The Anatomy of a Consulting Firm 03 - Leverage and Profitability

By David Maister

A consulting firm’s leverage is also central to its economics. The rewards of partnership or ownership (the high levels of compensation attained by vice presidents or senior partners) come only in part from the high hourly (or daily) rates that the top professionals can charge for their own time. A significant portion of profits derives from the surplus generated from hiring staff at a given salary and billing them out at multiples of that salary. By leveraging its high-cost seniors with low-cost juniors, the professional firm can lower its effective hourly rate and thus reduce its cost to clients while simultaneously generating additional profit for the partners.

The market for the firm’s services will determine the fees it can command for a given project; its costs will be determined by the firm’s ability to deliver the service with a cost-effective mix of junior, manager and senior time. If the firm can find a way to deliver its services at the same quality with a higher proportion of juniors to seniors, it will be able to achieve lower service-delivery costs. (Note that this is true whether the firm bills by the hour or on a fixed-fee basis.) The project team structure of the firm is therefore an important component of firm profitability.