Utilization: the most important lever of agency profitability

Paul Doerwald • November 2

How to go from barely keeping the lights on to a 10% profit margin in half an hour a day.

“Utilization” is the most misunderstood tool agency owners have at their disposal.

Definition: An employee’s utilization rate is the percentage of their total work time that they spend on billable work. A “normal” utilization is in the range of 50-75%, depending on factors we discuss below.

Utilization is a lever, like a throttle in an airplane, that you can adjust. It’s a very sensitive lever. Small adjustments can have very big outcomes. A small movement can cause profit to rain down. Another small movement can cause employees to burn out and leave. If you can tune the lever correctly, the engine of your business will purr. Too little or too much, and your engine will sputter or overheat.

Tuning your agency’s utilization can increase revenue with no change to your bill rate or the value you deliver.

Unfortunately, most agencies don’t know what utilization is, or they don’t pay attention to it, at their peril.

In our anecdotal research, about half of agencies don’t track their time. If you don’t track your time, you can’t determine your utilization rates.

Those agencies that do understand utilization often use it as a hammer. “You must record 7 billable hours every day”. In the short term this gets the agency money. In the long term it burns out employees, skews your metrics, and creates resentful clients. Employees have an incentive to exaggerate their hours to meet an arbitrary time target. This means the agency’s revenue & cost models are not based on reality.

Instead, treat utilization as a precision tool. Each member of your team has a “resting state” (think: resting heart rate) utilization rate. Your job as an agency owner is to determine what that natural rate is, and then optimize it. This article describes how.

To enjoy the outsize profitability that utilization enables, you need to track time. Time tracking is not only for organizations that bill by the hour. It doesn’t matter if you bill by project, retainer or “by value” (whatever that means to you). If you have a staff greater than you, you need to know how your time is being used.

How to calculate your utilization rate

The formula for utilization is very simple:

(total billable hourstotal work hours) ✖️ 100%

You can calculate utilization over any period — daily, weekly, monthly, quarterly, or annually. The longer the period, the more your utilization rate absorbs spikes such as illness, vacation and

What should I include in “Total work hours”?

This is a surprisingly nuanced question.

The simple answer is: If you have a 7.5 hour day, then you have a 37.5 hour week, and a 1950 hour year. Months vary from 150-172.5 hours (20-23 working days). These values are your “total work hours”.

The complex answer is: From the answer above, factor out vacations, holidays and personal days. You will get very accurate but hard-to-calculate short-term utilization rates.

In the complex scenario, a 1950 hour year minus 3 weeks vacation, 9 holidays and 6 personal days, leaves 1743.75 total work hours. You’ll need to do the same calculation for each quarter, month, week, and day. Some weeks will have 5 days, others 4, and some 0.

Without a tool to manage all the possible days off, I recommend using the simple approach. (Hint: Clockk will be launching such a tool in 2023). Utilization will skew downwards in the short term if there is a holiday. They will only have worked four of five days. On the other hand, you pay your salaried employees for holidays even though they don’t work. That arguably makes that day part of their utilization calculation.

Whether you choose “total work hours I’m paying you for” (1950) or “total work hours I actually expect you to work” (1743.75), be consistent.

What is a “billable hour”?

A billable hour is any time spent working on a client’s project. Or: a billable hour is any time spent in delivering value to your client.

There does not need to be a money exchange for work to be billable. You can have billable work that you are never paid for. This is not desirable, but it is realistic.

It is possible (although not usual) for some of your internal projects to be “billable”. This might be the case if your agency is spinning out a SaaS product. By treating the project as “billable”, you can assign it a dollar value. That lets you determine your investment in that project. This approach puts your SaaS product on an equal footing with your other client projects. Your staff is “utilized” because they are delivering value.

You would not consider your agency’s website, marketing, or sales efforts to be “billable”. These are “overhead” activities, along with HR, finance, etc., which are part of your cost of business.

With that in mind, here are some examples of things that should and should not treat as billable:

Billable Non-billable
Design, programming, copywriting, etc. for your client
Meetings with or about your client
Project & account managers’ time on the client project
Planning meetings
Monthly SEO review
Time spent on paid-by-retainer activities
Time spent delivering productized services
Updating your website
Social outreach
Preparing a pitch or proposal
Networking
Lunch
Employee reviews
Office socials
Tidying your desk
Emptying the dishwasher
Trialing a new time tracking tool
Sending invoices
Water cooler conversation

Your “resting state” utilization rate

“You must record 7 billable hours every day.”

A lot of agencies go wrong by setting a utilization target.

I get it. You’ve worked out your model, and if everyone bills 7 hours every day, your agency will make a lot of money, right? And 7 hours isn’t too much to ask — you’re paying your employees for 8! That’s a free paid hour every day to do whatever they want!

Wrong.

Setting a billable hour target is a recipe for long hours, stress, and burn-out.

Every worker has what I call a “resting state” utilization rate.

Think of your resting heart rate. At rest, your heart is still pumping. Everyone’s heart pumps at a different rate. Some slow, some fast. Except at the extremes, there’s no value judgment in that. Your resting heart rate is what it is.

Now imagine starting (or stopping) an exercise regimen. Over time, your resting heart rate will change as your heart adapts to its new circumstances. For quicker changes, the food you eat can also affect your resting heart rate (salt tends to spike mine).

Utilization is the same.

On day one in a new job, you don’t know what your utilization rate is. Over time, a picture emerges. It doesn’t matter what your utilization rate in your last position was, because your context is new. There are many contextual factors (see sidebar) that can affect your utilization rate.

Because context changes over time, your utilization rate will change as well. This is normal and expected.

Contextual factors that affect your utilization rate

Every workplace and every job is different. Here is a partial list of all the things that can affect your utilization rate, for better or for worse:

Your seniority. Junior employees have fewer responsibilities and can apply more time to billable work. Senior employees are more likely to be called into client meetings, interviews, pitches.

Your helpfulness. If you’re a helpful person, people will ask you for help. Every time they do, you’re taken away from your billable work.

Your interest. Some projects are more interesting than others. Some resonate with you and others don’t.

Your workspace. Do you thrive in an open setting with hustle and bustle? Would you rather have a private office? Are you more efficient at home? Are you energized by having people around?

Your administrative burdens. A CEO has so many administrative responsibilities that doing billable work is a challenge.

Your cleanliness disposition. Do you wash the dishes because you hate a messy kitchen? Do you keep a neat desk? Do you pull out the vacuum cleaner every week?

Your distractions. Are you on social? Personally, for your business, or for brands you manage? Do you receive a lot of email?

Your workload. Are you working on 1 project every day? 2? 5? 12? Context switching can be expensive for one, but can be intoxicating for another.

Your mental or physical health and/or personal stress. Are you going through a divorce? Young children? Ailing parent?

Some of these factors are static: your workspace doesn’t change day to day. Others are dynamic: your interest in a particular project, your children, your health. As such, your utilization rate fluctuates over time.

How manipulating your utilization is the difference between breaking even and a huge profit margin

WARNING: Lots of math ahead!

Let’s consider an example agency, “Top Rung Marketing”. Rowena Sheppard, the CEO, has 23 employees, including herself:

# Role Overhead Avg. salary (incl. bonus) Total
1 CEO TRUE $150,000.00 $150,000.00
1 Controller TRUE $163,000.00 $163,000.00
1 Office manager TRUE $63,000.00 $63,000.00
3 Sales TRUE $106,500.00 $319,500.00
3 Project managers FALSE $82,525.00 $247,575.00
2 Account managers FALSE $89,950.00 $179,900.00
3 Programmers FALSE $101,230.00 $303,690.00
4 Designers FALSE $72,540.00 $290,160.00
3 Copywriters FALSE $69,527.00 $208,581.00
1 SEO FALSE $76,500.00 $76,500.00
1 Video/photo/editor FALSE $82,410.00 $82,410.00
Total salaries $2,084,316.00
Total overhead $695,500.00
Total billable $1,388,816.00
Fully loaded multiplier1.32
Total salaries $2,751,297.12
Total overhead $918,060.00
Total billable $1,833,237.12

The “Fully loaded multiplier” of 1.32 adjusts each person’s salary to their fully loaded cost. This amount accounts for the office space they occupy, their “share” of marketing expenses, their desk, computer, software, training, conference & travel costs, etc. This particular multiplier doesn’t include salary overhead (CEO, Sales, Office Manager), as I’ve chosen to show them explicitly instead.

Let’s assume that Top Rung Marketing’s target bill rate is $150/hr. Top Rung uses this rate when preparing fixed-bid proposals, budgeting retainer projects, and for by-the-hour engagement.

Top Rung is also very diligent at time tracking. They have an average utilization rate of 63.3% across their billable employees (4.75 hours of a 7.5 hour day).

Aside: don’t sneer at 63.3%. Take a close look at your own organization. Are you sure you’re better than that? Do you have the timesheets to prove it? Do your timesheets * billable rate line up with observed reality vis-a-vis your billings?

Now let’s look at Top Rung’s total billing capacity. Assuming 3 weeks of vacation, 10 statutory holidays and 5 personal/sick days (6 weeks total), each individual can bill a maximum of 1725 hours per year.

(52 weeks - 6 weeks vacation/holidays/personal) ✖️ 5 days/wk ✖️ 7.5 hours/day = 1725 hours/yr

If Top Rung’s time tracking and utilization rate are correct, then the total revenue should be $2.8 million:

1725 hours ✖️ 17 workers ✖️ $150/hr ✖️ 63% 🟰 $2,785,875.00
Gross profit: $2,785,875.00$2,751,297.12 🟰 $34,577.88
Gross margin: $34,577.88$2,785,875.00 🟰 1.2%

1.2% is not good.

Now let’s see what happens when Rowena’s team adds 15 billable minutes per employee-day (66.7% utilization):

1725 hours ✖️ 17 workers ✖️ $150/hr ✖️ 66.7% 🟰 $2,932,500.00
Gross profit: $2,932,500.00$2,751,297.12 🟰 $181,202.88
Gross margin: $181,202.88$2,932,500.00 🟰 6.2%

Rowena’s costs are completely unchanged, but her gross profit and gross margin increased by 400%. Her absolute profit increased by a whopping $146,625. For only 15 billable minutes per employee-day!

Let’s do it again, with another 15 minutes/day, for a total of 30 minutes/day (70.0% utilization):

1725 hours ✖️ 17 workers ✖️ $150/hr ✖️ 70.0% 🟰 $3,079,125.00
Gross profit: $3,079,125.00$2,751,297.12 🟰 $327,827.88
Gross margin: $327,827.88$3,079,125.00 🟰 10.6%

Once again, Rowena’s costs have not changed. Her gross margin and gross profit have increased by another 75%. Her absolute profit has increased by another $146,625.

As shown in the chart below, 1 billable hour per employee-day yields almost $600,000 in new profit. Adding 1 billable hour per employee-day can be hard to do, but it has immense rewards.

Changing utilization rates on the same cost

Billable/day 4.75 5 5.25 5.5 5.75
Total/day 7.5 7.5 7.5 7.5 7.5
Utilization rate 63.3% 66.7% 70.0% 73.3% 76.7%
Capacity hours 1725 1725 1725 1725 1725
Billable workers 17 17 17 17 17
Hourly rate 150 150 150 150 150
Total cost $2,751,297.12 $2,751,297.12 $2,751,297.12 $2,751,297.12 $2,751,297.12
Revenue $2,785,875.00 $2,932,500.00 $3,079,125.00 $3,225,750.00 $3,372,375.00
Gross profit $34,577.88 $181,202.88 $327,827.88 $474,452.88 $621,077.88
Gross margin 1.2% 6.2% 10.6% 14.7% 18.4%
% increase in gross profit 424.0% 80.9% 44.7% 30.9%
% increase in gross margin 397.8% 72.3% 38.1% 25.2%
Total increase in profit $146,625.00 $146,625.00 $146,625.00 $146,625.00

But I don’t bill by the hour; I bill by project/value.

It doesn’t matter.

In professional services, no matter how you package it — projects, retainers, or productized services — you are always selling time.

“Value” has two sides to it. There’s the value the client receives, which is subjective. The client may be willing to spend more because of their return on investment. On the other hand, there’s the value you deliver, which is objective. You can only deliver so much value per time-unit, adjusting for employee skill and experience.

Think back to the maximum capacity calculation above. Each of Top Rung Marketing’s employees cannot deliver more than 1725 value-hours per year without working overtime. An example employee’s 65% utilization rate would have 1121.25 value-hours available (4.9 billable hours/day).

Let’s assume you have a project where you charged $15,000 and it only took our example employee 58 hours. That project has a whopping $259/hr bill rate. That’s great, but the dollar value is irrelevant. What matters is the time-value captured.

Let me explain.

The project took 58 hours (just under 8 billable days @ 7.5 hr/day). Assuming the employee worked ONLY on this one project, at a 65% utilization rate, it took them 89 calendar hours (almost 12 billable days @ 7.5) to complete the work.

If you could have optimized the employee’s day so their utilization climbs to 75% (5.6 billable hours/day — about 45 minutes more) then the work could have been completed in 77 hours (just over 10 days). There are 12 hours (1.5 days) of value that could have been delivered to another client.

You can “create” more time units by optimizing each worker’s day to maximize their utilization. You can sell these new hours and make more money. Reproduce the $259/hr bill rate and your agency has made an additional 12 hours ✖️ $259/hr 🟰 $3108 in top-line revenue and gross profit.

What about freelancers and subcontractors?

Freelancers and subcontractors always work at 100% utilization. Any overhead they have is internal to them. Efficiencies they find do not change their cost or the objective value they deliver to you. You cannot optimize their time, as that is their responsibility.

If a freelancer is sensitive to your utilization adjustments, they may in fact be “employees” not on payroll.

Do’s

Utilization is not a hammer to bludgeon employees. Instead, treat it like a precision toolset. Employees shouldn’t feel like they’re under attack and required to work harder. Instead, they should feel that management is paying closer attention to their needs. If you’re doing everything right, employees should become happier and more productive. Employee-friendly strategies for improving your staff’s utilization include:

Improve your time tracking

You can’t optimize utilization without accurate time tracking. In many agencies, simply by improving the quality of time tracking, you can easily “find” 30 minutes per day. This is value you were giving away to your clients for free. Below are several ways you can adjust or re-think time tracking in your organization to find this extra utilization.

Employees, even well-meaning ones, struggle to submit accurate timesheets. We discuss those issues throughout this blog. To summarize, here are some frequent issues that affect timesheet quality:

Time tracking isn’t a cultural value in the organization. In some organizations, management embodies in the importance of accurate time tracking. In other organizations, time tracking is top of mind for a few weeks now and then, then forgotten.

Forgetting to start/stop their timer. When juggling 3 or more projects in a day, it becomes almost impossible to reliably start and stop a timer.

Parking hours. Employees who can’t remember what they did may “park” their time in a big client who can presumably absorb the cost.

Conservative hours. Rather than parking time, some employees err on the conservative side. If they can’t honestly assign the time, then they don’t assign any at all.

Working on their own time. Especially for a client they like, employees might work “on their own time” (i.e. after hours). Since it’s their own time, they don’t need to track it, right? (Wrong! It’s value delivered that the employee should be recognized/compensated for.)

Salaries don’t correspond to billable hours. The employee doesn’t have an incentive to track time since their compensation doesn’t change.

Forgetting what they did. Unless they complete their timesheets as they work (i.e. throughout the day), they will forget what they worked on and for how long.

Making time tracking part of your organizational culture is the most important step. Communicate clear standards around what you consider billable time. Establish expectations around how your staff should track and report their time. Emphasize the importance of timesheets completed daily for accuracy. Make clear how conservative you want their billing to be (e.g. don’t bill any time you’re uncertain of vs. assign as many hours as you can get away with). Be clear about what level of detail you want (if any) in the description. Put in place a review system that confirms that your standards are being followed. Institute rewards (or penalties) for (non-)compliance and enforce them consistently.

Increasing your utilization rate by “finding” time with better time tracking isn’t cheating. This value was previously unaccounted-for. The extra time “found” lets you bill more hours (under hourly billing), have conversations with clients about increasing a project size, starting maintenance projects, etc.

With consistent timesheets, you’ll confidently pull reports with data you can reason about, and you’ll be able to calculate and manipulate utilization.

Find ways to help people stay in the flow

Different workers thrive in different scenarios. Your challenge as a manager is to determine which strategy will help which employee.

Work from home days. Some workers can have more efficient and productive days at home.

Quiet hours. Set a period or two during each day where you don’t allow any meetings or verbal conversations. You may choose whether to allow instant messages. IMs don’t break flow in the same way as talking does.

Private offices. Some thrive in open spaces, where others need to retreat to a private space. Frequently interrupted workers could enjoy a private office. A closed door means “go away” and an open door means “I’m available”.

High quality, comfortable headphones. Just like a closed door is a signal, wearing headphones is another way to say “I’m working, please don’t interrupt me.” I’ve heard of people who wear headphones without music just so no one would bother them.

Seating facing a wall, rather than inwards. A wall has fewer visual distractions than the hustle and bustle of an open plan office space.

Use some of that new revenue to fund efficiencies

By adding just 15 billable minutes per day, our example Top Rung Marketing was able to add $146,625/yr in new revenue. That’s $564/day. With similar success, you could use a portion of your new revenue to fund efficiencies.

Buy lunch. $564 is more than enough to cater an amazing lunch every day. This will encourage your staff to stay in the office and keep lunch short.

Get a cleaner. Hire someone to keep the office & everyone’s desk clean. Dirty dishes magically disappear every night.

Get more space. Although they present well, large open office spaces discourage focused work. You could expand into a larger space with more small and medium-sized offices. Certain employees could get dedicated offices (with doors that close). Others could sit in smaller groups with fewer distractions.

Don’ts

Incentives

Do not create incentives for increasing billable hours.

A challenge of time tracking is that employee compensation is not connected to billable hours.

Unfortunately, you create opportunities for abuse if you tie compensation to billable hours.

Instead, offer perks and rewards for:

  • Regularly completed timesheets.
  • Timesheets that meet company standards.
  • Creative ideas/solutions
  • Helping their teammates succeed.
  • Happy clients.
  • Contributing positively to workplace culture.

Competitions between employees should be infrequent and when they happen, friendly.

Set a utilization target

Do not set a utilization target. We discuss this above.

As with incentives, a utilization target has more negative side effects than positive:

Employees risk burnout because they need to work overtime to meet their utilization target. Employees will exaggerate billable time in their timesheets.

A utilization target will get you timesheets that reflect the target, but billings that don’t. The billable hours will match up, but the time-value delivered to the client won’t.

Conclusion

Optimizing your employees’ utilization rates is an easy way to increasing your billings and your margin. Unaccounted-for time is value given away for free.

To capture and adjust utilization rates, you need to track time. Tracking time is hard, and employees hate it.

Clockk is an AI-powered time tracking tool that pre-fills your timesheets based on the apps you use every day. It’s unique visualization shows you how much time you spent on each project. Clockk captures the 10 or 15 minutes that you would have forgotten. Sign up for free today.

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