Does a supplier having a profit margin in excess of 35+% seem unthinkable? Well it happens. I’ve seen it consistently over the past 10+ years. Here are some of the most common ways service based organizations (who bill/invoice by time and materials) can increase their profits. Simple as they may be, suppliers still leverage them in 2019. Some tricks are just too easy to get away with if no one is looking in the right places!
Service based organizations will always try to maximize their profit, and can you blame them? It’s not like we can expect them to work on a 1-2% margin and remain a viable, quality supplier and partner. I don’t think you would want them to either, knowing your business is at stake.
But on the other side, you have to ensure costs are reasonable and quality is maintained. It’s your job! So what’s a Sourcing Professional to do? If you know what to look for, it’s easier to find and negotiate against. So here are some of the top ways I’ve seen suppliers take advantage in service based contracts.
Time (Rate and Hours)
They only provide total project costs. The less we know, the worse off we are. If a supplier has a project cost of 500k lumped into one fee, then we can’t assess it’s value. Management consultants love this tactic. How do we even know what we are getting (how much is time vs. materials)? Bottom line – we don’t. And if they finish the project early or it takes less time than planned, you can rest assured the price won’t change to reflect it.
Bill for all hours, regardless if they were needed /actually used. This is a concept isn’t one that is addressed often enough or directly during the contracting phase (in my humble opinion). If you don’t have in writing that they can only bill you for actuals prior the project starting, you’ve given them the ability to bill for what they projected. I’d like to assume most companies are ethical and wouldn’t bill this way, but unfortunately I’ve been proved wrong.
Inflate titles to drive higher billing rates. I’ve seen this a lot with Marketing Agencies. Giving someone the title of Director, VP or higher typically drives higher billing rates (and thus higher margins).
Lower your rates and bill for extra hours. The old saying is “If it’s too good to be true, it probably is.” This is exactly what happens when you push too hard on rates. They just increase their hours to compensate.
Have a very tenured/senior staff on each project. On average – the higher the bill rate, the larger the margin. This is why it’s imperative to get the breakout of titles of staff – otherwise you could have a Creative VP adding lots of hours in very tactical work that is typically done by someone more junior.
Lower the amount of assumed work hours (2,088/year) to justify your higher-than-average rates. I’ve only seen this a handful of times, and the majority of the time it’s been with IT service providers. Lower the denominator to produce a higher (yearly rate/hours per year). Although a smart tactic, it then reduces the number of hours they can assume to bill at straight time for your project.
Materials (Travel and Expenses)
Mark-up your pass through material expenses. There are certain industries where this is acceptable but not all. Even when it is you should aim to get this as close to zero as possible. And it’s why reading the contract in detail is so important. You never know when you could find a “charge 20% on pass through expenses” business term hidden in the details.
Have senior staff attend all events, or bring the entire team. This one is pretty self explanatory. More people = more expenses. Or bringing senior staff when they provide minimal support or “oversight” and can still bill with a larger associated margin.
Invoicing (The Final Bill)
Don’t pass along rebates/refunds/discounts. This one is focused mainly on Marketing agencies, but can be applicable to other industries. Are you getting a new discount on buying something in bulk or a media rebate for volume? Well if you don’t notify your business partner you can just keep the savings for yourself.
Lump everything together/ Round up. If you don’t have a ton of extra time, you will tend to forget about tracking billing to ensure all negotiated rates and terms. Maybe you have technology or a tool to be able to support you. If you don’t, it will be a very labor intensive, and manual process. And if you are like some organizations who have Admins/AC’s without direct knowledge of a project approving invoices, it just opens you up for tons of errors. Mistakes can be made and approved.
Now this wasn’t meant to be an exhaustive list – just the most common ones I’ve seen working with Management Consultants, Marketing Agencies, Contractors and all other service based categories. And it goes without saying you should read each contract in detail to look for business terms that seem to have snuck in. So make sure you take the time to double check each contract clause, no matter what the length of the contract.
Now at this point you may be asking – Great, I found some of these issues – now what?! Well stay tuned for Part 2 to learn about negotiation tactics to confront these issues head on (and win!).
If you have any of your own that you’ve seen, I’d love for you to share with me in the comments!
How Service Based Companies Increase Their Profit – Part 1