Calculating Profitability: How Complex Is It?

There are several questions that service leaders often ask themselves when it relates to profitability.

  • How hard can it be to measure Profitability at the level I need?
  • How many years do I need to wait for good measurement tools?

If you look at history, the answer is possibly a very long time. Just consider:

  • The first car was manufactured in 1886 – the first dashboard with Kilometres or Miles Per Gallon added 90+ years later.
  • Electricity for the home came in 1879 – but the first energy smart meters were 130 years later.

Thinking deeper about profitability leads to additional questions like “What is the true measure of Profitability?” “What is more important: contract profitability, account profitability, or product profitability?” “Where do I include my indirect costs?”

You may have already read the blogs written by my colleagues on the importance of Cost to Serve and Contract Profitability. What I want to talk about in this article are the complexities from a higher level and why these need to be understood before we can truly state, “This is the profitability of X!”

Not Exactly Straightforward

So, let’s take a step back for a moment and understand who is managing your business. I am not referring to your CFO or your CRO but who is actually managing your day-to-day business and directly impacting those lines on your Profit & Loss or Income Statement that everyone at the top focuses on? It starts with the person responsible for the sale of your contract, which is the commercial element of profitability. Then it is managed by the service team, consisting of the technician and their manager, to apply the cost element to that contract. That seems pretty straightforward.

But is it really that straightforward? How does the commercial pricing structure get calculated? Do you have a vanilla contract offering or do your contracts differ by product, account, region, and/or customer’s desires? How often does the commercial owner review the costs that are applied to the contract? When they do review the costs, are they reviewing direct costs only or direct and indirect costs?

Having now worked with many service businesses across a wide of range verticals, I find it interesting to listen to comments from different parts of the business. Often, I will hear, “Our Time and materials business is so much more profitable than our contracts” or “Why do I report a contract profitability of ‘x’ percent but the finance team report 5% lower?”

These comments and lack of understanding have resulted in the profitability elements appearing more complex than they possibly should be.

Example Profitability Calculation

Let’s start with Time and Material profitability. Generally, this is a simple straightforward profitability calculation: we spent two hours of labor at a cost of $75 and billed $150. We fitted one part at a cost of $50 and billed $100, 50% profitability– simple.

Now let’s think of an annual contract: We spend 100 hrs of labor spread across three different technicians with 3 different wages for a total cost of $8,000 (fully burdened). Additionally, we fit parts at a cost of $4,000. Calculating the total annual costs of this contract equals $12,000. Taking this $12,000 cost away from the annual contract value of $18,000 leaves $6,000 of profit – or does it?

This is where the complexities come into play. Here we have accounted for the hours directly applied to this contract, but the three technicians are only 75% utilized so where do we apply this additional 25% of costs? It definitely does not get applied to any Time and Material billings, so we need to spread them across the contract customers in their region, but how?

Let’s take a simple approach, these three techs take care of 18 contracts so let’s divide that 25% of the non-utilized time up equally between those contracts. That would equate to an extra $25 a day per contract in additional costs. Annually that would be $6,000 to add to our contract example. So now costs are $18,000 and the revenue is $18,000 which is interesting as we have not even included the management or front/back-office costs into these calculations.

When we first look at this contract in isolation (direct costs) we see a healthy margin but as we start to account for the in-direct costs, we start to see a different picture. For many organizations, it’s not just about understanding the costs but knowing how to capture them, apply them and ensure the teams delivering the service from both commercial and costs have clear visibility and understanding.

Don’t Forget About In-Direct Costs

I have only touched on one in-direct cost in the above calculation and mentioned managers and back office, but there are a multitude of costs to think about when calculating these if you want an accurate picture. Some of these are: parts consumed but not reported, stock adjustments, inventory costs as the product gets older, warehousing, freight, management meetings, the commercial team, travel home, etc.

Then there is the more positive side of the equation to consider. If you provide billable work to a contract customer where do you add these costs and revenue streams? Do they go under contract or as time and material? These may cover consumables (direct sales), weekend work, field change orders, additional maintenances – which is why this blog is titled ‘profitability’ and not ‘contract profitability’!

So, with the above, how do we get a clear picture of profitability? Firstly, I would suggest starting at customer or account value. This will give you a profitability statement at an account level, machine sales, time and material billings, and contracts. This will also provide you the complete picture allowing you to drill down into more detail. But remember, you need to look into those in-direct costs such as non-customer-facing technician time, meetings, training, and non-utilized time to name a few. Once you have this you will have the ability to make good, informed decisions with both your operational team and your commercial team.

Before I leave you, I would like to add in a final spin on the profitability challenge and benefits especially if you have a mixed fleet within your install base. That challenge is to ascertain your profitability by product line and individual product. This can only be done if you have contracts priced at the product or asset level. This enables you to really start to see which products are bringing in the lion share of your profitability and also understand how life cycle management, aging products, and a diminishing install base really start to impact your P&L especially when you start to view the in-direct costs.

So, bringing us back to the Fuel consumption in a vehicle or the Smart Meter in your house; why is it so hard to get Contract or Account Profitability reporting out of your Field Service Management Solution in today’s intelligent world?

How do (or can) you manage your business without it?

 

ABOUT Kieran Notter

Kieran Notter is VP of Global Customer Transformation at ServiceMax. He is acknowledged as a service industry domain expert with 30 years’ experience. He specializes in field service revenue and working capital improvements, with a particular passion for supply chain operations. He is highly effective at partnering with customers to deliver tangible, practical results across their service operations. Having previously worked for companies including Kodak, Bell & Howell and, most recently, Pitney Bowes he understands the importance of a logical approach that is supported by real-time analytics. His considerable experience in implementing and using systems such as SAP, Servigistics (PTC), Oracle (Siebel), Salesforce and ServiceMax enables him to recognize a client’s challenges and facilitate solutions that lead to sustainable growth. His recent consultancy engagements have delivered improvements, such as reducing field service inventory levels by 45 percent while maintaining a higher first-time fix rate.