On the back of rising volatility in the global financial marketplace and fears of a U.S. recession spilling over into the European economies, stock indices have recently shown considerable weakness. When economic storms loom, smart executives typically start looking for a way to cut costs in advance of softening demand for their companies' products and services.  But what if you could know with some degree of certainty where your company is profitable and where it's not, and figure out a way to do more of the profitable work?  What if you fired unprofitable customers instead of firing the employees who have helped you build the company to its present stature? 

Many companies that successfully slash costs to survive a recession find top-line growth elusive when the recession ends.  Their best people are gone, their long term projects were cancelled and a short term focus is all they have left, resulting in the lack of a platform designed for growth.  This is generally due to overzealous or clumsy cutting of people and projects that could have been avoided, or at least performed with more intelligent precision, if per-customer per-project profitability metrics had been available. 

Understanding costs is the first step to understanding profitability. While most companies know their profitability company-wide, they often don't know it on a per-product or per-customer basis.  This is important because such precision of understanding is a requirement to developing a good strategy for moving your company forward. 

Both customers and products can be viewed as special kinds of projects, which means that understanding per-customer or per-product profitability devolves to understanding per-project profitability. 

Here is a five step process to take your company from its current state to one where you will know, with a high degree of accuracy, your profitability on a per-project basis. 

Step 1.  Recognize your current situation as “chaos” 

When companies do not know their per-project costs, they have no way to validate future project estimates.  If you don't know how long it took to complete your last project, then you don't know how accurate the initial estimate for that project was.  Calibrating project estimates is not just about calendar time.  A project that was delivered on time may not have been delivered on cost.  Some organizations achieve on-time delivery through adding resources to projects that are running behind.  If they do so invisibly, then you were on-time but not on-budget.  You need to know this in order to avoid overcommitment and underpricing. 

Without the metric of per-project cost, repeating past successes is impossible.  If you don't know which projects were on-time and on-budget then you don't know which projects were successful, which means you don't know which projects to try to repeat - which processes to keep and improve. 

Without the metric of per-project cost, recognition of project crisis becomes a matter of feelings rather than math.  This increases the likelihood that good processes you have instituted will be abandoned in times of crisis and people will revert to more comfortable methods of doing things, which can lead to certain drawbacks. 

Overcommitment, underpricing, inability to repeat past successes, and abandoning proven processes in times of crisis is the recipe for chaos. In recessionary times this puts managers in a situation where it is easy to overreact, cutting people or projects too harshly.

Step 2.  Transition to tracking project labor hours and expenses 

If you can get most of your people to track the majority of their time on a per-project basis, you will begin to know when projects are in trouble much earlier.  It is not necessary to have 100% compliance with a employee time-tracking system to gain significant insight into project progress, profitability, and adherence to estimates. 

Having basic time tracking data at your fingertips will surprise you.  You can learn the truth about projects that are consuming more labor hours than you thought, or customers you deemed expensive who are actually cheap to service. 

Often the noisiest customers are the ones who have paid you the most. Intuitively, people will label them as "a problem customer," but they are often sending you 10 times the revenue or more, so it is important to measure the true cost.  Just how much of a problem are these so-called problem customers?  A simple basic level of employee project time utilization data can give you insight into this question. 

In recessionary times you want to fire your unprofitable customers and kiss up to the profitable ones. 

Step 3.  Put labor rates on that time data and track all expenses 

Travel expenses represent the second largest controllable corporate expense for most companies, and some projects, products or customers eat more travel expense than others.

Collecting all this data on a per-project basis gives you the ability to know true direct per-project cost.  Profitability is not far behind.  

Once you have 100% (or close) compliance on time and expense data collection, management will have better insight into how to cut costs without a chainsaw. 

Step 4.  Allocating indirect costs 

Indirect costs, like the cost of lighting, janitorial staff, HR and marketing, inure to different projects in different ways.  There are two basic kinds of indirect costs: general indirect costs, like rent, that need to be allocated across every project in the

company, and semi-indirect costs, like customer relationship management, which should be applied to all projects for that customer.

Every company is different, so allocation of indirect cost is different for every company.  At Journyx, we allocate more marketing cost to software license sales than we do to professional services or software maintenance sales. We do this because marketing expenses are more directly related to winning the customer initially than they are to maintaining that customer relationship over time.  While marketing is not irrelevant to the long term customer relationship – customers feel more comfortable continuing to do business with companies that are visible in the marketplace – it does matter less than during the customer acquisition phase, which is when most of our licenses are sold. 

For your company, you need to create a general indirect cost allocation formula for each type of indirect cost: marketing, rent, legal fees, etc. 

Then there are semi-indirect costs.  If you have a large customer that you do multiple projects for or a suite of related products that are treated as a group, there are usually some costs that apply to those projects as a group, but not against any particular one of those projects.  An example of this would be management of the general customer relationship or marketing of the product suite.  In this case, you may want to allocate these semi-indirect costs by revenue or by direct cost over those projects. 

However you do it, input from all of the managers involved is both required and useful.  You may want to alter the allocation formulas over time if they are generally perceived as inaccurate, unfair, or leading to bad decisions. 

Once you have allocated indirect and semi-indirect costs across all projects, you will be fully cognizant of complete per-project costs.  Whether or not you are in a recession in your industry, you will have a very precise tool for making intelligent changes to company resource utilization and direction that are likely to lead to increased profits. 

Step 5 - Global Awareness of Per-Project Profitability 

Imagine if your engineers, developers, services team and salespeople all knew which customers were making money for you and which were not. Assuming they want your company to succeed – and you should fire them if they do not – would this not alter their behavior automatically in ways that would make you more money? 

Revenue - Cost = Profit 

That seems pretty simple, but sometimes it is non-trivial to gain an understanding of per-project revenue, and proxies have to be used. 

If you're managing an internal IT shop for a large Fortune 500 firm, you must get your customers to give you some estimate (in dollars) of the value their projects are providing to the overall company.  Allocating business value delivery – a proxy for revenue – can be every bit as complex as allocating indirect costs, but it is worth the effort to do so. 

If you're running a consultancy, bookings or billings data right out of the CRM system are your best bet. 

Regardless of your method, you may have to revise it later as new data becomes available.  Yet once you have an estimate of per-project profitability, you are now in the nirvanic state of understanding per-project per-customer per-product profitability, which gives you an enormous advantage over your competitors during a recession. 

You know where your profits are coming from, and they don't.  Now you can cut out the unprofitable work, or at least perform it consciously if it has to be done for strategic reasons.  You can also easily calculate ROI on anything and your estimates will keep getting better and better. 

Per-project profitability knowledge can make your company more solid in bad times and more flexible in good ones.  When times are hard and you need to cut, you will be able to cut intelligently and with precision, letting you know that you're making the right long term decision for the company.  Though recessions come and go, having great procedures in place to understand per-project profitability is the key to intelligent flexibility that will allow you to weather any financial storm.

About the Author:

Curt Finch is the CEO of Journyx. Founded in 1996, Journyx automates payroll, billing and cost accounting while easing management of employee time and expenses, and provides confidence that all resources are utilized correctly and completely. Curt earned a Bachelor of Science degree in Computer Science from Virginia Tech.  As a software programmer fixing bugs for IBM in the early ‘90’s, Curt found that tracking the time it took to fix each bug revealed the per-bug profitability. Curt knew that this concept of using time-tracking data to determine project profitability was a winning idea and something that companies were not doing – yet… Curt created the world's first web-based timesheet application and the foundation for the current Journyx product offerings in 1997. Learn more about Curt at http://journyx.com/company/curtfinch.   

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