Most professional services organisations over a certain size will go through at least an annual budgeting process. Putting aside sources of revenue other than service revenue, both revenue and cost will be a function of the number of staff you have, the utilisation you can reasonably expect from them, the target fees you believe they can sustain, the proportion of paid work that you believe you can invoice to the client, and the cost of each employee. Profit, in most professional services organisations, is a function of these factors more than of any other, assuming your overheads are not extravagant.
Suppose you have 10 staff, and expect utilisation of 80%, and realisation of 90% with a target fee rate of 1000 per day, and a standard cost, per employee, of 500 per day. Note that a ‘target fee rate’ is the average fee rate that you expect to negotiate with clients. It may be lower than your published fee rates. We will assume 230 available days in the year – weekdays, minus public holidays, vacation days and any other planned absences such as training days.
Your budget might show:
Revenue = (Available days) * (Utilisation) * (Realisation) * (Target Fee Rate)
Revenue = 230 * 0.8 * 0.9 * 1000 = 165,600
Cost = 230 * 0.8 * 500 = 92,000
Margin = 73,600
(Note that we assume that standard cost is calculated as total direct costs divided by utilised days.)
In some rare circumstances you can achieve high fee rates, high utilisation, high realisation and low staff costs, but more often you have to sacrifice one or more to achieve others:
If your fees are too high, your utilisation may fall.
If your staff are too cheap (and inexperienced) your realisation may fall.
Standard fee variance measures the extent to which you are achieving the target fee rates on which your capacity-based budgets are modelled.