Creating more value for your employer than it costs to keep you is just the beginning. That is more of a “break even” way to think about your job. Instead, think about how your net value to the company is the difference between the money they can make off of you and your cost to them. The higher the profit margin on you, the more valuable you are to the organization.
Let’s say you make shoes that your company can sell for $100 each. Let’s also say your cost to the company (your salary) is $200/day. So, you need to make at least 2 pairs a day to cover your salary cost. However, the company is going to have additional costs above your salary cost, such as rent, machinery, tools, any raw materials that go into the shoes, health insurance, property insurance, etc. So, you may need to make at least 5 pairs a day for the company to break even on you. For the company to actually make a profit on you, you need to make a minimum of 6 pairs a day. That’s your target to stay employed.
But what if the company employs other shoemakers who turn out 10 or 12 pairs a day with the same (or better) quality as your shoes? How long will they keep you employed making 6 pairs a day if the average production is 10 per day? The answer: only until they can find someone who can make more shoes than you—unless you offer some compelling other ways that you can add value.
These concepts can be applied to high intellectual-capital jobs, like consulting or law. Let’s re-visit Corinne from Lesson 53, the new consultant, getting paid $180,000. As we saw, she needs to bill more than her salary amount—at least $900,000 per year on average—to keep herself employed. The reason is that most large international consulting firms today employ a cost-based pricing “rule of 5” to determine what a consultant must earn to stay viable for the firm. They take the revenue that she is expected to generate and divide it by 5, allocating it accordingly:
1/5 = consultant’s salary;
1/5 = consultant’s overhead;
1/5 = firm overhead;
1/5 = management salaries (or partner profit in firms that don’t include this item); and
1/5 = partner profit
As we can see, the owners of the firm understand that Corinne’s “cost” is significantly more than her salary of $180,000. She has considerable overhead in the form of benefits, training, etc. She also uses resources of the firm, such as administrative help, equipment, stationery, and the firm’s cafeteria, which are included as firm overhead. She will be managed by levels of bosses with the firm whose salaries must be paid. Finally, the partners hope to make some profit off of Corinne, which they will split among themselves. As we have discussed in prior lessons (more from a manager’s or executive’s perspective), if there is no profit, then why keep her employed? Why not just invest her salary in the stock market and make some money that way?
The point is that Corinne needs to understand the difference between labor costs and the full costs to the owners of the organization. In other words, more goes into a successful business than just the cost of labor. This “more” might not be transparent but can be quite expensive, and thus employees should take it upon themselves to understand all that that “more” entails.
Thus, Corinne needs to recognize that with a salary of $180,000, she needs to bill $900,000 each year to earn her keep at the firm. If she bills and collects for 2,000 work hours each year (i.e., 50 weeks x 40 hours/week), she will need to charge $450/hour or $3,600 per day to make it worth the firm’s investment in her. The partners are getting a 20% return on her (or $180,000), which the partners will split among themselves.
However, our consultant cannot rest easy until she compares herself to the other consultants, especially the high performers. If the top consultants bill and collect for 3,000 hours each year at $450/hour, they are bringing in $1,350,000 to the firm. Since four of the five items (totaling $720,000) on the “rule of 5” list shown above should stay the same for all consultants, the top performers now add $630,000 to partner profits. (In other words, 4 of the 5 items equal $180,000, but the fifth item, partner profits, equals the original $180,000 plus the additional $450,000 from the 1,000 extra hours billed at $450 per hour.) This is a 350% return on their investment in her salary and a conservative 87.5% return on a star performer’s total cost of $720,000.
Should a downturn occur, who do you think Corinne’s bosses will get let go first?
You may be thinking that it’s not all just about Corinne’s billable hours. Indeed, there are lots of ways Corinne can bring value to the firm outside of increasing her hours. What if Corinne’s customers are more satisfied and, consequently, become repeat customers who bring additional business to the firm? She is now creating billable hours (and partner profits) for other consultants. She is now covering her costs and the costs of other consultants. And what if she has unique skills that attract new and different customers to the firm specifically because she works there? What if, because of her specific skills, she is able to shift from the firm’s cost-based pricing model to a demand-based pricing model where clients pay her higher fees because they specifically need her? Let’s say she is able to move from $450/hour to charge $675/hour, i.e., $5,400/day. She would now bring in $1,350,000 each year by only working 2,000 hours compared to her counterparts who may bring in the same amount but must work 3,000 to do so.
Now, who would you let go in a downturn?
To put it another way: which of two similarly paid consultants would you pay more—the consultant working 3,000 hours or the one who has many tools in her pocket to increase the firm’s profits?
When you start thinking this way, you are starting to understand “value-added.”
Critical Path Action Items
What is your “break even” point to cover your cost?
How much excess value, i.e. profit, must you produce to keep your job?
How much excess value do your co-workers produce? How do you compare to them?
What other value producing tools or assets do you have that will allow you to produce more excess value than your co-workers?