profitability

Profit is easy, right? You spend some money to provide a service or create a product, you sell it for more than it costs to produce, and there you go: profit. In reality, it’s not so simple. Setting the right price—low enough that customers are willing to pay for it, but high enough to cover your costs and give you room to reinvest and grow your agency—is only part of the equation. The other part is just knowing what your costs are to begin with. These are critical numbers, but they can be difficult to correctly account for when you’re providing a service and not manufacturing a product that has clearly defined costs in terms of raw materials, machinery, shipping, and the like.

There are many strategies available to service agency owners looking to keep costs down. One powerful yet often overlooked metric in cost calculation is utilization rate. Many service agencies don’t see the value in calculating and optimizing utilization rates. The truth is, it’s not as complicated as it may seem, and taking the time to learn will save you money and give you a better idea of how your employees can more efficiently use their time.

What are utilization rates?

“Utilization rate” refers to the percentage of an employee’s time spent on billable tasks. Billable tasks include anything done directly for a client, like website development, content creation, consulting time, or site visits. These tasks are typically part of a specific project whose parameters have been agreed upon by the agency and the client.

Non-billable tasks, meanwhile, are all of those tasks performed for the agency rather than the client, such as sales calls, training and onboarding, research, and developing new products. There are also non-billable tasks that are indirectly done for a client, such as responding to email or reviewing meeting notes.

Utilization rate = hours spent on billable tasks ÷ total hours available

If you clocked 40 hours in a week, and four of those hours were spent in meetings, responding to emails, and training, your utilization rate is 90%. We arrive at that number by dividing billable hours by total available hours: 36/40 = 0.9, or 90%. A content writer or graphic designer will likely have a very high utilization rate, as they will have little administrative responsibility and nearly all of their work will be billable to a client.

Here’s another example: You have a part-time employee available for 20 hours per week. If this employee spends three hours taking a course on Adobe InDesign and twelve on various graphic design projects for clients, their utilization rate is 60%. Why isn’t it 80% (12 billable hours divided by 15 hours worked)? Because the utilization rate is based on total available hours, not the number of actual hours worked, The employee is available for 20 hours per week, so their utilization rate is calculated against 20 hours rather than the 15 hours they actually worked that week. This way, it’s easier to see that the employee has additional capacity.

Higher utilization rates aren’t necessarily better. Some employees, such as salespeople, IT professionals, or those working in product development, spend most of their time on non-billable tasks, yet that non-billable work is crucial to the operation of a service agency. Furthermore, an employee with a high utilization rate may be neglecting meeting attendance and professional development because they have too much on their plate.

One more important point about using utilization rates to set prices: Since different employees have different hourly rates and do different amounts of non-billable work, you'll need to do some averaging. You can either calculate each employee's utilization rate individually and then average the rates across each role, or you can calculate an average utilization rate for all before calculating the rate for the role. If you’re using utilization rates just for cost calculations, either way works. But if you’re also using utilization rates to calculate resource capacity, we recommend calculating utilization rates individually and then averaging costs once the individual utilization rates have been applied to each employee’s cost rate.

Why Utilization Rates Matter

Factoring in utilization rates when setting your prices will help you determine if these tasks can be done more efficiently, and it will also help you make sure you are charging enough for your services. If you are using only billable work to calculate rates—both the hourly rate of your employees and the amounts you are charging clients—you will end up doing a lot of work for free, and you won’t even know just how much work you are doing for free, and that’s no way to grow your agency. All of that background administrative work you do to keep your company running is still work, and it should be considered when setting prices.

Utilization rates help you understand your labor costs and evaluate the efficiency of your processes, but they’re even more useful than that. Staffing, profitability, and billing decisions are all made easier when you have a good idea of how each employee is being utilized.

Staffing decisions.Are some employees overworked, with such high utilization rates that they have little time for anything else? It might be time to hire additional staff or redistribute work to other employees. Is an employee being underutilized because there’s just not enough for them to do at the moment? Perhaps they can be trained to take on administrative or other non-billable tasks. It is only by calculating utilization rates that you can get a clear understanding of how your employees are using their time, whether they have additional capacity, and whether you need to bring in additional staff.

Project profitability.By separating tasks and projects by client, you get a clearer picture of which clients are profitable and which are not. Otherwise, you could be putting way too much work into one client and not nearly enough into another. As we’ve said before, your agency doesn’t need every client; it just needs the right clients. Utilization rates help you determine which clients are “right” and which it might be time to move on from—that is, which are making you money and which are costing you money.

Client billing and transparency.Every marketing agency and professional services company has a system for billing clients, typically based on the effort required to complete a task (i.e., the number of hours). Utilization rates provide data for clearly and accurately documenting each employee’s time spent on a particular task. These numbers also provide you with transparent data for future proposals.

If you don’t have a good system for managing your resource capacity, projects, roles, rates, proposals, and billing, we’ll be happy to help! We’ve got plenty of experience helping agency owners become more profitable, and we can help you better utilize your current systems or integrate software to fill gaps. Click here tobook a free consultation to discuss your options.

Performance evaluations.Utilization rate can be a useful benchmark for not only evaluating employee performance but also for giving employees a way to assess their own use of time. Professional development and training, alongside tasks like staying organized and keeping up with email, are just as important to the success of a company as directly billable work is. By giving employees a utilization rate to aim for, they will have a better idea of how much time they should devote to non-billable tasks.

Utilization Rates: A Valuable Tool for Measuring Growth

Growing a service agency begins with turning a profit and then reinvesting that profit for growth. To turn a profit, you must accurately account for the costs of running your business and mark up those costs sufficiently to make money. Otherwise, you’re just spinning your wheels. StrategyWerx can help you get your business out of neutral and on the road to growth.