Why total $ value of a client (at the expense of other metrics) is a misleading figure

February 7, 2013 — Leave a comment

Understanding the total value of your clients to your business is an important process to undertake. It’s essentially to know who is “keeping the lights on” so to speak so that you can give them the love and attention that they deserve. Not all clients are created equal and they don’t expect to and shouldn’t be treated the same – know where your bread is buttered and ensure that it’s continuing to be buttered!

But in saying that, total value from a net $ perspective can be misleading and some simple calculations can show why. If you have an unprofitable Managed Services agreement it can undo all of the margin you’ve built in other parts of the business.  

It’s been said to me with relation to Managed IT agreements “Why don’t you consider the ad-hoc work they do or the server refresh we’re going to do in 6 months when you calculate their ‘value’ as a customer” and whether we’d be better off keeping them on the books or politely suggesting they may be better served elsewhere. There are a few problems with this logic delivered quite elegantly on a sum basis – these sums are based on a fully loaded labour cost of $75 per hour per engineer which I think is reasonably accurate.

 

1.            Ad-hoc work is not guaranteed and fluctuates month to month; infrastructure upgrades by the same token are not guaranteed and you could look after a customer for 12 months on agreements that are costing you money only for them to leave you before they undertake the server upgrade component because they are unhappy with your service due to you spending hours on their network and never fixing the core issues

2.            Notwithstanding this, assuming they stay with you and do an infrastructure upgrade in year 1 – let’s do some quick calculations:

If a customer has an MIT agreement on which the monthly fee is $2000 and the effective hourly rate is $50ph (40 hours worked) at a fully loaded labour rate of $75ph you’d actually lose EVERY month on this customer $25ph or $1000pm – assuming this a business would waste $12000 per annum on that particular customer

If that customer chooses to do a infrastructure refresh for $30000 ($20000 hardware and $10000 labour) of which gross margin is 15% on hardware and all project labour is billed at $120ph the sums look like this:

(-$10000 + ((15% of $20000=$3000) + (83 hours of labour *$45=$3735)) = -$3265                                 

$45 = difference between labour cost of $75 and billing rate of $120

For the whole year that customer is STILL MINUS $3265 for you to look after them and they don’t do infrastructure upgrades every year!

If you were to improve the MIT rate to $75ph  the customer turn-around is $10000 (from a negative of $3265 to a profit of $6735)

 

This is just working with some round figures for ease of calculation, however it’s pretty easy to demonstrate how tolerating a low average hourly rate does not lead to pay-offs in the longer term.

 

3.            The other discussion point  that can be predicated is “This customer does another 20 hours of additional ad-hoc work per month, so they HAVE to be profitable”.

 

Taking the same customer from above with a MIT effective hourly rate of $50ph on a $2000 agreement and assuming they do another 20 hours of Professional Services work per month at this rate of $120)

(-$1000 + (20 hours x $45)) =$0  – again bearing in mind the $45 figure is the difference between the cost and revenue of the additional professional services work)

 

At BEST a business would break even (on a 0% Gross Margin) with this customer assuming this work occurs every month, but you would be doing 60 hours of work for $0 profit and it’s very easy to see how this could go sideways quickly and become a massive loss.

So, what’s the most important metric in your Managed Services business? The one I keep an eye on the most – Average Effective Hourly Rate by location on a rolling 3 basis.

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