Chapter 7: Commercial Aspects of Consultancy

If a consultancy firm is to be viable, it must generate revenue. The bulk of income will come from charging fees to clients and so in this chapter we start by considering how these might be determined.

DETERMINING FEE RATES

For the most part the fees charged to a client will be related to the cost of the project, the cost being primarily that of the time spent on it by the consultants in the project team. (Other methods of generating revenue in a consultancy practice are dealt with in a later section.) The cost of the time is usually based on a daily fee rate; the level of fee rate required can be calculated as follows.

At the start of Chapter 4, we considered a consultancy firm that had 25 consultants paid on average £40,000 per annum. The fully absorbed on-costs and overheads were assumed to be as much again, resulting in total costs of £2 million per annum. If average utilization on fees (days on fees divided by paid days) is 60 per cent, the number of fee days in which this has to be recovered is:

• 60% (utilization) × 260 (days per year) × 25 (no of consultants) = 3900

Break-even fee rate (the fee level required to recover costs) is therefore:

• = £2m/3900 = £513 per day

As the consultancy would also need to make a profit, the budgeted fee rate would need to exceed this, so a budgeted fee rate of, say, £600 per day might be set. This would have to be compared with market rates; if this fee rate is markedly greater, then it may mean that overhead costs have to be reduced, so that the fee rate can be cut.

Consultancies frequently charge different fee rates for different grades of consultant. These can be calculated based on individual salaries, as follows. Using the same example from above, the average annual fee income to be generated by a single consultant is:

• 60% (utilization) × 260 (days per year) × £600 (fee rate) = £93,600 p.a.

The ratio of average fee income to average salary is:

• £93,600/£40,000 = 2.34

In practice, among medium- and large-sized practices (with larger overheads) this ratio might be twice as much. Someone earning £30,000 per annum would therefore be expected to generate (2.34 × £30,000 per annum =) £70,200 revenue, and their fee rate would be set accordingly. More usual, however, is to allocate consultants to grades according to their experience, skill and responsibilities, and to set a different fee rate for each grade.

Reductions in Fee Rate

There are circumstances when reducing fee rates may be appropriate, such as when a contract offers the opportunity to assign a team of consultants for a long period without interruption. Consultancy managers like large contracts, because as a rule, the cost of selling is a smaller percentage of revenue and because long assignments mean fewer gaps between assignments, when consultants might not be earning fees. Both these points mean that the utilization in a consultancy becomes potentially greater when large jobs are being done.

Returning to the example quoted earlier in this chapter: suppose the benefit of changing the sales mix, so that most work consisted of long consultancy assignments, was to increase utilization from 60 per cent to 65 per cent. The revenue would be increased thus:

• revenue = 65% (utilization) × 260 (days) × £600 (daily fee rate) × 25 (number of consultants) = £2,535,000

This is an increase of about 8 per cent from that where utilization is 60 per cent. A client, recognizing the benefits of a long assignment, may use this as a negotiating ploy to win a reduction in fee rate. In theory, the consultancy could drop its fee rate by 8 per cent (from £600 per day to £550 per day) and maintain its former revenue. In practice, of course, the decision is rarely arithmetically so precise. The decision to discount will depend on:

• how much you want the work;

• the commercial context - for example, to discourage a competitor winning the work with a long-term, profitable client;

• your relationship with the client;

• what's happening in the rest of the market;

• whether you believe you will lose the assignment if you don't discount.

During a recession, consultancies have been known to discount very heavily to get business. Apart from generating a contribution to fixed costs, the reasons for so doing include wishing to get a toehold in a new client, with the hope of identifying and selling extension work and wanting to keep the consultancy team engaged. Consultants need to be kept busy!