For many product companies, it can seem difficult at first to get CFOs to see the value in professional services (PS). The simple answer to addressing this challenge is to focus your PS business on profit margin growth. Only when margins are great, should you focus on revenue growth.
As a PS executive in a product company, you probably are all too familiar with this reality. Valuation multiples for PS revenues are 1x to 2x compared to 8x to 10x for product revenues. So, CFOs are not interested in PS revenue growth, but what matters to them is earnings contribution of PS business. The current trend of optimizing PS business through headcount reduction and expansion of partner-led implementations is a direct result of CFOs desire to increase earnings contribution of PS business.
But what’s the yardstick for great PS margins? Your PS margins should be the same as product margins, and once that happens, CFOs will start to love the PS business. Interestingly, most PS engagements are scoped and quoted at about 30% margin, which is in line with product margin. However, some challenges drag it down to about 15%. Eliminating these margin drags is key to boosting the earnings contribution of your PS business.
What Challenges Erode PS Margins?
As seen in this chart, delivery challenges erode the biggest chunk of PS margins. If you’re like 70% of PS teams, you’re using a professional services automation (PSA) solution to address key delivery challenges like gaining real-time visibility into billing and utilization rate, instituting project and resource management excellence, and proactively managing bench strength. What most PS teams don’t intuitively realize is that there’s as big an opportunity to increase margins outside of delivery through sales excellence and fine tuning how delivery and sales work together. But what’s even more fascinating is that for the same level of effort, you can get higher returns by focusing on the sales function. The simple explanation for this is the inertia of a much larger delivery team compared to a smaller sales team.
Here are four of the most common sales and sales-delivery sync challenges that cause about 8% margin erosion:
Challenge #1: Explosion in Service Offerings
It’s tempting for a PS organization to solve every customer problem they encounter, but too many service offerings can erode delivery effectiveness dramatically. In general, the fewer the service offerings, the better the overall margins. Repeatability in both sales play and project implementations results in higher margins. Saying “yes” to everything that the customer wants results in a delivery organization with disparate skills. This dramatically reduces fungibility of resources which is necessary to boost utilization rates and to build muscle memory with a track record of repeatable, successful implementations.
Challenge #2: Inaccurate Estimates
Increasingly, Sales teams are being tasked with driving price estimates for PS engagements, but there are significant inaccuracies in some of these estimates. This can be due to reasons such as junior resources getting quoted when only senior resources are available at the forecasted project kick-off date, or to meet the client budget junior resources are quoted when the project requires senior resources. Furthermore, estimates can be meaningfully off, especially for new products where there’s limited track record of successful implementations. Such scenarios require more expansive reviews and approvals from Delivery and Product teams to protect margin.
Challenge #3: Poor Contracting
The quality of statement-of-work (SoW) documents impacts PS margins. Nothing reduces margin like small variations in terms across many PS engagements. For example, how many times have you seen new client requirements getting snuck in at the last minute? What about key assumptions and non-negotiable legal and financial terms getting modified? How about services intellectual property (IP) getting snuck in for free or, worse yet, getting assigned to the client due to a clause in the MSA that the sales rep didn’t know while authoring the SoW or CR? When such exceptions become the norm in the name of higher customer satisfaction, you end up exposing your company to much greater financial and legal risks.
Challenge #4: Poor Pipeline Visibility
Lack of demand visibility is often inaccurately described by delivery as, “[…]Sales is all over the place—deals they say will close this quarter either don't close or the timing is way off.” More effective delivery resource management requires better demand visibility. However, in most organizations, CRM systems contain dollar estimates and what the Delivery team needs is people and skill estimates. Visibility into forecasts is limited only to line of sight, i.e., what’s closing inside the quarter while delivery needs to hire and staff well into the next few quarters. This requires visibility into quotes being prepared as well as SoWs being actively negotiated with clients.
How Can Professional Services Teams Address These Challenges?
Fortunately, you can mitigate these challenges by embracing a product services mindset and taking a couple of concrete steps.
Roll Out a Service Catalog
You need to publish a services catalog that captures all available service offerings (e.g., integration services, migration services, implementation services) across all products, all deal types (fixed price, time and material, outcome-based) and all geographies, including partner-led implementations. Be judicious about what gets added to the services catalog and the yardstick should be services with a repeatable sales play and consistent delivery cadence. This catalog should also provide headcount and skills visibility to the delivery team to help with longer term resource management. As an added bonus you will magically see CSAT increase because of less thrash across Sales and Delivery teams.
Establish Guard Rails
Enable your Sales team to create custom SoWs from standard terms by making geography- and practice area-specific pre-approved content available through a centrally managed solution. Any modifications to “locked down” content like IP terms, legal clause or payment milestones should automatically trigger an approval process with complete visibility for everyone involved.
When it comes to price estimates, Sales should be able to quickly walk through the services catalog to select the pertinent services to generate an accurate rough-order-of-magnitude estimate. To streamline resource forecasting this estimate should also trigger a “soft-hold” of named resources in the PSA solution.
In summary, you can dramatically increase PS margins by rolling out a robust services catalog and tying it to your proposal and contracting process. Once PS margins are closer to product margins, your CFO is guaranteed to get excited about the PS business.
About the Author
Varun Parmar is the co-founder and CEO of Doculus which provides a solution to automate proposal and SoW generation for professional services and managed services teams. He has over 15 years of product management experience across companies like Adobe and EMC. Prior to Doculus, Varun was the Chief Product Officer of EMC’s enterprise file sync and share business. Varun holds 6 patents in the field of document collaboration and a joint master’s degree in business and engineering from the Massachusetts Institute of Technology (MIT). Contact him at [email protected].