Overpaid Staff Aren't Necessarily Overpaid
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That’s a very confusing statement on the surface, so let me explain. The global economy is sending mixed signals these days and so salary load is top of mind for principals. Let me walk you through the decision matrix so that you can make a smart business decision about that. (Please forward this to your controller if you need help following this.)
First, figure out your salary allowance. Look at your fee basis for last year. Look at total revenue ($4M in our example firm) and subtract cost of goods sold ($1M) These COGS capture outside expenses like media and freelancers but not employees on salary–put employee salaries in here and you’ll get it wrong. That leaves us with $3M in agency gross income, gross profit, or fee revenue, which all refer to basically the same thing. You can afford to spend 45% of that on unburdened compensation, including your own. So add up what people make ($36K + $78k + $128k, etc.) and see where you stand. Our example firm can afford to spend 45% of $3M, or $1,350k. It turns out that they are spending $1,620k. It appears that folks are overpaid, but not so quick.
Second, normalize the allowance. There’s a calculation here that you cannot skip, and that’s to calculate utilization, or the extent to which this firm is good at turning time into money. This example firm has 19 people, has 46.5 work weeks per year, on average has employees working (not billing) 42 hours per week, and uses $160/hour to put proposals together. You can input those numbers over on our benchmarking calculator, but here’s what it shows: this firm has a potential fee base of $3,600k, which means that they are leaving $600k on the table, with a utilization rate of 50% instead of 60%. Individuals bill from none to 85% of their time, but the group should average out at 60%. This firm isn’t, and that gap represents $2,300 every work day. So now to the normalization part: a firm can spend 45% of their fee base on unburdened compemsation, but if this firm closed their utilization gap, moving from 50% to 60%, they’d have a revised fee base of $600k more, and they could spend 45% of that on compensation. In that case, their allowance would move from $1,350k to $1,620k.
Third, interpret this data. At first blush, it seems like our people are overpaid. But when we dive into the numbers, it’s more likely that the allowance is too low. Fix the utilization issue and the allowance will rise to cover the compensation. Your people might be overpaid, but it’s more likely that you have a utilization problem.
You can get away with that from a combination of three other things:
- Pay yourself less.
- Save money somewhere else, like on your rent or benefits.
- Live with less than 15–20% net profit.
Most firms are not overpaying employees, but most firms are under-performing, which makes it look like they are.
Again, if you're eyes are glazing over, don't set this aside and move on! Forward the email to your controller and let them run this calculation.
