Consultancies little secret

There's an unspoken secret amongst consultants. It's the zero rate charge out. The practice is becoming increasingly common, although no one is prepared to own up to it. "There's definite pressure on day rates and there are people out there at zero. Clients tell me about it confidentially all the time," says Jerry Norton, director of strategic development in financial services at Logica, the UK IT services and software group.

Zero-charge out is a recession fighting tactic that has a number of goals. First, according to Anthony Miller at Ovum, the market research company, consultants get to update and refresh their skills through relevant client engagements. Second, the consultancy has a stronger chance of winning repeat business. Third, it means that spare consulting capacity is available to deploy when the overall demand for IT services improves.

Says Brad Smith, an analyst at market researchers Kennedy Information Group: "A lot of services companies have tried creative ways to keep staff. Accenture offered its people sabbaticals last year; they were given a stipend and got to keep their medical benefits. Pro bono work is not uncommon either nor is the ‘big bonus on completion of project but very little money beforehand' approach."

But a veil of silence cloaks this type of activity because any suggestion of a cut price/ free consulting engagement implies the IT services industry is in dire straits "The biggest enemy for us is when someone manages to commoditise a day's consulting work, because the margins evaporate," says Stuart Hamilton, chief technology officer at UK IT consultancy, Axon Group.

“Undercutting is rife. Consultancies refuse to admit it, but experienced staff are working for fractions of normal rates – and even for free”

Pro bono work, while on the rise, still does not occur quite so much in Europe as elsewhere. "Sending staff out on non-billable engagements is much more common in the US. The downturn hit harder there especially amongst high-end consultancies which have been under extreme margin pressure," says Ian Spence, an IT services analyst at UK investment bank Granville Baird.

That said, many analysts still firmly believe that free consulting has not materially affected overall standard charge out rates. "The basic model in the US is to hire a person for $100,000, for example, and then charge them out for three to four times that much. Consultants never mess with their rates unless they are small," says Dave Foote, president and chief research analyst at US-based Foote Consulting.

However, average billing rate information from investment bank, Lehman Brothers, suggests otherwise. It recorded average billing rates amongst US consultancies dropping by almost a quarter in the first nine months of 2001. KPMG Consulting, for example, reduced day rates from $237 (€268) an hour in the first quarter of 2001 to $213 (€241) by the end of the third quarter, according to Lehman.

"Billing rates have dropped in the last nine months both in the consulting and contractor market place. Staff agencies, for example, have had to slash their fee rates by at least 10%," according to Ovum's Miller.

The problem for the consulting companies is that even more than before, their clients are trying to squeeze as many unnecessary cost as possible out of their contracts to achieve the maximum return on their investments. And that is causing a reduction in consulting day rates. "Clients got burnt in the dot-com boom when they spent vast sums on ecommerce projects with very little return," says Paul Kingsley, CEO of IT consultants Oyster Partners. "Now they are looking for measurable and definable return on investment."

The e-services consultancies have already been hit by a collapse in demand for their services. But there is anecdotal evidence to suggest that the reduction in rates and lay-offs commonly associated with these type of businesses has spread into other software sectors. For example several analysts, who declined to be named, say they talk to people with Broadvision and Vignette skills who now earn a mere £500 (€807) per day, when they had been earning a £1,200 (€1,936) day rate less than 18 months ago.

“Weve won business against the Big Five when theyve offered services for free.” Stuart Hamilton, Axon


Undercutting is rife. Accenture and KPMG, two of the world's largest consulting practices, for example, are regularly sending their experienced staff out at £300 (€484) per day on SAP consulting projects when the market rate would normally be double that amount, according to a well-placed industry source. Neither company would comment.

Often day rates are affected by the degree of ‘body shopping' in the market. A ‘body shop' can range from a company using cheap labour from developing countries to undercut market rates, to a large consulting practice sending out an experienced consultant on a short-term project at a vastly reduced rate. "All the ‘big five' [Accenture, KPMG, PriceWaterhouseCoopers, Cap Gemini Ernest & Young, Deloitte & Touche] and the major systems integrators are doing this. They find out that the client needs a short-term resource and offer it very cheaply under the guise of ‘added-value relationship building.' It's easy to mask to the client and the industry," says Miller. "When new project work drops off, consultants are often put out in the contract market. The employer jobs them for three months and acts like an IT staffing agency in all but name," he explains.

Cap Gemini Ernst &Young, for example, operates its Sogeti subsidiary operation as a ‘body shop' in Europe and will roll-out a similar practice in the UK at the end of the year. Logica has run a ‘body shop' for several years although it goes by another name – a Managed Resource Pool (MRP). The MRP is an offshore consulting practice based in India, where it employees local people on short-term contracts. Xansa, the British IT services and outsourcing group, is also well known as a ‘body shopper' in the UK.

Although ‘body-shopping' keeps a consultant's skills fresh and generates repeat business, the practice does have a downside. "It may squeeze rates but it often gives the client a false sense of economy," says Logica's Norton. Consultants may fall into the trap of taking such work less seriously, he says, and accepting less responsibility for the success – or otherwise – of the overall project.

The weakness in the classic body shop model has led to a new breed of body shop that is willing to take responsibility over the network of contractors and, thereby, be accountable for the work being finished on budget and on time. "Sogeti's body shop, rather like our own, is much more for the large multi-nationals, which want to take the headache out of managing hundreds of smaller contracts. That can be a nightmare. Big suppliers want one or two large body shops to backfill their staff requirements and offer a good on-going level of support and services," Norton explains. (Cap Gemini says it does not even have a ‘body shopping' business).

The biggest threat to consulting rates, however, has come with the rise of the Design, Build, Finance and Operate (DBFO) contract, which has changed the structure of deals so that the average daily rate each consultant receives is much lower. A DBFO contact calls for a lower upfront investment from the client, since full payment is tied to some tangible cost-saving or revenue generation as a result of implementing the project. "We hardly saw any of these deals a couple of years ago but they're really popular now," says Kevin Prouty at technology analyst company AMR Research.

Logica is a major exponent of this type of engagement. "Most of our bigger contracts in every sector have some element of Design, Build, Finance, Operate. We fund the initial up front project cost and then spread it across three years, say. A couple of years ago only government projects were financed in this way but now everyone is interested in it," says Norton.


Going, Going, Gone?
Company   Revenue per professional      
  Third quarter 2001 Second quarter 2001 First Quarter 2001
KPMG Consulting $288,000 $322,000 $329,000
EDS $234,000 $214,000 $210,000
Computer Sciences $204,000 $200,000 $212,000
Source: Lehman Brothers

DBFO contracts, however, can't prevent utilisation rates – the number of staff gainfully employed on a project – from sliding. "Utilisation rates should be around the 70-75% mark on average. Some consultancies can break-even at 50% utilisation but they'll have to be charging out for at least four times the hire salary. Most break-even at 60%. But not many companies are operating to this model right now," says Spence at Granville Baird.

In fact, as only a cursory glimpse at last year's employment climate shows, most consulting organisations were unable to make it through last year without cutting staff levels.

This isn't always a bad thing, according to some analysts. "A lot of not necessarily top calibre people were hired in 1999 and 2000. They weren't that good and their employers were looking for an excuse to let them go. A market correction was the perfect time to say good-bye, "says Foote at Foote Consulting. Between 5% and 8% of billable headcount has been slashed across every big name consultancy in Europe in the last year, according to Forrester Research.

Lay-offs immediately improve employee utilisation rates and reduce the cost structure of the business. "The tough point for us was the second half of last year, but as a result of restructuring and redeployment in our business we're seen our utilisation rates increase dramatically this year," says Kingsley at Oyster Consulting.

Some consultancies only resort to redundancy as the last available option; mainly because of the negative market perception job cuts create. Axon Group, for example, has sliced its consultant's basic rate and built a more attractive bonus structure in a bid to cut its own overall costs and increase project success rates. "Our staff now get a relatively low basic of £30,000 or less. Most of their salary is payable upon completing certain deliverables.

That means a guy earns a £1,000 on average per day with a 15% to 45% bonus on top of that," says Hamilton at Axon.

Over in the US, IT consultancy operation, DiamondCluster, has continued to carry a greater proportion of unbillable staff in the hopes of avoiding more redundancies. However, it has had a devastating impact on margins and average billing rates, according to Lehman Brothers. The investment bank has noted that DiamondCluster had the highest average hourly billing rate – $368 per hour – and the highest revenue per consultant per annum – $436,000 – of all the organisations it surveyed in 2000. By the third quarter of 2001, Diamond Cluster's average billing rate had dropped 58.3% to $182,000, according to the research.

A focus on high staff retention is key to some sectors of IT services because it is a means of defending a company's competitive advantage against a type of rival not seen in boom times – the software vendor's own consulting arms. "In a downturn software vendors go from offering the traditional product-led services to more broad-based consulting engagements," says Prouty at AMR Research. He argues that enterprise resource planning specialist, J D Edwards, has made that transition over the last nine months. Aggressive hiring from an established player is a quick and effective way to boost a consulting operation, according to Miller at Ovum.

But clearly, while it spells more choice for clients, the entrance of software suppliers into the consulting fray has meant it has become a more crowded market. "It's a case of more interested parties chasing less business. Cheap day rates, free consulting work, lay-offs – all this type of thing – are symptomatic of a more competitive market," says Smith at Kennedy Information Group.

Either way undercutting the competition will not always clinch a deal. "We've won business against the Big Five when they've offered services for free. I personally bid against Accenture when we charged our normal rates and they charged nothing," says Hamilton at Axon. The market may have got tougher but there is definitely business available for those consultancies that don't rely on cheap or even zero day rates for their competitive edge.

So has the consulting landscape radically changed since the downturn? The answer to this question depends on which sector of the IT services you examine.

Consulting can be divided into three broad areas: outsourcing, systems integration and management consulting. Not all of these sectors are seeing the same degree of price-pressure or dearth of demand. Outsourcing, for example, is on the rise while management consulting is down, according to Forrester. The research firm predicts that outsourcing will hit hyper growth in the next few years spurred by a return to business process outsourcing (BPO). However, management consulting will fall by more than €7 billion in 2002, from a base of €25 billion in 2000, it warns.

One thing is clear, although the worst appears to be over, the consulting sector is having to adapt to a new reality.

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Ben Rossi

Ben was Vitesse Media's editorial director, leading content creation and editorial strategy across all Vitesse products, including its market-leading B2B and consumer magazines, websites, research and...

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