How Utilization Rate Affects Your Profitability (& How to Increase It)

Utilization rate is one of the most important metrics for any agency. In this guide, we’ll look at the agency utilization rate in-depth and share some tactics to increase it.

In a business that predominantly bills by the hour, there are few metrics more important than utilization rate.

Your utilization rate tells you how much of your employees’ available time is spent on billable work. If this rate is too high, you likely need to add more resources. Too low and it means that you’re not bringing in enough work.

As I mentioned in an earlier article, this is one of the key metrics you need to track to zoom in on your agency’s true profitability.

In this guide, I’ll do a deep dive into utilization rate. I’ll show you how it affects your operational efficiency, how to track it, and share some tactics to increase it.

 

Understand Utilization Rates

Time is the limiting factor for every service business. No matter how efficient you are, you only have 24 hours in a day.

Minus sick leaves, vacation time, and public holidays, most agencies get between 1600 to 1800 working hours each year.

Not all of these hours are actually billable. You’ll want to set aside time for training, pro bono work, agency business development, team building activities, etc. Together, these make up your agency’s “non-billable hours”.

The rest of the time would be your billable hours. Together, they make up your total available hours.

Utilization rate is essentially a measure of how much of this available time is actually used in productive work, expressed as a percentage.

Thus, if an employee works 1500 hours out of 1800 available hours, he would have a utilization rate of 83.34%.

A closely related metric is the realization rate. This metric measures the total billed hours worked out of all available billable hours for a resource.

In the above case, if the agency set aside 200 hours for training and non-billable work, the total billable hours would be 1600.

Thus, an employee working 1500 hours would have a realization rate of 93.75% (as opposed to a utilization rate of 83.34%).

You can calculate utilization/realization rates for each resource on a weekly, monthly, and yearly basis. You can also calculate the utilization rate for all billable staff with this formula:

If three resources have a utilization rate of 66%, 86%, and 80%, the agency’s utilization rate is 77.34%.

There’s yet another metric you should know: chargeable utilization.

This is a measure of the percentage of billable hours that are actually chargeable to a client. It’s a rare client where you can get paid for 100% of the billed work. Some hours will have to be scrubbed, some work will be redone, eating into your billed hours.

Chargeable utilization tells you what percentage of your total billed hours results in revenue.

Although it is crucial for tracking an agency’s profitability, chargeable utilization is difficult to use since it is time-delayed (you can’t tell in an ongoing project whether there will be revisions later). Nevertheless, you should track this metric on a quarterly basis to get an estimate of your charge ability vs billing hours.

Workamajig’s Chargeability Report, for instance, shows you chargeable and non-chargeable hours as a percentage of your total hours. You also get to see how you performed vs your original plan.

 Workamajig's Chargeability summary shows you chargeable and non-chargeable hours for each resource and role

What the Utilization Rate Tells You

For a simple metric, the utilization rate gives you a great deal of insight into your agency’s profitability and productivity, such as:

1. A large gap between utilization and realization rates means that your resources are spending too much time on non-billable tasks.
2. A consistently high utilization rate means that your resources are overworked.
3. A low utilization rate means that you need to bring in more work.
4. Tracking utilization for each skill and employee-type (lead designer, senior developer, etc.) helps you plan your hiring.
5. Tracking utilization rate by skill shows you demand for different services.
6. A utilization rate above 100% can imply a lot of out-of-scope work and poor planning.
7. Tying utilization rate to profits can show you the most profiting services for your agency.
8. Tracking realization rate by client shows you which of your clients are profitable and which ones lead to out-of-scope work (i.e. lead to over-utilization/realization).

But perhaps the most important aspect of utilization rate is on your agency’s profitability and how you calculate your billing rates, as we’ll see below.

How Utilization Rate Affects Your Agency’s Operations

From the outset, it’s easy to see how utilization rate affects your agency’s profitability. If you’re not fully utilizing your resources, you’re leaving profits on the table.

Dig deeper, however, and you’ll realize that utilization rate affects nearly every aspect of your agency’s operations.

Consider how your salespeople sell your services. Without utilization data, they won't pursue every lead, regardless of the kind of work it creates.

But when you arm them with utilization rates, your salespeople can pursue leads that result in work that is:

• Profitable
• Within scope
• Focused on your agency’s specialization

This will help you land better clients and run a more focused sales team.

Let’s look at some ways utilization affects how your agency works:

1. Understand billing rates better

One question every agency owner asks is “how much should I charge for my services?”

The standard approach to calculate your billing rates is to add overhead costs, resource salary, and profit margin, then divide it by total available hours.

Thus, if overhead costs per employee are $10,000/year, and each resource costs $100,000, you would need to make $132,000/resource/year to make a 20% profit margin.

At 1800 available hours, this translates to an hourly rate of $73.34/hour/resource.

While this approach gives you a ballpark figure, it completely ignores the reality of running an agency. Your resources will seldom, if ever, have 100% utilization. There will be fallow periods where you’ll struggle to get work. And there will be feast periods where you’ll even have to hire freelancers to meet higher demand.

Incorporating the utilization rate into the billing rate gives a more accurate estimate of your profitability.

Use this formula to calculate your pre-profit billing rate:

Add a profit margin to this rate to hit your financial targets.

A much better approach is to calculate your billing rate targets for each month, quarter, and year. Then use these figures to establish a baseline utilization rate for each period.

For example, if your target billing rate for the year is $100/hour, and each resource costs $126,000 in overheads + salary, you need them to operate at 70% utilization to hit your targets.

Use this formula to calculate your target utilization rate:

This would be your benchmark; any deviation means you need to ramp up utilization.

2. Map skill demand

How do you decide what skills/services your agency should specialize in?

One way of answering this question is to look at utilization rates for different skills over the years. This can tell you:

• Which skills to develop (and which to ignore)
• Which skills to hire for
• Seasonal demand for different skills

For instance, you might see that your SEO resources have a 50% higher utilization rate than your social media marketers. Thus, you can focus your efforts on developing and marketing your SEO expertise since that’s more in-demand.

At the same time, you might find that social media utilization increases around the Holiday season. By tracking utilization rates, you can hire freelance social media marketers in advance to meet this higher demand.

You can take this further by tracking the billable vs non-billable time spent per skill. If you’re spending too much time on non-billable work for a skill, it likely means that clients are back with unpaid revision/rework requests. This indicates poor proficiency at that particular skill and a need for retraining.

3. Develop talent

Utilization rates also help in spotting talent development issues.

You want your senior resources to work on your highest value projects. You also want them to spend more time on business development and coaching/mentoring junior resources.

If your utilization rates indicate that your junior resources are underutilized while senior resources are spending too much time on low-value clients, you have a talent development issue at hand. Junior resources aren’t learning enough and seniors don’t have enough time for more high-value development/mentoring work.

Thus, it helps to track utilization rates not only by skill but also resource seniority. This can also help you spot junior resources that need additional training (i.e. they spend too much time on non-billable work due to constant revision requests).

How to Increase Utilization Rate

As you can see, the utilization rate impacts every facet of your agency’s operations. Tracking it will give you deep insight into how your agency works and where it can improve.

Do keep in mind that there is a limit to how much billable work you can extract from creative workers. 100% utilization is neither feasible nor desirable.

“In any services firm, you typically cannot get better than 75%-80% utilization of an hourly worker. -- i.e. in an eight hour day, most employees will not do better than six hours of client-facing work”, says Arjun Moorthy of HubSpot.

Nonetheless, increasing utilization rate can result in substantial financial benefits. For a 100 person company, improving utilization from 70% to 75% can add $900,000 in additional revenue (at $100/hour rate).

So here are some ways to raise your utilization rate:

1. Use better time-tracking software

You can’t really map utilization rate without tracking how your resources use their time. This is obviously neither enjoyable nor convenient, but consider it a cost of doing business.

One way to make time-tracking easier is to incorporate into your workflow. Resources are often reluctant to track their time if they have to open another software to do it. If you can make it a part of the platform they already use, you’ll see much higher compliance and more accurate data.

“Time tracking is functionally easy, but is often seen as a chore by creatives. This is particularly true if they have to break their workflow to track time”, says David Coen of Pikwizard.

Workamajig, for example, has a time-tracking feature built into its project management dashboard. Since employees don’t have to open another software, they are more likely to record their time.

 Workamajig's time tracking tool is built into the employee dashboard

2. Use better reporting

Tracking utilization rates in isolation doesn’t help you much. You need to connect it to other key metrics - profitability, realized rate, etc. This will help you place utilization rate in the context of your agency’s operations.

For example, the ‘Time Productivity Analysis’ in Workamajig shows the utilization and realization rates for each resource. It also connects this rate to their cost and revenue generated.

This gives you a much better idea of which of your resources are profitable, which are not, and what can you do to raise their utilization.

3. Establish utilization rate benchmarks (and share them with resources)

Utilization rate consistently ranks among the top 5 metrics tracked by agencies.

 Image source: SoDa Report on Slideshare

Despite its widespread adoption, agencies seldom have a baseline utilization rate. They usually depend on industry benchmarks which can be inaccurate and ignore the contextual realities of your agency.

This creates a situation where neither managers nor employees know whether their utilization rate is “good enough”.

One way to establish a baseline is to work backward from your target billing rate. Use the formula I shared earlier to calculate your benchmark rate.

Share this target with your employees. This will help them understand where they stand and motivate them to meet the benchmark figure.

4. Track utilization rates across the entire agency

Utilization rate works best when it’s tracked across the entire agency and not just a particular department or office.

Two reasons why:

• It can reveal insight into regional client preferences and managerial practices for different offices/departments.
• It can help you borrow expertise from other offices or departments in case of temporary over-utilization.

Essentially, this allows you to “share” utilization across the entire agency. If a junior designer at one office is temporarily over-utilized, you can borrow expertise from an under-utilized designer at another office.

This is preferable to hiring freelancers since it doesn’t add to your costs. Plus, an in-house resource would already be familiar with your work practices.

 Workamajig’s Staff Schedule shows you available and utilized hours for each resource and role.

5. Minimize ‘valueless’ bench time

In agency terms, “bench time” is non-billable time, i.e. time you can’t bill clients for. This can be attributed to three points of failure:

• Sales: There isn’t enough work for your existing skills
• Skills: Your existing skills aren’t sufficient to meet market demands
• Management: Your project managers couldn’t delegate work effectively

Bench-time is unavoidable in any agency, but you can minimize its impact. Better project management practices, for instance, can ensure that your resources are optimally distributed.

Similarly, if your resources are on the bench because of inadequate skills, use this time to retrain them. This ensures that your bench time isn’t wasted. Rather, you can utilize these resources later at even better rates.

Over to You

Utilization rate is usually one of the top KPIs for any agency, and rightfully so. Tracking the productivity of your resources gives you a great deal of insight into your agency’s operations. From hiring to sales, it can help you to understand every facet of your agency better.

How do you track utilization rate in your agency? Share with us in the comments below!