A Critical Metric for Building Business Value
Although Merger & Acquisition (M&A) activity in the recruitment industry has slowed down noticeably in the last couple of years, consolidation, growth by acquisition and realisation of asset value strategies are still often foremost in the mind of the business owner. According to the June 2003 Harvard Business Review, however, three out of four such transactions fail to achieve their objectives and more often than not dilute shareholder value and therefore place the utmost imperative on thorough due diligence.
One of the key reasons for these failures is the pursuit of revenue at the expense of profitability. Particularly evident in companies whose revenue strategies are based around contingency recruitment, this drive for revenue has been the catalyst of new business development and marketing efforts that consume a disproportionate number of head hours. Consultants often dedicate upwards of 50% of their working hours towards chasing and servicing new clients, with the remainder spent on existing clients, despite the truism of the 80/20 Rule (80% of your revenue will come from 20% of your clients, and vice versa).
Whilst this imbalance is not inappropriate for growing businesses, owners looking for their next acquisition or their own exit need to understand its effect on actual business value.
The Harvard Business Review suggests that profit-per-customer is a critical metric in determining business value and contingency recruitment firms will find this most appropriate. The premise is that the top 20% of clients (those that provide 80% of the revenue) are the most valuable - obviously - and provide the company's profit (the article actually segments customers into quartiles, but we'll use the 80/20 rule for simplicity). The middle 60% tend to break even or provide some profit, whilst the bottom 20% actually erode the company’s profitability, directly impacting the value of the business.
Take a consultant running a permanent desk billing $20,000 per month. Using the 80/20 rule, $16,000 of this revenue will come from their top 20% clients, $3,000 from the middle 60% and $1,000 from the bottom 20%. Assuming costs of having the consultant on board are around $8,000 per month (roughly twice their base salary) and 50% of their time is spent on the less valuable clients, we can see how focusing on the bottom 20% adversely affects the business' profitability:
| Client Segment | Revenue | Costs | Profitability |
|---|---|---|---|
| TOTAL | $20,000 | $8,000 | 150% |
| Top 20% | $16,000 | $4,000 | 300% |
| Middle 60% | $3,000 | $2,000 | 50% |
| Bottom 20% | $1,000 | $2,000 | -100% |
Whilst these figures are simplistic, they illustrate an important point. For the business owner looking to exit the business at its maximum value, it is critical that a profit-per-customer analysis is conducted to identify those client relationships detrimental to the company's profitability. The same can be recommended for a potential acquirer, as they are essentially buying client relationships when they acquire a recruitment business. This is fundamental data for the acquisition strategy and the due diligence process and will allow the acquirer to determine exactly what is being purchased and the true value of the target.
Is the pursuit of new business killing your company's profitability? Find out quickly and stop the bleeding by analysing the value of client relationships using the profit-per-customer metric. If M&A is on the horizon, you need to maximise your profitability by ensuring that your consultant’s energies are focused on the most effective activities.
