When measuring staff performance in a professional services context, one of the metrics we use to inform our decisions is staff ROI %. This calculates the revenue earned by a team member over a determined period by the cost of the team member and expresses it as a percentage. This can be thought of as 'for every $1.00 I pay my staff member, how many do I return?'. This number hovers between 250% and 300% for most practices.
It is tempting to use the staff members individual monthly salary as a fixed-cost input into this equation. This keeps your calculations simple and intuitively feels right. This article explains why this is a bad idea by illustrating the unforeseen consequences of this and suggests a better alternative.
Let's look at an example:
Sam is an intermediate accountant with 3 years experience earning $60k per year ($5k per month) at Aardvark & Aardvark CA. He enjoys his job and his team and is getting better at it. Aaron is a partner at Aardvark & Aardvark CA and decides that ROI % is one of the measures to be used to incentivise the right behaviour amongst his team. In calculating this Aaron decides to use the fixed cost of Sam's salary as his monthly cost for Sam's time. Aaron reviews and shares Sam's ROI % with Sam on a monthly and quarterly basis. In June, Sam and Aaron decide on a KPI of 300%.
Sam knows his ROI % is a function of revenue and his wages. Unable to control his salary cost (but wanting to earn his next pay rise) Sam can only control the revenue he brings in. Revenue for Sam is a function of the billable value he puts into customer jobs and his write-off's that are unable to be invoiced. By increasing his billable value and reducing or maintaining a low write-off % Sam can increase his revenue and with a fixed cost for his salary, improving his ROI.
Sam can't see his revenue on a weekly basis as invoicing is completed monthly. What he can do is measure the amount of time and the billable value of that time put into customer work for the month. Sam know's if he's effective with his time and focusses on customer work he can increase the revenue he contributes to the practice. Sam's hourly rate is $150/hour and he typically works 40 hours per week, approximately 30 of which are on customer jobs with the balance on internal meetings etc. Sam's monthly billable value is typically between $15k - $20k.
At the end of July Sam has completed 160 hours with 100 hours of customer work at a billable value of $15,000. Not all of this time was able to be invoiced with $2,250 being written off (-15%) across all his jobs. Sam's revenue contribution for July was $12,750 which when divided by his fixed monthly salary of $5k provides an ROI of 255%. For every $1.00 that Aardvark & Aardvark pay Sam, they return $2.55. This is below his KPI agreed with Aaron of 300% ROI. Sam and Aaron agree there is room for improvement here next month.
As August continues Sam is concerned, it's the second to last Friday of the month there is one working week remaining. Having just completed his timesheet he has only done 80 hours of customer work at a billable value of $12,000. It feels light. He's 3/4 of the way through the month but has generated just over half of the billable value he was expecting for the month. Sam call's his partner, Peggy who's pregnant and also caring for a toddler. 'Can you go to your sisters baby shower without me? I'm going to need to work late tonight and come in tomorrow to meet my targets.'
Sam stays late that Friday, putting in another 4 hours on customer work. He gets home late to a cold dinner and an un-talkative Peggy.
Sam works an additional 8 hours on the Saturday and enjoys working without the distractions of a bustling office. He starts the following week feeling much better about meeting his targets.
At the end of August Sam has completed 172 hours, 132 of which were billable with a billable value of $19,800. Not all of his time was able to be invoiced however with net write-offs of $2,970 across his jobs (-15%). Sam's revenue contribution for August was $16,830. Dividing this by his fixed salary of $5k Sam's ROI for August is 336%! Sam is glad he worked that weekend and a couple of extra late nights. Sam's average hourly rate is $97.85.
Sam worked longer hours to achieve a higher billable value. By being more focussed on the weekends and evening work he was able to also slightly increase his productivity. He is just as effective with his time as he always was with a write-off % of -15%. Aaron review's Sam's performance against his (single) KPI ROI%. If Sam keeps hitting his KPI for 2 more months, he's going to earn himself a pay increase.
With a baby on the way Sam could do with the extra income. Each month September and October he works extra nights and the odd weekend day to increase his billable value and revenue contribution in relation to his fixed salary. This keeps his ROI high, but his productivity, write-offs and the type of work he is doing is the same. Despite this, Aaron increase's Sam's pay in November to $70,000 pa. Sam's hard work paid off! Peggy is proud. Aaron is happy as Sam has increased his revenue contribution to the practice from $12,750 to $16,830 each month for the last 3 months.
Sam's new monthly cost to Aardvark & Aardvark CA is $5,833. In line with his pay increase, Sam's billable rate has increased to $165/hr.
November continues. Sam is grateful to be back to working a 40 hour week and so is Peggy. Sam completes 160 total hours for November of which 120 are billable for a billable value of $19,800 at his new billable rate. Unfortunately, despite his pay increase Sam isn't any better at his job. His billable rate may have increased but his average hourly rate remains at $97.85. Sam's skills have not improved with the increase in his pay. He is unable to justify the $165/hour billable rate he charges to jobs and these jobs frequently to go over budget. Sam's write-offs for November are $4,144! (-21%). His revenue contribution for November is $15,656. When divided by his new (fixed) salary cost of $5,833 his ROI for November is 268%. He is not meeting his targets. Sam's Manager, Aaron put's it down to inexperience and tells him to work on his write-offs and focus on customer work.
Sam listens but despite his best efforts he's 3/4s of the way into December with $15,000 of billable time earned on 90 billable hours. Sam realises that he's on track to hit the same billable value as he did in November. Not wanting to miss his targets two months in a row, Sam has a plan. He call's Peggy: 'Can you put the cot together on your own tomorrow? I'm going to need to work to reach my targets. Can you leave my dinner in the microwave? I'm going to be home late.'
Sam puts in another 4 hours that evening and another 12 hours the following two weekends. Peggy successfully assembles the cot.
At the end of December Sam has completed 176 hours of time of which 136 hours are billable at a value of $22,440. Sam's write-offs remain the same at -21% as despite his higher pay, he is not better or faster at his job. Sam's write offs for December are $4,712 giving him a revenue contribution of $17,728. Dividing this by his (fixed) salary cost of $5,833 Sam just scrapes in with a ROI of 303% for December. Sam is glad he worked those extra evenings and weekends. Peggy... not so much.
Aaron has costed Sam's time at the fixed monthly cost of Sam's salary. Although this seems intuitive, it has put Sam on a treadmill he can't get off. Sam has artificially increased his ROI by working LONG. Sam's skills have not improved sufficiently to justify the increase in his pay or his new billable rate. As a result his write-offs have increased and his average hourly rate has remained the same. His job and the services he does have remained the same. His pay increase and subsequent billable rate increase has been a trap.
The only way Sam can now maintain his ROI is to increase his revenue by working LONG. Sam is unlikely to take a pay cut. Pay only goes one way. Eventually Sam gets sick of working long ours and repeatedly struggling and failing to meet his ROI % KPI. He's been set up for failure and starts to look for new work. Aaron's not sure why these write offs continue to occur. Aaron is disappointed in Sam's performance as he hasn't appeared to earn the pay rise he was provided. Without knowing it Aaron has traded short term revenue for long term gain from a productive, effective and healthy team member; all by costing Sam's time at the fixed cost rate and distorting Sam's ROI%.
How could this have gone differently?
If we cost Sam's time in July at a per hour cost rate of $31.25 based on his annual salary of $60k and an expected total time of 160 hours per month, Sam's ROI% for July would have been the same. 160 hours x $31.25 for a total cost of $5,000 on a revenue contribution of $12,750 providing an ROI of 255%.
In August when/if Sam decided to work LONG to achieve his targets his revenue would have increased (all other factors remaining equal) and his cost will have also increased (despite his salary remaining the same). The 172 hours he worked would have been costed at $5,375 on a revenue contribution of $16,830 providing an ROI of 313%. Still achieving his target but not the massive increase we saw by fixing his cost at his salary for the same period. Working longer hours has not lead to a dramatic change in his ROI due to the increase in Sam's cost.
Sam and Aaron may have worked out in August that ROI is not the only metric Sam needs to be working on here. His productivity is 76% (132/172) and his write-offs are -15%. By increasing his productivity and reducing his write-offs Sam could achieve the same increase in revenue contribution without having to work longer. By focussing on his write-offs and spending more time on customer jobs Sam would repeatedly hit an ROI just over 300%.
If we were to increase Sam's pay in November to a new hourly cost rate of $36.46, Sam would be unable to 'game' his ROI % by working LONG as while this would increase his revenue, his cost to Aardvark & Aardvark CA would also increase. Sam's 176 hours in December would have been costed at $6,417 on a revenue contribution of $17,728 for an ROI of 276%. A very different story to the 303% ROI calculated using the fixed-salary cost method.
Sam and Aaron would have figured out that working LONG is not the answer. Sam needs the training and support to allow him to justify his new billable rate that accompanied his pay rise. He can do this by reducing his write-offs through getting faster at doing repeatable tasks or doing higher value work (through training). By improving his focus on customer work Sam can further increase his productivity to ensure we are increasing is revenue contribution the right way.
You might also enjoy: 'Avoiding the Death Spiral: Actual Costs and Excess Capacity'
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