Timesheet Trap: Strangling Service Companies Growth

Every service founder is stuck in the same dilemma — they know their employees hate filling timesheets, which often leads to inaccuracies and delays. At the same time, they continue to rely on timesheets to bill their customers instead of adopting value-based pricing.

In the modern AI-driven era, tech service firms aiming to cultivate value-centric culture should reconsider traditional time-tracking practices. Rigid time tracking can suffocate creativity and innovation by failing to incentivize the team to deliver truly transformative solutions.

Let’s delve into how they’re actually holding back on the growth of services firms

The History of Timesheets

The billable hour model became widely adopted in the legal industry in the mid-20th century. Before this, lawyers typically charged clients using a variety of methods, including fixed fees or contingency fees depending on the case outcome. However, the popularity of the billable hour model surged in subsequent decades, influenced by management consultants advising law and accounting firms to boost efficiency and profits.

The industrial revolution marked significant technological advancements and made time tracking crucial, as productivity was measured by hours worked in labor-intensive tasks. As the work was mechanical, the only way to grow was to do more of it. In the 1980s, the technology services industry also adopted timesheets to track billable hours, a fitting solution at the time.

However, as the technology has evolved, the limitations of this antiquated practice have become increasingly apparent, hindering growth and stifling innovation.

Why Do Companies Still Use Timesheets?

Charging customers by the hour means the longer you work, the more you can charge. This method suits professionals like lawyers and accountants who primarily sell their time. However, technology services firms, which produce designs or other tangible results, could choose to charge based on the value of their work instead of the time spent. In reality, by using timesheets, they often undersell their value and lose potential revenue.

Unfortunately, switching to alternate billing models such as fixed fee or outcome-based is not straightforward, even for IT and consulting firms. It is challenging to determine the value or estimate the work needed, in advance due to many complexities. It also becomes critical to avoid scope creep. So, we often take the easy path to commoditize our work by equating it to time as it’s simpler to measure and bill. It also seems fairer for clients.

The Downsides of Timesheet Tracking

To that effect, in practice, timesheets are primarily used for two purposes:

  1. To charge customers based on time spent by employees
  2. To measure productivity or performance of employees

Let’s understand the reality of both scenarios.

The time it takes to complete any task varies widely due to factors like employee skills, experience, and efficiency. Timesheets focus on the time spent rather than accurately reflecting the value provided to clients. This myopic approach can lead to a mismatch between the time billed and the value delivered, potentially affecting client satisfaction. It becomes a moot point as companies continue to charge clients the standard 40 hours a week. Companies will not bill less, and most clients will not accept more.

Additionally, setting hourly rates is highly subjective as companies typically align their rates with competitors rather than basing them on the actual value of their services.

Timesheets also do not provide a comprehensive view of employee performance. They are not an effective productivity management tool. If employees need to spend 40 hours a week, they will figure out a way to occupy those hours. They merely measure the duration of work, neglecting crucial factors such as the quality of work, client satisfaction, or the degree of project completion.

Another drawback of timesheets is their inability to accommodate productized services. In a world where agility and scalability are key drivers of success, timesheets prevent organizations from efficiently packaging and offering their services as standardized products. This rigidity hinders growth, stifles innovation, and limits the potential for service providers to expand their reach and revenue streams.

Ditch the Timesheets Dependency

Eliminating the timesheets can seem like a formidable, impossible task. However, at my previous services startup, I have personally experienced how reducing timesheet dependencies, limiting them to specific scenarios, can result in happier employees and higher revenue. The transition was challenging, but well worth the results.

By ditching timesheets, you can liberate your employees from the time-consuming burden of filling out timecards, allowing them to channel their energy into more productive endeavors. This simple act opens up innovative opportunities for billing your customers and paves the way for profitable growth

Unfortunately, for management, convincing clients to adopt new billing methods while implementing internal changes is a daunting task. It strains resources and disrupts established processes. In many instances, clients still ask for timesheets because they provide a perceived sense of control over billable hours, despite their inaccuracies.

Here is the ideal approach that help services companies to measure productivity and maximize profitability while delivering top-notch solutions to their clients:

Value-Based Pricing Model

Value-based pricing is a strategic approach to charge your services based on its perceived value to the client, instead of simply billing by the hour, or cost-plus pricing. Few examples are fixed fees, managed projects, or outcome-based engagements. These billing models are built on the principles of the value, not just the time spent. You’ll need to sharpen your project scoping and estimation skills to avoid any future scope creep, but you’ll also have the opportunity for healthier profit margins and happier customers and employees.

With fixed fees, you quote a project price upfront for a given scope. Outcome-based pricing means you charge for achieving specific results for the client such as number of tickets resolved or lines of code delivered. Both approaches shift the focus from tracking hours to delivering solutions that truly meet the client’s needs.

There are risks, like projects taking longer than expected. But you’ll be motivated to work efficiently and manage scope carefully. And when you succeed, you get paid for the value, not just the hours.

If forced to still deal with timesheets by a few customers, use a hybrid approach: Leverage a platform that is not dependent on timesheets for billing the customers, but still provides flexibility to automate the timesheet process in given scenarios. SuccessPro is the world’s first vertical SaaS platform for tech-first service companies that eliminates the spreadsheets & timesheet-dependency. It replaces them with a customer PO and effort-centric solution that breaks down barriers between sales, delivery, and finance departments.

In Conclusion…

As the service industry continues to evolve, it is necessary for businesses to break free from the shackles of timesheets. The time has come to bid farewell to the timesheet trap and embrace a more dynamic, client-centric approach to service delivery.

Does this problem sound familiar to you? If so, I’d love to hear more about your specific situation, and share our solution with you.

Maximize Your Service Business’s Valuation

Founders of service-based companies frequently overlook evaluating their business’s worth until contemplating an investment or devising an exit strategy. Their perception of the company’s value is often vague and abstract, and they have unrealistic and inflated valuation expectations. Determining the true value was one of the most daunting tasks we undertook during my tenure as a founder and CFO of a service company. 

There  are several factors that influence the final valuation, such as company’s current revenue, growth potential, margin forecast, customer base type, competitive advantages from intellectual property and reusable assets, technology trends, the industry’s economic conditions and market volatility, employee capabilities and qualifications, and most importantly, brand value and market reputation.

A higher valuation not only translates to a more substantial payout in the event of an IPO or acquisition, but also opens doors to more favorable terms when raising capital or attracting strategic partners. It helps the business command greater respect and credibility within the industry, potentially opening up new opportunities for growth and expansion.

Different Valuation Approaches for Services Companies

The valuation of a service company can be calculated using multiple different approaches. It is ideal to apply more than one method to ensure you arrive at an accurate valuation.

Let’s explore various valuation approaches suitable for services firms.

Earning Multiple Approach:  

The earnings multiples approach bases a company’s valuation on its ability to generate future earnings. It determines the company’s value at a multiple of their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), typically ranging from 8 to 14 times company earnings. Another approach is to apply a multiple to the company’s revenue, typically ranging from 2 to 4 times annual revenue. This earnings multiple method is the most widely used as services companies tend to have predictable revenue streams and decent cash flows. However, this approach can oversimplify the unique nature of some service businesses.

Regardless of whether you use EBITDA or revenue multiples, the end result is often similar. In my experience, the ideal gross margin profile for service firms should be around 40%, and ideal EBITDA margins around 20% for hybrid companies operating onsite-offshore models as a general thumb rule.

Discounted Cash Flow (DCF) Analysis: 

Estimating future cash flows and discounting them to present value using a rate that accounts for risk and time value of money is  another income-based valuation approach. While it is more accurate than earnings multiples, it is also complex, requiring detailed forecasting, financial modeling and assumptions about cash flows, growth rates, and discount rates. This makes it ideal for stable, mature service businesses with predictability in performance. 

Other Valuation Methods: 

While earnings multiples and DCF analysis are prevalent, other valuation methods like asset-based or market-based approaches may also apply. However, the asset-based approach, relying heavily on tangible and physical assets, is inadequate for technology services firms whose value lies in intangibles like intellectual property, customer relationships, and employee expertise – difficult to value accurately. Similarly, the market approach falls short due to a scarcity of truly comparable businesses, especially for niche technology services firms. These companies can be quite unique in offerings, client bases, pricing models, and operating metrics, making market comparisons challenging.

Key Strategies To Maximize Valuation

Maximizing the value of your services business takes focused effort and time. You need to roll up your sleeves to execute your well thought out plan. It’s like staging a home – it requires a vision, careful planning, and attention to detail to create an appealing environment that attracts buyers.

Let’s dive into the art of valuation – the secret sauce that can turn your business from a humble startup into a titan of industry.

1. Drive Top-Line Growth and Expansion:

A company’s growth rate is often measured by the Compound Annual Growth Rate (CAGR). If your company has a scalable business model, a large addressable market, and a profitable growth plan, it will be more attractive. Implementing the right interventions to maintain a sustainable growth rate, such as expanding into new markets and geographies, acquiring complementary businesses, or developing new innovative product and service offerings with recurring revenue streams, can positively impact valuation multiples. However, growth should not be at the cost of profitability, working capital management, or cash flow.

2. Optimize Financial Performance:

Every firm needs to develop the financial discipline to deliver a sustainable and healthy earning forecast. Buyers and investors essentially pay upfront for the promise of future cash flows. They scrutinize financial performance carefully, making clear and transparent financial reporting critical. Beyond reporting, businesses must focus on increasing profitability, optimizing margins, and efficient working capital management. Streamlining operations can reduce unnecessary expenses and boost profit margins, making the business more attractive. Showing a clear path to future profitability translates to higher valuation multiples, indicating strong demand and future ROI.

3. Diversify Customers Portfolio: 

A diverse, loyal and stable customer base that is not overly reliant on a few key customers, increases valuation by reducing concentration risk. It demonstrates a broad market appeal and eliminates the possibilities for sudden revenue dips in customer churn scenarios. As a general rule, revenue from your largest customer should not exceed 20% of total revenue. Additionally, long-term contracts with clients can provide a predictable and steady income stream, further enhancing the business’s value. The key is in developing strong relationships and mutual trust with your clients and turning them into repeat customers. 

4. Develop IP for Competitive Advantage: 

Developing valuable Intellectual Property (IP), such as proprietary products, methodologies, patents, or trademarks, can enhance a service business’s valuation. Exclusive service offerings or unique business practices, such as platform migration accelerators, analytics tools, and custom strategy frameworks, also augment perceived value. The key is to offer high-value, differentiated services that competitors would struggle to replicate, and position your company as a niche market leader capable of commanding premium prices. Such offerings can unlock recurring revenue streams, scalability potential, and distinct competitive advantages.

5. Improve Brand Recognition and Reputation:

Brand reputation refers to how the market and customers perceive your business based on its image, values, and performance. A well-recognized, reputed brand establishes trust and signals quality, reliability, and the ability to attract and retain customers consistently. Brand reputation can be measured by external signals such as Net Promoter Score (NPS) from customers, Glassdoor ratings from employees, social media metrics, customer churn, renewal rates etc. 

To build a strong brand reputation, businesses should focus on providing higher customer satisfaction, better employee well-being, delivering high-quality services, and consistently reinforcing their brand values and messaging. Strategic marketing initiatives like content marketing, social media presence, event sponsorships, and thought leadership efforts can pay off in the long run. Companies that prioritize engagement with their customers and employees are more likely to have loyal and satisfied stakeholders, as well as advocates who are willing to promote their brand.

6. Improve Quality of Revenue:

Buyers and investors scrutinize revenue quality closely because it provides insight into the sustainability and defensibility of a company’s revenue streams going forward. For service firms, high-quality revenue indicates that the business has created robust, recurring revenue models with loyal customers and defensible competitive positioning. Here’s how they can achieve it: 

  • Niche Focus: Companies operating in high-growth or niche technology or domains, such as AI/ML, cyber security, analytics, healthtech and more, tend to command higher valuation multiples compared to those that operate in more mature or declining industries.
  • Project vs. Staff Augmentation: The nature of the work undertaken by the company can also impact valuation. Project execution work, where the company takes end-to-end responsibility for delivering a solution, is typically valued higher than staff augmentation services, where the company provides resources to support a client’s project.
  • Prioritize Value-Based Pricing Models: Shifting the business model towards value-based pricing engagements such as fixed-fee or outcome-based pricing from time and material (T&M) can increase perceived value and command higher valuation multiples. We’ve discussed that in detail here. 

7. Develop High Performing Team: 

The primary asset of every service business are the employees. Service businesses thrive on their employees’ expertise, knowledge, and reputation. Building a strong leadership team, investing in employee training, and implementing a succession plan are crucial. By nurturing talent, these organizations solidify their industry standing, attract top professionals, and inspire client confidence.

Fostering a culture of innovation can have returns that pay off in the long run. Invest in R&D. Encourage and reward creativity and out-of-the-box thinking. 

A business which depends heavily on subcontractors is not considered valuable by seasoned investors. So if your business has a lot of subcontractors or contingent workers, try to bring them in-house at the right price, or replace them with new hires.

8. Focus on corporate governance and compliance:

In our increasingly regulated world, investors have grown cautious about risks. Strong corporate governance practices and stringent compliance and ethical conduct are essential when positioning your business for an acquisition or IPO. Ensuring complete financial transparency and accountability by eliminating gaps between actual performance and reported numbers. Misaligned financials raise red flags that can make a deal fall through.

Strong internal controls, audited statements, and documented compliance protocols demonstrate a commitment to reliable reporting and risk mitigation. This oversight enforces accurate valuation drivers and mitigates regulatory violations impacting future cash flows. Comprehensive governance also includes aspects like cybersecurity, data privacy, and labor practices. Any lapses here can expose potential investors to future liabilities or operational risks.

9. Invest in Technologies and Data Analytics:

Adopting and integrating the latest industry-specific technologies such as vertical PSA (Professional Services Automation) platform and tools can streamline operations and improve service delivery. Utilizing artificial intelligence and machine learning enabled tools can generate actionable and real-time insights, further reducing time spent on manual data analysis. By leveraging technology in key areas, services firms can maximize profit margins.

We’ve made the first and only vertical SaaS specifically made for tech services companies in the market. SuccessPro was designed to target the most challenging operational and scaling problems I faced in my decades-spanning service industry career.

In Conclusion…

By carefully addressing these key factors and implementing strategic interventions, service business owners can position their companies for optimal valuation, whether they are seeking an exit, raising capital, or exploring strategic partnerships.

A strong, niche service business, with a clear path of growth, loyal & capable employees, and a diversified but dependable client base will draw investors to your business like moth to a flame.

Looking to make your service business investor-ready?  If so, I’d love to hear more about your specific situation, and share our solution with you. 

Let’s chat!