Challenge 2. Measurement of output and fixing it’s price

Challenge 2. Measurement of output and fixing it’s price

In continuation with the blog series where we first discussed three critical challenges faced to Monitor Efficiency in Service Sector, and then the first challenge related to the Input Cost Measurement, we are now to discuss the second challenge about Measurement of output and Fixing it’s price. We would discuss it with an example.

The service rendered may be called “ Audit” or “ designing for a bridge” or “ Filing of writ in High court” depending upon the nature of services rendered by an enterprise. However as discussed earlier, any of the above referred service actually represents time of one or more employees of the enterprise utilized or delivered to customer in completing the project/assignment.

Thus on one hand we can attribute hourly cost (explained in earlier blog) of different persons to the time utilized for completing the assignment, to find out direct cost of the assignment/ project.

Similarly, it would be simple , logical and most appropriate way of determining price to be charged for the assignment also by fixing a standard billing rate per hour for different persons (like a price list for different products of a manufacturing enterprise)involved in delivering the service and applying the same to time utilized.

Fixing billing rate per hour (or per day) for different employees will enable the enterprise to objectively ascertain the price to be charged for any project/ assignment.

Billing rate per hour for an employee minus direct cost per hour for that employee would give us profit / Value addition or rather contribution or gross margin per hour that will be generated from that employee.

One basic consideration in fixing billing rates for each direct employee is to ensure that the total gross margin for all the direct employees for the year after deducting the estimated Overheads for the year leaves profit as expected by the enterprise.

In reality all the available time of the employees may not be fully realizable due to unavoidable wastage of time, or due to time utilized for administrative, marketing activities or for training purpose. This aspect may be kept in mind while fixing the billing rates.

Billing Rate Determination Methodology

As sumptions for M/s ABC Consultants:

  1. Organization has 3 employees, their cost details are given in Table 1
  2. Overheads per annum : 1,250,000
  3. Profit objective for the year: 1,400,000
Table 1: CTC details of Direct Employees
EmployeeAvailable days in a yearCTC Per DayCTC Per Annum
Ajit (SR Manager)21412,0002,568,000
Mary (JR Manager)2144,000856,000
Vijay (JR Manager)2141,500321,000
3,745,000

Process of Billing rate determination:

Expected/Estimated Revenue (-) Direct Employee CTC (-) Overheads = Profit

OR

Expected/Estimated Revenue = Direct Employee CTC + Overdheads + Profits
6,395,000 = 3,745,000 + 1,250,000 + 1,400,000

  • Billing Rates may be fixed on multiple of – Revenue : Direct Employee CTC
  • Revenue / Direct Employee CTC= 1.71
  • Considering some unavoidable wastages at 5%, mulitple to be used could be 1.71*1.05 = 1.80

Conclusion : This multiple could be used as a broad guide to fix the billing rate for each employee as given in Table 2

Table 2: Billing Rates
EmployeeAvailable days in a yearAvailable Days (-) 5% Estimated WastagesCTC Per dayBilling Rate using 1.80 as multipleRevenue Per Annum
Ajit (SR Manager)21420312,00021,6004,391,280
Mary (JR MAnager)2142034,0007,2001,463,760
Vijay (JR Manager)2142031,5002,700548,910
Expected Revenue6,403,950

Finding : You will observe the billing rates determined would generate expected revenue as per above formulae

Note: These rates are expected to provide broad guidelines for the rates. It needs to be understood that the rates will also be influenced by external factors like competition, customer perception and willingness to pay etc. Thus the rates can be further fine tuned as required.

The overheads will include all expenses other than the direct costs. Overheads thus would include indirect employees cost plus expenses like rent, electricity, marketing expenses, depreciation,interest etc. These Overheads are expected to be more or less constant for any given level of activity and hence easier to estimate and predict. In any case if there is a significant change in the original estimate of overheads, billing rates can be adjusted suitably if considered necessary.

Fixing billing rates helps in controlling your profitability at project/ assignment level on ongoing basis especially say in situation A where the price of the assignments is agreed in advance or is based on % of the value of project of the client. If you are able to achieve this for majority of the projects, enterprise level profit objective can be achieved automatically. (Please see next blog where need for budgeting in such situation is explained)

In situation B where the billing is based on actual time spent on the assignment the achievement of profit is much easier provided

  1. Billing rates are fixed properly as per methodology explained above
  2. The time utilized for all the projects for all the direct employees is captured in a reliable and fairly full proof manner
  3. The time of all the direct employees on activities other that on assignments/ projects is also captured for preventing / controlling wastage and leakage.

Eff factor deals with situation A as well as B.

Read the next concluding blog where we will address the third challenge.

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