Only by understanding the connection between fees, time and resourcing can you properly control your profitability. Neil Backwith joins the #FuturePRoofed community to explore costing, capacity and profitability in PR.
We’ll be revealing the next chapter of #FuturePRoofed tomorrow – follow us at @WeArePRoofed to make sure you don’t miss it.
UNDERSTANDING THE BASIC BUSINESS MODEL FOR A ‘TIME-BASED’ PROFESSIONAL SERVICE Neil Backwith
· What we actually sell in public relations
· How to set hourly rates, capacity plan and forecast income
· What to measure to manage profitability
We all know how a shop makes profit - by buying goods in atwholesaleprices, adding a margin and selling them out at higher, retail prices. But how does it work when the product is knowledge or expertise as in PR? The answer lies in understanding that what our clients want to buy (usually some sort of outcome) and what we have to sell (our time) are different and need to be brought together.
Time and knowledge
Ask 100 PR people what they ‘sell’ and 90 will say ‘expertise’ or ‘ability’ or ‘knowledge’ or some such abstract descriptor. The other 10 will say ‘time’. The 10 are right and the 90 are wrong - the 90 are describing what it is that qualifies them to charge for their time at all.
It’s a subtle difference but an important one; and it is the one fact which enables us to build a bridge between what clients want from us (some sort of outcome or result) and what we need to charge for it (our fee).
The only way we know to cost a project or a programme is with reference to how long it will take to do. The time part is relatively easy to work out using our experience and then we multiply the time (usually in hours) by our rates to calculate our fee. But how do we know what rates to charge?
Most of us set our rates by referencing the market and copying what others are doing - which is fine provided that the ‘others’ have got it right.
There has to be a better way than that (and there is) but to work it out we need to understand a bit of background.
First we need to dispatch the idea of charging for ‘value’ or ‘worth’. There are a few (very few) occasions when it might be possible to charge ‘what it’s worth’ - some M&A advisers do just that - but in the vast majority of PR work it is nigh on impossible to judge.
Setting our hourly rates
So let’s look at the fundamentals: the PR business (like all professional services) is based on buying-in, marking up and selling-out just like a retail shop.
The difference is that we buy-in time from our employees (or freelancers), add a margin to cover overheads and profit, and sell it out. The complexity comes in when we realise that we can’t sell-out all the time that we buy-in. We need to set aside some time for non-billable work. So each person will need to have a split of their time between billable (available to sell to clients) and non-billable (new business, training, admin etc.).
We don’t generate any income at all from non-billable time, so all the income has to come from the work that we bill-out to clients - the billable time. Except that we don’t necessarily bill-out all our billable time either - some is excess capacity, some is over-servicing and so on.
This means we need to decide:
1. How many billable hours per week are reasonable for each employee level?
2. How many of those billable hours do we think will be fully paid for (billed)?
Then we can calculate how much we need to charge for each hour that we expect to sell in order to:
1. Recover the salary of the employee
2. Recover the overheads (including the salaries of non-billable staff)
3. Make our desired profit margin.
That’s the basis for setting hourly rates.
Now that the billable hours per level have been decided (and it is a decision based on what you believe to be right for your business), the capacity of the firm can be calculated - in hours and in £s.
For example: a firm with 10 billable executives averaging 26 billed hours per person per week at an average rate of £125 ph would have the following capacity:
• 10 (execs) x 45 (working weeks) x 26 (hours pw) = 11,700 hrs
· 10 (execs) x 45 (working weeks) x 26 (hours pw) x £120 (per hour) = £1.404m
A firm at the top end of the market with highly experienced executives may choose to aim for a relatively low number of billable hours but at very high rates; whereas another firm doing heavily commoditised work might need to aim for very high utilisation of people (high billable hours per head) but charge much lower hourly rates.
Either way, the aim is to work to as close to full capacity as possible. Remember, time for non-billable activity has already been allowed in setting the billable hours norms.
Income and profit forecasting
The biggest mistake we all make when running PR firms is to recruit more people than we need - to recruit ahead of the curve in anticipation of future business. By so doing we carry too much spare capacity and depress our profitability.
The ideal way is to forecast our expected income (from our fees) and to calculate from that figure how many people we will need to undertake the work. It isn’t difficult; by dividing the £Fee Income we are expecting by the average hourly rate, we get the number of hours we are expecting to ‘sell’. This can be compared to the number of hours available per person and we can see straight away whether or not we have sufficient (or too much) capacity.
A short term need for extra capacity can be met by freelancers or, if it is for a very short period of just a few weeks, by using some of the non-billable time which has been set aside. The secret here is to try to match the resource levels to the workloads as well as you can. The tedium of capacity planning is well rewarded in additional profit!
Another flaw in our management of our teams is often that we allow the pressure to do non-billable work to take priority over the need to do billable work. That’s a real no-no.
The key ratios
The temptation to produce dozens of key ratios and charts and whole dashboards of data is quite compelling. But don’t succumb.
Measure a few things consistently and they will be all you need:
1. The staff cost to income ratio
Staff costs (inc NI and freelancers) should be between 50% and 55% of your fee income. Too high and profits will suffer; too low and your team will suffer - with all the consequent problems!
2. Billable hours versus the norm
This should show how the average billable hours per week that you have set for your team compares with reality. If the average norm is 26 billable hours per person per week and you are achieving 24, then profits will be down and there is excess capacity unsold. If you are achieving 29 then profits will be high but staff will be stressed and new business won’t get done.
This is the difference between the billable hours your team are working and the ‘billed’ hours you are being paid for (calculated by dividing your fee income by the average hourly rate). This is also known as ‘over-servicing’. Aim for 5% or less.
Managing profitability can be done.
The principles here are all aimed at one thing: understanding the basis of ‘selling time’. In truth that is a bit of a misnomer because, of course when dealing with clients we sell ‘results’ or ‘outcomes’ or ‘deliverables’ as appropriate. But only by understanding the principles of ‘time’ can we cost the projects, recruit the right number of staff and manage our profitability.
Neil Backwith, Management Consultant, Corporate Strategy and Development. A Psychology graduate of University College London, Neil spent 10 years ‘on the client side’ and in 1982 joined Countrywide Communications (now Porter Novelli) as an account manager. He rose to Group MD in 1993 and worked to develop and implement the ‘go global’ strategy which saw Countrywide merge with Porter Novelli in the US and ultimately become one of the top 3 International PR Groups with more than 100 offices across 50 countries. Neil ‘retired’ from his post as CEO (EMEA) in April 2004 to establish his own management consultancy aimed at helping other firms improve their commercial success. He regularly lectures, speaks at conferences and trains directors on commercial management as well as working as a consultant. He is the author of the PRCA book ‘Managing Professional Communications Agencies’ published in 2007.