To understand utilization and utilization rates, let’s imagine we have a widget-making machine. The machine has a maximum number of widgets it can produce in a day, because it takes a certain amount of time for the machine to manufacture one widget.
Let's say, assuming the machine runs non-stop, it can produce 1,000 widgets a day. That's the machine’s total available capacity. But of course, it can't run non-stop, every day, all day. It needs to shut down occasionally for maintenance and repairs, user training, and any number of other reasons. This means it will never make as many widgets as it's capable of producing.
The difference between the number of widgets it can make compared to the number of widgets it makes is the basis for the machine's utilization rate.
While utilization rate is generally applied to people, not objects, you get the idea.
In this article, we cover:
- What is resource utilization?
- The utilization rate formula
- What can we learn from utilization rates?
- What's an ideal utilization rate and how do you calculate it?
- How to raise utilization rates
Resource Utilization Definition — It’s All About Billable Work
Utilization is defined as the amount of an employee's available time that's used for productive, billable work, expressed as a percentage.
An employee's utilization rate is a critical metric for organizations to track. It’s a measure of billing efficiency that helps the company understand if it's billing enough to cover its cost plus overhead.
When it comes to resource management, utilization rates help in forecasting, resource optimization, and many other essential business functions. It's a simple measurement that has powerful effects on how your business runs.
Utilization Rate Formula
Here’s the formula to calculate utilization:
Total Billable Hours / Total Hours Available
Let’s say we want to find the utilization rate for Leslie, a front-end developer at a web design firm. In a given week, she has 40 available hours. That works out to 2,080 hours a year. Assuming she takes two weeks of vacation, her total available hours for the year is 2,000.
Now let's say she bills 1,500 hours to various client projects throughout the year. Using this utilization ratio, we can calculate her utilization rate as:
1,500 / 2,000 = .75
Her utilization rate was 75%. This means that last year Leslie was 75% billable. Had she billed all 2,000 of her available hours to billable client work, her utilization rate would have been 100%, but that almost never happens and it isn't desirable.
Why not? Because realistically, employees have other job responsibilities that aren't billable to clients, and optimal utilization rates need to account for non-billable time.
Leslie is the head of her department, so she's tasked with training junior department members. She's responsible for helping with project estimates. And she takes time for lunch and (much-needed) coffee breaks. None of these functions are billable, so Leslie's optimal utilization rate should account for the time she spends on these activities.
For this reason, most organizations set target utilization rates for their employees that factor in how many of their available hours they need to spend doing non-billable work and how many hours they need to bill for the company to maintain profitability.
Target utilization rates vary from person to person and between positions. Managers generally have lower target utilization rates, while front-line personnel have higher rates.
In Leslie's case, her target utilization rate is 75%. This means that at least 75% of her available time should be spent on billable work, while no more than 25% should be non-billable administrative, unbillable revisions, or pro bono work. As long as she stays at, or better than, these percentages, she's considered to be utilized efficiently.
What Can You Learn from Utilization Rates?
There are many valuable insights you can gain by quantifying utilization rates.
By looking at employee utilization rates by department or by job function, you can see where demand is heaviest (they have the highest utilization rates). This helps identify opportunities to grow the company, and where you may want to consider adding staff.
If you tie utilization rates to profit, you gain insight into which services are most profitable.
Both of these insights help salespeople. By knowing which types of projects are most profitable, and which play to the company's unique strengths, they don't need to waste valuable time on leads that don’t align with the organization’s business strategy.
A utilization rate which consistently approaches 100% indicates that you’re overworking your staff, and it may be time to expand.
A utilization rate which is consistently low means there isn’t enough work in the pipeline, too many hours are being wasted on non-billable administrative functions, or it might indicate that your company has too many freelancers on projects
Utilization rates that are consistently too high or too low aren’t good for your organization and typically indicate future risks.
But what’s too high? And what’s too low? To find out, you first need to know the ideal utilization rate for your specific situation.
What’s an Ideal Utilization Rate?
The ideal utilization rate for your organization balances the targeted billable rate with all of the company’s staffing expenses, plus overhead and profit margin. But we're getting a bit ahead of ourselves.
First, we need to talk about organizational utilization rates, or capacity utilization rates.
Capacity Utilization Rate
The capacity utilization rate is the average utilization rate for every employee in the organization, which can be calculated using this utilization formula:
Total of all employee utilization rates / Total number of employees
So if we imagine that Leslie works for a very small company with five billable employees, we can calculate their capacity utilization rate as:
(75% + 80% + 60% +85% + 70%) / 5 =
370% / 5 = 74%
(The first five percentages in this formula represent the five employees’ utilization rates)
This means that the average utilization rate at Leslie’s company is 74%.
The capacity utilization rate is an important figure because it illustrates how efficient the entire company is at utilizing their available hours.
A company with a low capacity utilization rate is losing the billable value of all of those hours, leaving a lot of money on the table.
Using Capacity Utilization Rate to Calculate Optimal Billing Rate
Typically, when a company wants to find out what it should charge per hour for all of its labor resources, it uses this formula:
(Resource costs + overhead + profit margin) / Total average labor hours
Let’s say the average labor cost at Leslie’s company is $100,000, per employee overhead is $20,000, and their goal is a 20% profit margin ($120,000 x .20 = $24,000). Assuming everyone has 2,000 available hours, you can calculate their billing rate like this:
(100,000 + 20,000 + 24,000) / 2,000 =
144,000 / 2,000 = 72
Leslie's company would need to charge $72 an hour to cover their expenses and realize a 20% profit.
However, this formula assumes every employee has a 100% utilization rate, and we've already talked about how this is unrealistic and undesirable.
Including the capacity utilization rate in this equation gives a much more realistic billable figure:
(144,000 / 2,000) / Capacity utilization rate (which was 74% for Leslie’s company, or .74)
(144,000 / 2,000) / .74 =
72 / .74 = 97.29
Rounded down, the optimal billable rate to realize their 20% profit margin is $97 per hour. This rate is higher because it has to account for the other 26% of the company’s available hours that are non-billable, thus generating no revenue.
Calculating the Ideal Utilization Rate
Now we're ready to understand the ideal utilization rate. While it's okay to use an organization's capacity utilization rate to work out an optimal hourly charge, this assumes that the capacity utilization rate is a healthy one.
What if Leslie's company's capacity utilization rate were 50% instead of 74%? That would give an optimal hourly billing rate of $144 instead of $97, and that might be more than the company's clients want to pay per hour. You would be penalizing your clients because of your lack of billable hours.
It’s better to start with a target hourly billable rate, then work back to an ideal utilization rate which allows the target billable rate to deliver the desired 20% profit margin.
So, the formula for ideal utilization rate is:
(Resource costs + overhead + profit margin) / Total available hours x Target billable rate
Let’s say we want to target an $80 hourly billable rate. Using the total costs from earlier, we get:
144,000 / 2,000 x 80 =
144,000 / 180,000 = .80
This tells us that for Leslie’s company to be able to cover all of their expenses, plus make a 20% profit, they would need a capacity utilization rate of 80% if they wanted to charge their clients $80 an hour.
Now you might be wondering, how do they go about raising their utilization rates?
How to Raise Utilization Rates
To raise an organization's capacity utilization rate, you need to increase all of its employee utilization rates, since capacity is an average of the individuals.
A good first step is to set baselines for each employee, as we discussed earlier. If you remember, Leslie's utilization is 75%, which allows her some time for non-billable administrative work.
It's vital that you share these target utilization rates with each employee and their managers. It's impossible to hit a target if you don't know what you're shooting for. Allow employees to take ownership of their utilization rate, and don’t punish employees who don't hit their target rate (unless it's because of negligence). It's probably not their fault if there isn't enough billable work to charge for.
Instead, reward employees who manage to hit or exceed their utilization targets. Employees who are positively motivated to hit their goals will take a more active role in the company. They may even go so far as to try and bring in business to boost billable hours. Ideally, your employees should see target utilization rates as an exciting challenge, not a weight on their shoulders.
Use Time Tracking Software
There are plenty of benefits to using time tracking software to track billable hours, as long as the tool is easy to use. It’s possible that your employees are already billing at higher rates, but because time tracking is such a hassle, they either aren’t adequately or accurately billing all of their hours. Or perhaps some of their hours are getting miscategorized because of poor software design and implementation.
Time tracking software ideally makes the process as easy and as accurate as possible. Once your employees start accurately recording their hours in a timely fashion, you may discover that your organization is doing better than you thought.
Minimize Non-Billable Time
This is a big one. As we said, every company needs some non-billable time built into its schedule, but too much non-billable time is an indication of waste. This can be an indication that:
- You don’t have enough billable work to fill your pipeline, and employees are twiddling their thumbs
- There are inefficiencies in internal processes that are causing excess administrative time
- Managers need to get back in the trenches and take on more billable work
- Available training time isn’t adequately preparing junior team members to handle the available workload
We already know that available time is a finite resource. If too much of it is getting sucked up by non-billable, administrative work, it skews your team’s availability, distorting perception of the number of hours that could be devoted to paying work.
This can lead to disastrous consequences, like being turned down for a perceived lack of capacity to do the work, and further degrading the backlog of billable work that could raise your utilization rates.
From that perspective, reducing wasted non-billable hours can create a positive feedback loop that ramps utilization rates in an upward trajectory.
There’s a Better Way
The best way to optimize your utilization rates is to gather good, accurate information. Getting a firm grasp on your historical utilization data helps you understand past trends. These insights can then be used to forecast utilization more accurately, so you can plan ahead and make smarter decisions about your business pipeline.
10,000ft offers powerful reporting tools to help make sense of your organization's resource utilization and get a firm handle on actionable steps you can take to increase (or decrease) your utilization rates.
10,000ft helps teams of all sizes in a range of industries manage their utilization, including:
Sign up for a free trial and our team will work with you to see if 10,000ft is the right fit.