By Michael A. Webber, Aff. ACEC, All. AIA, A/E Finance
Summary
Yes, architecture & engineering firms can make good profits and stockholders a very good return-on-investment (ROI). A valuable source of Key Performance Indicators (KPIs) is the Deltek Clarity A&E Industry Study on financial performance. Their 35th Annual report (2013 data), conducted with collaboration from ACEC, ACEC-CA and SMPS, has just been released.
As well as KPIs for the industry as a whole and other sub-segments, the study breaks out KPIs for “High Performing Firms”. Using the criteria of a minimum 20% Operating Profit Rate and minimum 3.00 Net Revenue Multiplier to identify them, a full 25% of the firms responding were categorized as High Performing Firms: 28% were Small (1-50 employees) firms, 23% were Medium (51-250 employees) size firms, and 20% were Large (251+ employees) firms. Further, there is credible evidence to indicate that many of these firms repeat as High Performers year-after-year.
As ACEC's representative for, and an author of this survey, I was particularly interested to see what other financial KPIs could help point to more specific success factors. The rest of this article presents and discusses the primary KPIs for “High Performing Firms” and “All Other Firms”.
Introduction
A recently published AIA Best Practice, entitled “7 Characteristics of High Performing Firms” stated, “In any market and geographic area there are high quality architecture firms that have talented designers and skilled technical architects who provide excellent professional design services. ... Some of these firms perform at a higher level in terms of revenue, profit, and long-term viability." The Deltek Study provides data corroborating that statement.
Results & Discussion
As mentioned, the criteria for “High Performing Firms” were a minimum 20% Operating Profit Rate and minimum 3.00 Net Revenue Multiplier. The actual median KPIs for the High Performing Firms were:
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Operating Profit Rate on Net Revenue
2013 11.1% 22.1% 7.8% 183.3%
2012 10.1% 25.0% 8.3% 201.2%
We start with this KPI because it is the one with which virtually all owners are most familiar and pay first attention. Again this year, High Performers almost tripled the operating Profit Rates of All Other Firms. The other KPIs to be discussed hopefully will provide more insight into how such results were achieved.
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Net Revenue per Employee
2013 $127,098 $149,765 $121,133 23.6%
2012 $121,902 $144,133 $117,484 22.7%
One of the primary reasons High Performers were able to achieve such high Operating Profit results was because of the billable production (Net Revenue) these firms derived on average from each employee. Net Revenue billings, which do not include any consultant, direct expense (whether reimbursable or not), or any bad debt or write-offs, are 20% to 25% higher per employee for High Performers than for All Other Firms.
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Net Labor Multiplier
2013 2.99 3.33 2.88 15.6%
2012 2.91 3.43 2.86 19.9%
The high Net Revenues per Employee achieved were a result of firms managing their ways on projects to these Net Labor Multipliers. Recognize that these multipliers are the overall results from all projects worked on during the entire year. It is not possible here to determine whether the results were because of higher fees, greater effectiveness & efficiency, staff mix, technology, or other reasons, but, because the High Performers comprise a full quarter of respondents, it is probably a combination all of these – applied continuously project-by-project. Collectively, the reasons could be summarized by calling it better overall operational & financial management.
One thing that this high production was not automatically the result of was higher Utilization Rates or Direct Hours per Employee. These results are only fractionally higher for High Performers vs. All Other Firms compared to the more extreme differences in Net Revenue per Employee, Operating Profit Rate & Net labor Multiplier, but the differences help.
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Utilization Rate
2013 59.4% 61.5% 58.8% 4.6%
2012 59.9% 60.4% 59.5% 1.5%
Direct Labor Hours per Employee
2013 1,275 1,319 1,261 4.6%
2012 1,246 1,324 1,227 7.9%
Utilization Rate deserves a bit more discussion. It is a commonly-held misnomer that Utilization Rates should be maximized. Based on research by PSMJ Resources, Inc., Utilization Rate has only a 11% statistical correlation to Operating Profit Rate. (The Net Labor Multiplier, as seen above where High Performers far exceed All Others, has a 27% correlation, but the Total Labor Multiplier, below, has a 47% correlation.) Utilization Rates measure Direct Labor vs. Total Labor (Direct + Indirect Labor). Granted Indirect Labor includes Vacation, Holiday & Sick time, but it also includes administrative (back office) staff & time, continuing education & professional development, and – most importantly – marketing time. These activities, especially marketing, are necessary and appropriate. Also recognize that marketing is usually conducted by higher ranking (i.e., higher paid) staff, and the Utilization Rate is dollar weighted. As such, Utilization Rates are something to be optimized rather than maximized.
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Overhead Rate (w/o bonuses)
2013 161.1% 154.1% 163.4% <5.7%>
2012 161.6% 161.8% 161.2% 0.4%
Here again, High Performers do not have markedly lower Overhead Rates (Indirect Labor costs being the largest component of total overhead expenses). As broken out in the survey, there are no markedly different per employee expenses on the other major Overhead components, either: Other Salary-Related & Other Staff Expenses, Facility, Corporate, or even non-labor Marketing Expenses.
Further, High Performers do not markedly overpay employees – except when it comes to Bonuses per Employee:
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Compensation per Employee
Direct Labor $42,456 $44,153 $41,720 5.8%
Indirect Labor $28,914 $28,139 $29,280 <3.9%>
Total Labor per Employee $71,370 $72,292 $71,000 1.8%
Salary-Related Expenses: P/R Taxes,
Group Health & Life, 401(k), etc. $14,590 $14,782 $14,542 1.7%
Bonuses $4,336 $12,699 $3,224 393.9%
Total Compensation $90,296 $99,773 $88,766 12.4%
Even their Salary-Related Expenses, including insurance programs, and 401(k) matches or pension contributions are consistent with All Other Firms. [Note: These other Salary-Related Expenses add an average of about 20% to all employees’ salaries. In other words, on average, each employee is actually paid their salary plus another 20% for statutory & fringe benefits.]
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Total Labor Multiplier
2013 1.74 2.02 1.68 20.2%
2012 1.75 2.09 1.70 22.9%
As mentioned above, PSMJ cites the Total Labor Multiplier as the one KPI most highly correlated to Operating Profit Rate. Without going through the mathematics, the Total Labor Multiplier is the product of Net Labor Multiplier times Utilization Rate. The High Performers achieve their significantly higher result by managing projects towards higher Net Labor Multipliers while optimizing their Utilization Rates.
Do High Performing Firms Continue to Out Perform Year-After-Year? The Data Indicate, Yes.
The Deltek report comments, “We recognize that some High Performers are probably just ‘one-hit-wonders,’ having a good year before reverting back to the mean. However, in Deltek’s experience working with thousands of A&E firms, we’ve also found a top tier of companies that meet these high standards year in and year out. A common thread is that these High Performers closely monitor their operating metrics, and their better visibility into the business gives them the insight to manage risk through good times and bad. The result: They do a better job managing projects for clients, can charge higher fees, and are able to reward and retain their best people.”
Here is more evidence that Deltek’s supposition is correct. Below are metrics that come from the Balance Sheet, and generally reflect the amounts of money that Stockholders have invested and retained within the firm to finance operations and growth, particularly growth of staff. (Each individual new hire generally requires an additional $20K to $25K of additional Working Capital.)
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Working Capital per Employee
2013 $29,037 $38,399 $25,842 48.6%
2012 $26,953 $44,849 $25,214 77.9%
Retained Earnings per Employee
2013 $21,822 $29,752 $20,992 41.7%
2012 (not available)
Total Equity per Employee
2013 $32,584 $43,340 $27,991 54.8%
2012 $27,805 $47,394 $26,718 77.4%
Somewhat surprising was the extent to which each of these amounts are relatively the same for all firms -- regardless of size or type of firm -- with the exception of the High Performers. And we are not talking about slight variances. The High Performers have 50%+ higher amounts of Working Capital per Employee, Retained Earnings per Employee, and Total Equity per Employee. The higher Retained Earnings per Employee shows that these firms already started the year with these higher investments, which substantiates that argument that they already were previously in the High Performers category.
This article started with the statement, “Yes, architecture & engineering firms can make good money and provide a very good return-on-investment (ROI).” We have seen that High Performers had triple the Operating Profit Rate of Other Firms, but even after paying employees essentially triple as much in bonuses, the High Performers realized a Pre-Tax Return on Equity still almost triple All Other Firms:
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Pre-Tax Return on Equity
2013 18.1% 37.1% 12.7% 192.1%
2012 21.8% 46.5% 17.1% 171.9%
Are these returns good? This is a number that one can compare to stock market, 401(k), and most other financial investment types, so, yes, High Performing Firms have provided stockholders a very good ROI.
Lastly, this year’s High Performers plan to keep up their above average profit performance. With basically the same Net Revenue growth estimates (6%) for 2014 as All Other firms, the High Performers forecast continued Operating Profit Rates in excess of 20%:
All High All Other % ∆ HPF
Participants Performers Firms vs. Others
Operating Profit Rate on Net Revenue
2014 Forecast 11.4% 20.7% 8.4% 146.4%
2013 11.1% 22.1% 7.8% 183.3%
Conclusion
The AIA’s Best Practices article finishes by saying, “Inherent in these [High Performing Firms] is a business mindset and discipline to grow revenue and make a healthy profit year after year. … In a High Performing Firm, attention to these financial performance issues becomes as much a focus of the leaders and managers as does design and managing the practice. Having a principal or a Chief Financial Officer with a strength in financial management is not just a huge asset, but a necessity for monitoring and maintaining the financial health of a High Performing Firm.”