One of the more important metrics to monitor in a professional services firm is the effective bill rate. The effective bill rate is calculated by dividing the total revenue generated from a project by the total number of hours worked on it. The total number of hours worked should include both the billable and non-billable hours. Time spent on the sales process or on overall relationship management is generally not included in the effective bill rate calculation.

Why is the effective bill rate metric so important? Because for many firms, it can vary considerably from the proposed (or expected) bill rate of a project. Let’s say your firm proposes a 1,000-hour project at $200 per hour for a total fee of $200,000. During the project, a junior-level team member makes some mistakes and 200 hours of work need to be redone. Since it wouldn’t be fair to charge the customer for those hours, the additional 200 hours are deemed non-billable (worked at no cost to the client). Thus, the $200,000 in revenue actually required 1,200 hours of work, which yields an effective rate of $166.67 (which is 16.7% below the originally planned rate).

An advantage of tracking the effective bill rate of each project is that it helps you compare fixed fee engagements with time and materials engagements. Some professional services firms tend to propose engagements on a fixed fee basis with the intention of delivering projects at a higher gross margin. But fixed fee engagements carry various delivery risks (typically related to scope management) that can have a negative impact on the bottom line. If the same $200,000 project above was proposed on a fixed fee basis but took 2,000 hours to deliver, its effective bill rate would be $100 per hour. By monitoring the effective bill rates of all projects, firm leadership can ascertain the project types that yield the highest profit margins.

Actual-to-Plan Effective Rate Variance

Monitoring the effective bill rate by itself is useful to professional services firms that deliver similar types of engagements with a standard project team composition. When the entire portfolio of projects is monolithic, the effective bill rate is a good way to compare the performance of one project to the next. But when the projects and project team structure vary, the effective bill rate can no longer be used as a standalone benchmark.

Let’s assume a software engineering consultancy has just completed two projects. Project A resulted in an effective bill rate of $125 per hour while Project B resulted in an effective bill rate of $90 per hour. Project A is a much better project, right? Maybe, but maybe not. If Project B was primarily delivered by an offshore team at a much lower labor cost, it could have a higher gross margin than Project A.

When evaluating effective rates, what is most important is the variance between a project’s planned effective rate and its actual effective rate. When a project is first estimated, you should have a decent understanding of the expected roles, tasks, hours, revenue, costs, and profit. By the time that project is resourced and ready to begin, the planned effective rate should be highly accurate.

Ideally, you want every project to have a planned effective rate at the outset so that you can monitor the variance to plan throughout the project. In our previous example, if Project A had a planned effective rate of $150 and Project B had a planned effective rate of $80, it becomes clear that Project B was managed better to plan. Firms with widely-varying labor costs (such as leverage models or offshore models) should focus heavily on the effective rate variance to plan.