Leverage models in professional services. Profitability vs. growth. Examples, measurements, and trivia quiz.

What is leverage in consulting business? How are agency growth and leverage correlated? How can you get rich by consulting? In what kind of agency are you?

Photo by Jeremy Thomas
In any professional service, there are three key benefits clients seek:
  1. Expertise (new solutions to new problems). "Hire us because we are smart."
  2. Experience (practise in solving this type of problems)."Hire us because we've been there before."
  3. Efficiency (well-known problems, performance efficiency). "Hire us because we are cost effective and fast."
Clients prioritize these values according to a problem:
  • Brain surgery requires frontier expertise, talent and innovation
  • Cosmetic surgery client looks for experience in particular aesthetic procedures
  • Teeth-whitening customer is interested in cost effectiveness, close location and sooner appointment
All types of projects could bring good business but only if staffing required by work matches the staffing an agency has.

The majority of consulting businesses start with few partners joining their forces. These partners have to balance the client and the people (employees) marketplaces to achieve planned economic goals.

In a partnership, the ultimate measure of a business's success is profit per partner, which is driven by three main factors:
  1. Profit margin
  2. Productivity (revenue per employee, or average hourly rate × utilization)
  3. Leverage
Leverage is the ratio of the "finders," "minders" and "grinders" in the firm organization.

1. Finders are senior-level staff (partners, VPs), people responsible for client relations and general services marketing. Senior employees billed under the highest rate bring new business and grow it.

2. Minders are middle-level employees responsible for day-to-day supervision and coordination of projects.

3. Grinders performs technical tasks necessary to complete the job (junior level in the organization).

Smaller companies could have just two levels of partners and associates. Large companies might distinguish between junior and senior partners.

Any employee can be well-paid, but the agency's business model relates to leverage as a mix of billing rate levels, target utilizations and billable hours quantity with a fixed overhead cost.

Here is the classic example of professional services organizational structure:
Overhead staff (non billable employees) cost is $30,000 per professional.
If a manager does not bring value that can be directly invoiced to a client as billable hours, he is considered overhead and not even a junior-level professional or consultant.

Grinder-level professional with a finder-level salary minimizes agency leverage.

One-level agency structure would mean an unleveraged business with some overhead cost.

Actual titles have nothing to do with leverage structure. For example, there could be a firm with 15 senior consultants (grinders or junior-level in leverage structure) and five managers who are more experienced than senior consultants (minders or middle-level) and three principles (owners or shareholders of the company).

Take a quiz to check your understanding of agency positioning and business.
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What kind of problems does your agency solve more often?
What are key elements of your services?
What is your selling point?
What is the type of your average project team?
What is the typical project in your firm?
What are your agency fees?
What is the leverage ratio in your agency?
The Dupont formula of Return on Equity (ROE) for industrial companies could be used in professional services:
$$ \frac { Profits }{ Partner } \; =\; \frac { Profit }{ Fees } \; ×\; \frac { Fees }{ Staff } \; ×\; \frac { Staff }{ Partners } \; =\; Margin ×\; Productivity ×\; Leverage $$

Calculate how leveraged is your firm

The simple formula is the relation of the number of partners to all other employees:
X – number of partners in your agency,
Y – number of consultants who are not overhead employees,
Leverage = Y/X

A more complex formula could be used to detect the leverage change overtime in all levels of the firm.
By leveraging its high-cost seniors with low-cost juniors, the professional firm can lower its effective hourly rate and thus reduce its cost to clients while simultaneously generating additional profit for the partners
They leverage structure on average projects to influence economics and position the firm in the client and people markets.

It is usually more profitable for an agency to perform similar to previous projects with developed knowledge, expertise and approaches.

By providing reproducible services and standardized elements, the agency reduces risks and increases quality. But employees are not interested in doing the same project over and over. The solution is to utilize juniors for whom tasks would be new and challenging while promoting experienced people to the higher level to supervise and train juniors and eventually become partners of the firm.

It is important to understand that growth does not always mean higher profits. For example, let's compare the first and third year of an agency performance with the same cost and billable rates but different headcount.
This example shows that the agency has grown but per-partner profits have not increased. To solve that problem, the agency has to charge higher rates or deliver projects with less senior and more junior time.
Three factors drive profits in professional services: margin, productivity and leverage. Some firms can achieve their economic goals with modest leverage but high margins. Others agencies get equally high profit per partner with small margins, average productivity but a high leverage.

Only a few consulting companies use net profit per partner as their main method of regular reporting on the firm's performance. That is because the majority of reporting systems do not provide a convenient way to measure it. And if you never measure profitability per project, it's hard to reward partners properly.

A leveraged partner may deliver more cash into partnership profits than the unleveraged partner with high chargeability and realization (very smart and productive).

In Metric.ai profit per partner could be easily measured by simply adding a role "partner" (also could be a department or office) to reflect the connection between each project and a partner.
Editing projects in a custom "Partners" role so the Metric.ai can calculate profit per partner
Editing projects in a custom "Partners" role so the Metric.ai can calculate profit per partner
After a certain level, employee utilization cannot be increased or will be a bad influence on an agency. Growing by 20% and adding 20% more partners to maintain the same effective team structure is not increasing profit per partner. So the firm must have skill-building, specialization, innovation and value-added services that will make clients pay more for the services.
Only increased fee levels or leverage move the firm forward
— David Maister