remember that in the webinar on sales & profit growth, the key message was that buyers of consultancies want to know how well you can keep clients and sell on.
Paul: Exactly. And, the message of this lever is that you need to reduce risk in your revenue and make it predictable. One way in which you can ensure you keep clients and make your revenue more predictable is by turning short-term, one-off projects into larger projects and then into integrated programmes. The analysis of project size - shown here - gives you a very valuable insight into the size of your engagements. You need to make your offerings more sticky so that you continue to deliver value for longer. From the example shown here it looks like the company has a lot of work to do in that respect because they have a very long tail of very small projects, although they are obviously capable of selling larger ones as well.
Pat: Paul, I like that last point and I’d like to tell a quick story about a client of ours that succeeded in making their offering more sticky. They used to offer one-off training packages which led to short-lived engagements. In other words: one and done! So, to address this they re-positioned their services so that they aligned with large change programmes that their clients were delivering, becoming an integral element of those programmes. This meant that instead of selling discrete pieces of work they were now being engaged for a year at a time. Incidentally, their client benefitted hugely from this new model because their own change programmes started to succeed at a much higher rate than ever before.
Thanks for that, Pat, it’s a good example of how to reduce revenue risk. Now let’s go to the second element in this lever which concerns cash. The message is that you need to manage cash so that growth is not constrained. There are four things you can do to stay on top of this:
As a rule of thumb, try to have 3 months of cost as cash in the bank and invest the rest for growth. In other words, if your revenue stopped immediately you’d be able to keep going for 3 months. If you’re still very small you might feel more comfortable with enough cash to cover 6 months’ costs but remember, while the cash is sitting in your bank it’s not helping you to grow. Whatever is right for your business, you need to ensure you have a good visual dashboard that tracks actual performance against target.
Make sure your terms and conditions are favourable to you. This may seem difficult for a small consultancy that’s serving a large client but there are a number of strategies you can deploy. For example:
Invoice at the start of the month for fixed-fee projects and ‘true up’ at the end of the programme
Get staged payments that run ahead of the work delivered. It may be possible to invoice, say, 30-40% of a project at the start of the engagement
Separate expense invoices from fee invoices. This prevents the payment of a large fee invoice from being delayed because of a trivial dispute over an expense item
Measure your debtor days and closely monitor clients that have not been paying on time
Find out when the client payment runs are and make sure your invoice is due to be paid before the run takes place – to be certain it’s really going to happen. Often the on-site project managers are in the best place to do this because they can form relationships with the right people and smooth the payment process before problems arise
Needless to say, managing the cash so that growth is not constrained is not just good for your business now but it is also evidence to potential buyers of good management and control
Pat: Paul, you mentioned consultancies that deal with very large companies who often have standard payment terms of 60 days, regardless of the consultancies preferred terms. How would a buyer view that?
Paul: To be honest, Pat, buyers want to see good control of cash so if payments are being made in 60 days because those are the terms, rather than because of poor cash control, then that’s not a problem.
Now finally, the third element of the lever deals with the issue of balancing capacity with demand. This simply means having the right number of delivery resources available: too few means you lose revenue; too many means you lose margin. Owners of consultancies are understandably wary of recruiting people in busy periods only to find that the increase in demand doesn’t last, leaving them with the heavy cost of under-utilised employees. Although this critical decision-making process can never be an exact science (after all, forecasts are only ever wrong or lucky), you’re more likely to make the right decision with good information than with bad.
There’s quite some detail on this slide so we’ll go through it a bit at a time because these are tools that can help you:
The graph in the top left-hand corner shows the demand plotted at the end of May. The revenue includes all booked work, plus good and hot prospects. There are no prospects in May or earlier because, in this example, that’s in the past. When you do this for your business, you should discount your prospects to reflect the probability of them converting, but don’t get carried away with trying to be too precise about the probability. We recommend simply using two buckets: hot prospects are those where your client has given you a strong indication that they will engage you, but you don’t yet have the order – discount those to 65% of their value; good prospects are those where you have submitted a proposal, there is a real project with a budget, but it may be competitive, so discount those down to 35%. All other prospects should be valued at zero. Now, when you look at the forecast you can map it against your capacity. The example shows capacity of £100,000 which seems a bit light for the next three months because, as you can see, demand may well be more than that. The gap could be filled with sub-contractors, but if the sales pipeline grows much more then the business is likely to start to creak.
Incidentally, you can analyse the same data cumulatively (as shown in the bottom left-hand graph) and use it to compare your performance against budget for the year. The example shows a gap between budget and forecast which should focus the mind on sales.
Pat: Paul, this seems a perfect time to ask a question that someone posed when they registered for this webinar. The revenue profile shown in the graph looks relatively healthy but still has quite a bit of variation in it. The question we have been asked is, “How do you smooth out the revenue line to overcome the feast and famine issue.”
Paul: Yes, this is a very common problem in consulting. It occurs because the same resource that does the selling also does the delivery, so when they are delivering they don’t sell and the pipeline dries up. This is particularly acute when the business is small, because there are fewer resources and, of course, even minor fluctuations in demand have a big impact. The more you grow, the easier it becomes to manage the noise. I think the key is to ensure that your sales effort does not become diluted by delivery; keep Sales focused on selling, steadily building a future pipeline.
However, no matter how good you are at increasing sales, demand will never be completely smooth which begs the question of how to manage your capacity. For our clients who are already tracking their revenue pipeline in the way we have shown on the left, we sometimes suggest an additional tool called a ‘pipeline index’ which casts light on the demand-capacity balance. To do this you need to calculate your delivery capacity at full sales value, making assumptions about utilisation levels and day rates, and divide this number into the discounted sales value. If the index is one then your capacity and demand are perfectly matched. The higher the index above one, the more stretched your resources will be; and below one means you have insufficient demand. Again, don’t get carried away with the arithmetic: it’s useful information to help support an informed decision.
When you look at your utilisation analysis (and there’s a hint here: you should measure it!) you might find that there’s some re-balancing required to get more out of under-utilised people and, perhaps, relieve the pressure on those who are too busy (this is what the graph in the bottom right-hand corner shows). However, as I mentioned earlier, you can also temporarily plug any shortfall in resource with properly qualified sub-contractors. You must make sure, though, that you get a blended rate of 50% GM so that you don’t make working with contractors too costly.
Pat: That’s an interesting point about sub-contractors. Would potential buyers of a consulting firm look down on the use of them?
Paul: Only if the core competence of the business was locked into the sub-contractors and owned by them rather than by you. Generally speaking, buyers understand that sub-contractors can be a very cost-effective way of managing the variation in demand.