2 Excel Templates
1) Gross Profit Sensitivity on Billing Rate Increase
This topic is also addressed narratively in the last section of my newsletter: Gross Profit Sensitivity on Billing Rate – Price Increase.
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2) Weighted Average Cost of Capital Model
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Here are 2 Infographics for Today:
1) Goodwill Fact Sheet
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2) Financial Statement Analysis
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Here’s today’s “How to” guide:
How to optimize gross profit and capacity with a billing rate (price) increase
I faced a significant challenge with excessive capacity utilization, both for myself and my clients. At the same time, demand for services increased.
These circumstances led me to consider an idea that could result in a win-win situation.
Here’s how.
Specifically, I came up with the idea to examine how a price increase—which de facto reduces demand and, consequently, the need for labor—would impact gross profit.
Since the conversion rate of submitted fee proposals is a crucial variable in this analysis, I included it as an assumption.
To begin, I needed a database of submitted proposals, including the value of the proposal, whether we won the project or not, and if not, the reason for losing it.
The conversion rate is 55%.
Of the remaining 45%, only 30% of lost projects were due to higher pricing.
The other 70% were lost for reasons such as poorly communicated value propositions on our part, the client abandoning their search for a service provider, weaker elements in other parts of the proposal, and so on.
Therefore, the first conclusion is that price did not play a significant role in the conversion rate.
This insight led me to investigate whether a price increase could lead to higher gross profit. I conducted a simulation to test this hypothesis.
Here’s what this example shows If we increase the billing rate from $100 to $115, the conversion rate drops because, due to the higher price, some prospects will not accept the offer.
However, if the conversion rate drops from 55% to 48%, the gross profit would increase from $619k to $626k. The gain is not substantial, but it is still a gain. Let’s see what happens next.
The gross margin increases from 45% to 52%, improving efficiency. We need 10 executors instead of 14, and we need 10k billable hours instead of 14k billable hours.
