Most consultants know the most important number for a consultancy is gross margin.

However, there are a lot of ways to look at margin — and many nuances to look out for

This article will provide a practical guide on how you should be looking at margin in your consulting business.

Armed with this information, you’ll ensure you’re doing the right kind of work and you have a clear view of where the margin is coming from in your business.

By taking the time to analyze where you make the most margin, you are identifying where you add the most value. This enables you as a consultant to maximize your potential.

My Observations on Gross Margin Reporting

I’ve spoken to literally thousands of consultants over the past few years, and you’d be amazed at the number of consultants who can’t tell you what margin they are making on their projects.

I’ve even come across cases where people don’t want to know, deeming it to be unimportant.

And I’ve seen every elaborate way of obscuring the numbers to try and make margin look better, including…

• carving off sales time into a separate project,
• conflating high-margin licensing revenue with consulting services,
• and reporting on margin before writing off a whole lot of time that couldn’t actually be billed.

After much investigation, discussion, and pontificating I’ve come to realize an important point that makes this behavior all make sense.

As a consultant, you sell your time, expertise, and ability to think and reason. You are selling yourself. There is no separation between you and your business.

And if your project is losing money, that feels like a direct reflection on you as an individual.

By taking the time to analyze where you make the most margin, you are identifying where you add the most value. This enables you as a consultant to maximize your potential.

Everyone has value to add. It’s just a matter of finding it.

4 Ways of Looking at Margin

Gross margin is the most important metric for any consulting business.

While gross margin can be rolled up to a single number for your entire business, for businesses with many people and many projects, that number doesn’t always tell you what you really need to know.

You need to dig deeper and analyze margin from multiple perspectives.

These include:

1. Margin by Project
2. Margin by Client
3. Margin by Individual
4. Margin by Team or Function

Gross margin is the most important metric for any consulting business.

1. Margin from a Project Perspective

Knowing what kind of projects are making the most margin is the first step.

First, dig deep and find out what projects typically overrun and cause warranty issues.

It’s common for poorly scoped long-tail projects to erode good margins.

Ensure scope is tight and clear, and that additional work is charged.

Fixed-fee projects can provide amazing margins when they go well.

They can also be extremely risky when poorly scoped. It’s common for high uncertainty projects to drag on for weeks, or even months.

A good approach is an agreed fixed-fee project with a well-defined scope, and then ongoing support or more uncertain components of a project to be charged at time & materials.

Before entering fixed fee engagements, think about how “bread and butter” the engagement is for you.

2. Margin from a Client Perspective

Analyzing margin from a project perspective will give you the best indication of the kind of work you should be focusing on.

However, looking at it from a rolled-up client perspective can be a good sanity check to make sure you aren’t lying to yourself.

Most importantly, it will tell you:

Are your loss leaders really loss leaders or just losses? Sometimes you have to take a hit up front to land that Fortune 500 customer. If you’ve been continually taking that hit for 12+ months then you’re possibly just being taken advantage of.

The true cost of your sales time. Carving the cost of sales off into another project “because it’s not really a project cost, it’s just a cost of doing business!” is a sentiment I’ve heard far to many times. Justify it however you like, unless your sales team are all on work experience, all that time spent writing RFPs cost you real money and needs to show a return.

If you have any consulting staff doing under 50% utilization you should reassess. Even a person with a large team should be able to do that.

3. Margin from an Individual Perspective

In a consultancy, generally the more managerial the role, the lower the utilization target, because the individual is meant to spend more time doing management work.

While rates for more experience generally increase, it’s easy to have your most senior resources doing little billable work. Zero billable hours multiplied by the highest rate in the world is still zero revenue.

If you have any consulting staff doing under 50% utilization you should reassess. Even a person with a large team should be able to do that.

Management team members might have lower target utilization, but their charge-out rates should increase in proportion.

If you have any billable staff members who you are losing money on, I would increase their hourly rates. If you can’t command a hire rate for their skills, then you should increase their target billable hours until they are margin positive.

4. Margin from a Team or Function Perspective

Justification for an individual to be making a loss is rare. However, there are cases where it may be acceptable for individuals to be making small margins as long as their broader team or function is making good margins.

The most common scenarios I’ve seen where this is appropriate is as follows:

Where a manager is heavily involved in recruitment of new consultants, and has a track record of consistently bringing new high quality talent into the business.

Where an individual has a strong personal brand and they are spending their time on content creation that is directly tied to capitalizing on their brand (i.e. someone else couldn’t do it) which is showing direct results for new business.

Once you are running larger businesses, there are also scenarios where certain teams or functions may produce lower margins but they are directly tied to your differentiator as a business.

An example might be that you run a very high-cost support function that provides over and above service for the same cost as your competitors.

If this is built into the DNA of your company’s differentiator and go-to-market, then you might have a good justification for it.

If the team is just part of your broader service offering then there might be good reason to put your resources elsewhere.

Other Considerations For Gross Margin

Personal Biases

With consulting as a profession so tightly aligned with individual contributions, it’s no surprise that personal biases have a huge impact.

The most common example of this is that high-profile, exciting projects, often have the lowest margins. And that’s while being touted as the most important project the business offers.

An example I come across is technology companies that have a steady stream of support revenue coming in from managed services offerings: managing email, patching servers, deploying new laptops, etc. Bread and butter, boring stuff.

This business is often high margin, clear scope, and in many cases backed by recurring support agreements. Despite this, the projects that get the fanfare at the company all-hands meetings are the ones using the latest shiny technologies — and in many cases are just breaking even.

Sacrificing margin in the name of building a strategic relationship is also nothing new.

I hear time and time again that a lower margin should be justified because a consultant is trying to build a strategic relationship with a new client. This often happens when the service being offered includes a technology or process the consultant hasn’t worked with before, so the consultant believes the new client is “taking a chance on them”.

My advice would be to back yourself. If it’s a new tech for you, it’s probably a new tech for others.

If you’re adding value then charge for it.

Projected Margin

Being able to project margin before a project starts is a great way to ensure you are properly pricing a project.

Projecting margin is done by using a system where you can resource up your team with associated cost and charge rates (or fixed fee and charge rates) to determine what the final margin number will be assuming everything goes to plan.

By reporting on the expected margin at the completion of a project, you are also in the best possible place to know how much room you have to work with if things start to go off track.

Any good system will be able to show you the projected end-of-project margin in real-time, accounting for both work remaining and completed.

I have seen dozens of examples in the consulting world where a project is discounted upfront to win a deal. At the same time, the resources aren’t secured internally. This forces the introduction of highly paid sub-contractors to be brought in and get the work done. And this is a surefire recipe to send your margin into the red.

Multi-Currency Projects

Having projects which run in multiple currencies can quickly make an otherwise simple margin calculation complex.

Consider the example of an Australian-based consultancy doing work for a US-based company, and utilizing an outsourced development team based in Europe.

Revenue is USD-based, and costs are spread across both AUD and the EURO.

If you are running projects that span currencies then having a management system in place that can show you real-time currency conversion is a must.

It’s also not real revenue until the money hits the bank account.

Including Expenses and Other Non-Services Work

When looking at the margin for your consulting business, it’s important that you are focusing on the margin you make on consulting services.

Take the following example:

A company implements a large software solution on behalf of a software provider. As part of their partnership with the software provider, they get a 50% margin on the licensing portion of the implementation. They then do the implementation where they make a 30% margin on their services provided. The all-up project reporting shows that they are making a 40% margin. The people working on the project are credited for doing an amazing job.

It’s important not to confuse the fact that a project made high margins due to having licensing revenue bundled with it with individuals doing higher-than-normal margin work.

It’s Only Margin if it’s Money in the Bank

Writing off time is another surefire way to erode margins.

Sometimes it happens. Your team makes a mistake, and unfortunately, you have to take the hit.

But if the work is not billed, then you don’t get the revenue while still wearing all the costs.

It’s also not real revenue until the money hits the bank account.

It sounds simple, but having a system that can clearly show you any write-offs — as well as any outstanding debtors — is the best way to keep on top of these things.

Note from Michael: We received a great question from one of our Clarity Coaching clients asking “What do we do with the marketing, social media, administration hours, if we don’t have any specific projects to put it on?” 

Here’s what Matt had to say in response:

“There are two main ways this can be thought about, one simple and one a little more complex.

Fundamentally this comes down to how you structure your P&L. Your typically billable resources should sit in your “Cost of Sales” block, and your general marketing, social media, Admin should sit in your “OPEX” block.

To start with, yes if a typically billable resource spends 15 unbillable hours working to land a customer, this should be directly attributed to that project, and impact it’s margin directly as this person’s costs would sit in your “Cost of Sales”. So far so good.

Now on to the core of your question.

In its simplest form you can compare your gross margins (at a project, client, individual, and team level), as well as your total gross margin (total revenue – cost of sales) against your total operating profit (revenue – cost of sales & OPEX).

If you are happy with the margins you are making on people and projects, and at a total gross margin level, but are not happy with your overall operating profit then this tells you that you are spending too much on the overhead activities you mentioned (marketing, social, admin, etc.).

A more accurate method is to calculate what is effectively an “Hourly OPEX Overhead Rate”. In order to do this, we take the annual cost of the entire OPEX block from our budget. For simplicity let’s say this is $1m total. We then want to distribute this across the number of billable resources (i.e. staff in the “Cost of Sales” block) we have in our budget for the year, let’s say we have 100 billable resources. This means that every staff member has a $10,000 overhead burden they need to carry for the year ($1m / 100 staff). If we divide that $10,000 by the number of expected work hours in the year, we get our Hourly OPEX Overhead Rate. A common number that is used for expected work hours in a year is 2080, but this may vary based on your business / geography. Using the 2080 number would make our Hourly OPEX Overhead Rate $4.80 per hour.

We can then take that rate and add it to the costs side of the calculation on our normal gross margin reporting. So, if we have a 10-hour project it will carry a $48 overhead on the costs side (effectively lowering the direct project margin by $48), and if we have a 1000 hour project it will carry a $4800 overhead cost.

Ways to get even more accurate:

1. Increase the cadence of calculating your “hourly opex overhead”. We find that annually usually gives a good enough guide, but if you are rapidly scaling then you may want to increase the frequency to quarterly.
2. If you have a lot of fractional resources you may want to prorate your calculated Hourly OPEX Overhead Cost to account for reduced total capacity for those resources. Unless you run a large pool of part time staff this generally over-com”

Conclusion

Margin is an incredibly simple concept that has a lot of nuances once you scratch the surface.

By looking at margin from multiple perspectives and spotting common themes and trends, you are in the best place to know what type of work and what type of people you should be focusing on.

Having a software platform that can show you…

• margin in real-time,
• also accounting for any multi-currency situations,
• any write-offs,
• and aged debtors,

…is the best way to keep a close on where the margin is coming from — and certainly makes it much harder for any personal biases to creep in.

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Matt Hayter is the Founder and CEO of Projectworks,  a cloud based workforce management platform designed to help professional and creative services businesses better manage their organisations in the areas of project management, people management, and project financials.