Benchmarking and the Path to Continuous Improvement

Top tier businesses make it a practice to establish performance targets that align with their business strategies and operating plans. These targets serve as “goal posts” toward which every member of the team drives their daily activities. They’re a key resource for periodic operational reviews to highlight successes and pinpoint trouble spots. And they’re a means to foster continuous improvement over time. As famed statistician Karl Pearson said: “That which is measured improves. That which is measured and reported improves exponentially.”

High-level financial metrics for architecture and engineering companies assess the degree to which senior leadership manages the firm’s overall health. Key performance indicators include:

• Operating Profit on Net Revenue (pre-tax income divided by net revenue), which gauges the firm’s ability to attract secure revenue, charge attractive fees, and manage its overhead
• Backlog (value of projects under contract less job-to-date revenue), which suggests the number of months the firm could remain operational without landing new projects
• Average Collection Period (average time between issuing invoices and receiving payments), which speaks to the fiscal stability of the clientele, the quality of the business relationships, and the firm’s administrative efficiency
• Current Ratio (current assets divided by current liabilities), which gauges the firm’s ability to meet short term obligations
• Debt-to-Equity (total debt divided by paid-in-capital plus retained earnings), which measures the firm’s financial leverage and borrowing capacity
• Return on Equity (pre-tax income divided by equity), which gauges the relative appeal of ownership interest in the firm

These statistics reflect the first few “layers of the onion.” Industry-specific metrics assess the firm’s operational health. The following three metrics provide critically important insights.

The Net Labor Multiplier measures the dollars in revenue earned per dollar spent on direct labor (i.e., the total cost of labor charged to projects). This calculation provides an indication of the firm’s capacity to cover its costs, fund overhead, and return a profit. The Net Labor Multiplier tends to hover around a value of 3 across the industry. Firms that consistently outperform this ratio have the ability to:

• Charge above-average billing rates for their work
• Capture fees for a higher percentage of work conducted in behalf of clients
• Retain experienced staff who perform their tasks efficiently
• Stay within budgets and meet scheduled deliverables

The Utilization Rate measures the percentage of percentage of total staff labor charged to billable projects. Because labor represents the firm’s largest expense, this metric weighs heavily on the firm’s profitability. “Best in class” firms are highly effective in staffing the firm with the skill sets, experience levels, and a work ethic that aligns with the project workload. They provide appropriate training and supervision to ensure efficient use of professional time, and they engage in cross-training to expand the breadth of work with which each employee might engage. Their compensation and benefits structure, potential for advancement, and collegial work environment minimizes employee turnover, thereby reducing recruiting and onboarding expense.

The Overhead Rate shows the relationship between expenses that are not charged to billable contracts (e.g., unbilled labor, administrative expenses). The lower a firm maintains its unbilled overhead, the higher its profitability. While belt-tightening in this domain is generally a virtue, overhead should not thwart appropriate investment in business development, employee training, and the infrastructure to support a healthy and productive work environment. Fortunately, some contracts provide for reimbursement of this essential overhead spending.

By setting performance expectations and tracking the numbers over time, management gains a window into the company’s past, present, and future. They get a sense for whether things are moving in a favorable or an unfavorable direction, and they have the wherewithal to take action accordingly. They’ve also got the means to see how they’re doing in comparison to their peers based on industry-specific benchmarking surveys.

Performance metrics and benchmarking data tell you where you are and where you’ve been. They’re a great resource for capturing an operational moment in time and analyzing its relationship to other “snapshots” in history. But they don’t capture where you’re going or what’s possible. It takes a deep understanding of your industry’s best practices to truly assess the degree to which you’ve achieved (or can achieve) your potential. And it takes an ear to the ground of operational and technological developments to make sure that you’re ahead of the power curve when the next “game changer” hits the market.