You might have noticed that it's getting harder and harder to make money in the agency business. Salaries are going up, inflation is pushing up costs, pricing is getting forced down, and investments in your culture and technology are rising.
About the only expense that might be on the decline is your office—if you’ve gone to a distributed model.
The days of 30% net profit are long gone. Today, data from Promethean Research supports a 17% net profit as average for most agencies going into 2022.
But that doesn’t mean there aren’t real actions you can take today to make sure you’re optimizing the net profit at your agency and I’m here to share with you those that worked for us, along with their impact on our net profit margins over the past year or so.
I’m hoping that this information helps you make smart decisions going forward. We all work too hard to eke out a few percentage points for the bottom line.
Start With Strategy
Agencies skip strategy all the time. Some don’t know how to do it, and others don’t want to charge for it, but without it, I promise you your engagements are going to be less profitable.
It might seem counterintuitive to add something into your engagements to improve profitability, but try to think about it like this:
If you want to build an outdoor BBQ grill and you have all the pieces, which method is going to be more efficient? Using an instruction manual to walk you through each step or trying to figure it out on your own?
Creating the instruction manual will take some time, but ultimately, it will be less time than you trying to figure it out on your own.
Our engagements are the same way. If you create the strategy or instruction manual, no matter what you’re doing for your client, it's going to take you less time, you’ll have to do less rework, your team will be much more efficient, you’ll need fewer people and you’ll make more money than trying to have your team figure it out as they go.
This is going to help you with your clients too.
When they work with you on the strategy, they’re signing off on the scope, the requirements, and their expectations.
I can’t guarantee that this won’t change, because it does in almost every engagement, but at least you can go back to them and talk about their changes, the impact on the project investment, timeline, and expected results.
Set Pricing Correctly
The next best way to improve profitability is to set your pricing correctly. First, you have to know what everything costs you to deliver. That means you have to know how long it takes you to deliver.
Agencies sell only one thing. Time.
You have people, they have hours, you pay them one rate and you sell it to the clients at a higher rate. If you don’t know how long it takes you to deliver, it's like not knowing how many widgets are going out to customers.
This is why I recommend agencies use Services Catalogs to keep track of how long it takes to do work, how much you mark up that work, and then how you value-price that work. Keeping this in one place and keeping this updated helps ensure you charge correctly for the work you’re delivering.
I also recommend you install a set of processes that allow your delivery team to work closely with your client services team to collaborate regularly on client work. Let the delivery team understand the project requirements, set the pricing for the time it's going to take to deliver, and then mark it up accordingly.
This gives you the best chance to value engineer almost everything the agency is doing and optimize your profit potential.
Stop Over Servicing
If I talk to 10 agency owners a month, 10 of them tell me they’re over-servicing their clients. I get it. Clients ask for stuff all the time and it's easier to say yes than it is to explain that they either need to pay extra for it or move something that’s currently on the plan, off the plan,
This is especially hard for people who work for you. They don’t have a vested interest in having those difficult conversations.
The result is that clients get more than they pay for. Some get it and they know what they’re doing. Most don’t even realize they’re putting extra stress on the profitability of your agency.
However, it's 100% your role as the owner to stop over-servicing. This is the one area that improves profitability instantly.
There are a few ways to stop over-servicing:
One is to clearly scope or spec out exactly what you’re doing each month, get a client to sign off, and then stick to that scope. Unfortunately, that’s not how most agencies work, nor would I recommend this. It’s far too rigid for most clients and not the kind of collaborative relationship most agencies want to foster with their clients.
Another option is to just keep track of hours and at the end of the month bill your clients for the hours you’ve used and wait 30 days to collect your money. Again, this is the old ad agency model. When the client gets that bill at the end of the month, someone has to be available to go through each line and explain what they did and why it took that amount of time.
Also, this is not very collaborative or strategic in nature.
With those two options off the table, there is another way.
It involves working with the client in an Agile way and using points to help them keep track of the work you’re doing, while not having to worry about hours.
Agile delivery lets you co-create the work scope monthly and the points help keep you from doing work you’re not getting paid to do. When clients want more than they agreed to, your team uses the points pricing and the Agile work planning guard rails to either move something out, get the client to pay more, or have them agree to wait for the next work planning cycle to get this new work in.
It works like a charm. If you’d like to talk about this more, schedule time with me and I’m happy to share how we use this at Square 2.
While no business is easy. agencies are especially challenging. We don’t make anything and we don’t ship anything. Our businesses run with people and work for people. It’s very complex.
That means you have to have a good handle on the metrics associated with your business. You have to (or you have to hire someone you trust) keep an eye on many different metrics in the business.
How profitable are each of your clients? How long is it taking your team to do or provide different services? Are there any services that are habitually unprofitable? How billable are each of your team members? How allocated are they? How efficient are they at their role?
You have to be looking at these numbers each month. If they’re not in line or trending in the right direction, you have to take immediate action to fix it. You can’t take your eye off the ball for a minute.
The agency business is changing very quickly. You might be providing new services this year that you didn’t provide last year. This is going to put strains on the business and the team that could impact your numbers. What you did last year is very likely not going to be what you do this year.
You have to keep a very close eye on every key metric in the organization.
Get Paid Full Value
If profitability is an issue, it is for almost every agency I talk with. One of the first areas where improvement can be realized quickly is in what you’re charging.
The short story is that you’re not charging enough. You’re not charging enough because you’re not 100% confident that you are awesome at what you do. You’re not charging enough because you don’t think you can win any business if you charge more. You’re not charging enough because you know another agency and you used their pricing to come up with yours.
Regardless, you’re not charging enough for the value you provide.
It’s not about how much does it cost you to do a website and how much can you market it up. Pricing should be based on what is the value of that website to your client’s business and that’s what you should be charging.
If you have a client who gets 10 leads a month and they turn one of those leads into a new customer worth $100,000 a year, then you come along and take them to 20 leads a month and help them close three new customers a year for $300,000 a year.
Now instead of a $1.2 million company, they’re a $3.6 million company. Do you think your work is worth more than $5,000 a month? Of course. Is it worth $10,000 a month? Of course. Is it worth $20,000 a month? Yes, it is.
But agencies charge between $3,000 and $5,000 a month for this work every single day and rationalize it by saying, “This is what the market will bear.” That is not true. You can charge more and you should be charging more.
You’re worth it and the value of what you do for companies is worth way more than what you're currently charging. If you want to improve profit, then start charging more.
Leverage Technology Partner Programs
Finally, there is one more lever that can be moved to improve profitability and that has to do with technology.
Today, almost every agency should have at least one partnership with one technology company. Many of you have ongoing and successful relationships with HubSpot. The HubSpot commission check adds additional profit potential to the agency's bottom line.
What’s even better is that most of that income comes with zero cost to deliver. We call this passive income. This is income that doesn’t require any work nor does it have any cost associated with it.
You can lean into one partner like HubSpot or consider looking for a portfolio of technology partners. This includes all who pay commission for either referral or for software that you sell on their behalf.
This type of income has the potential to take your 5% net profit at the end of the month and make it 15% net profit. That’s a significant contribution.
This is something that should be a major initiative for your agency in 2022.
Together, these six levers all help drive agency profitability. Even if you focused on one or two, profitability would improve. What’s going to be harder is managing all six over time.
The agency business is built on shifting sands. The industry is changing very quickly. However, by installing the right controls to limit over-servicing, pricing our client work correctly, and having strong technology partnerships you can drive solid profitability month over month.
Start Today Tip – As a CEO or owner, this has to be at the top of your list of priorities. I understand you wear many hats and in addition, you’re selling, working with clients, and trying to hire people. However, this needs your attention or you might not have a business in 12 months. Pick one of these six initiatives and make it your top priority for the second quarter. Create goals and a documented plan with three to five action steps that you and your team will take over during the next few months. Identify the KPIs, and track them over the next three months. If you make progress, identify the next item on this list and plan to tackle it in the same way during the third quarter. Get your team involved. Profitability is in everyone’s best interest, not just yours. Help your team understand that.