Tracking Your Agency’s Profitability Doesn’t Have to Be Scary
While creative agency owners have thousands of unique characteristics, in my decade-plus working in this industry, I’ve found that they tend to fall into one of two categories of owners. Business-focused or Creative-focused
Business-Focused vs. Creative-Focused Agency Owners
The first type of creative agency owner is what I call a “business owner.” These owners typically have strong business acumen, come from a sales, operations or finance background, and have not always worked for agencies before starting their own. Instead, they often end up as agency owners when they are approached by the second type of agency owner (the creative-focused owner) to partner together.
Creative-focused owners, on the other hand, have typically worked at a creative agency in some capacity or as brand marketers in the corporate world for years. They often start off freelancing on the side and eventually decide to start their own agency when they begin getting more and more offers for side gigs.
Creative-focused owners often have experience in multiple areas of marketing and are usually very skilled in one creative area or have a specialty, such as graphic design, web development, video production, etc.
They also have trusting relationships with other creatives who can help bridge gaps in their creative areas of expertise.
However, they don’t always look to bridge their gap in business operations or finance expertise to round out skills they lack.
If you fall into the creative-focused agency owner category and struggle with the financial side of your business, then this article is for you.
I know that producing innovative, creative work is what excites you most. You might struggle to put as much energy into the business side of your agency as you do the creative, but I also know that you know that to sustain your agency, you need to be bringing in more money than it costs you to produce your services.
If you’re like many other creative agency owners, however, you likely haven’t even started thinking about tracking your agency’s profitability in a serious way.
So far, maybe you’ve gotten by. If clients love your creative work, they keep coming back or refer you to others. I’ve seen many agencies grow their teams to ten, 20, or even more than 50 people without figuring out how to track their company’s profitability. So it can work up to a point.
But it’s not sustainable.
This brings me to why we’re here.
If you’re not already seeing the cracks in your business, you likely will. If you haven’t put time into building processes as you’ve grown, your agency work environment will become more hectic and chaotic. It will get harder to attract and retain the best talent.
“Suddenly” you’ll find yourself no longer getting by on great work alone. And this is the time when I usually hear from agency owners like you.
Agency owners usually end up getting serious about tracking profitability for a few reasons. Here are a few common ones:
- You just finished a meeting with your accountant, during which you were blind-sided by the news that your most important client isn’t actually profitable,
- Or maybe you just got good news – you landed a whale, that big national client you’ve always wanted; now you’re not sure how much time, effort, cost, or resources you’ll need to service their account,
- You have a gut feeling that you’re over-servicing clients but don’t know how to figure out if your feeling is right.
And now you’re kind of freaking out because you are not sure exactly where you are in your business and what right next step to make. But if you’re reading this article, you likely know on some level you need help. Congrats – you’ve taken the first step toward tracking your agency’s profitability. What next?
First, take a deep breath and don’t panic.
It’s not too late… Even if managing the business side of things doesn’t feel completely natural, taking a look at your agency’s profitability and learning how to track it may be one of the single most important steps you take as an agency owner. Because no matter how great your creative is, an unprofitable business eventually has to close its doors.
Next, you can do this.
People ask me why some agencies don’t review their financials regularly. My answer? Maturity. And I don’t mean the age of the agency. I mean the financial and business maturity of the owner.
Many agencies only review their financials quarterly or yearly – when their accountant does the books. The most immature agencies only take a look when they run out of cash. I recommend you track your financials monthly.
While it might not be fun, it will be worth it. Taking this step is your best bet for being able to keep creating the work you set out to make when you launched your agency.
This is how you keep your vision alive.
Now, let’s look at pricing models.
Agency owners price their services in a variety of different ways. The better you price, the more profit you can keep. Here are the most common:
- Fixed fee ($ x for deliverable): This is a model where you charge a single fixed fee to complete a particular project. Agencies often use this model until they build up enough trust with a client to move to a retainer model.
- Pros: Fixed fee can be a good option for work that’s done on a project-to-project basis.
- Cons: Clients might feel that their project won’t be done to the best of the agency’s ability and agencies don’t benefit from bringing unique ideas or solutions to the table.
- Time & Materials ($/hour + markup %): In this model, you bill your client on an hourly basis for the time spent to complete the project. You also charge for anything extra you needed to purchase for their project.
- Pros: This is the easiest way to control your profit
- Cons: This is often a model that clients and agencies alike dislike the most. Why? Because the client wants to be able to forecast their budget and doesn’t like the idea of suddenly getting a bill that’s way over their anticipated costs (an expectation gap in expected cost vs. the real cost). This can cause friction with the agency and result in client dissatisfaction even when the creative or project results are stellar.
- Retainer #1 ($x per month with recurring deliverables) or Retainer #2 ($x per month and become a client’s marketing team): In both retainer models, a client is paying a monthly fee for a set of services.
- Pros: Your agency has guaranteed revenue from this client throughout the duration of the contract.
- Cons: It can be very easy to fall into over-servicing under a retainer model, especially if your team loves the client or the work. They may say yes to everything, and suddenly your margins shrink.
- Value-based pricing: This is a newer model that is gaining steam in the agency world. Essentially, instead of charging a client $40,000 for a website builder that makes you a 20% margin, you find out what the website is worth to the client based on the ROI and charge based on that. You can also build in a commission here based on their ROI, which works well for the client because the agency has more skin in the game.
- Pros: You can stand to make more in some cases based on the potential value of the project for a client. This model really hones in on the actual value of your work versus just the time, materials and profit margin.
- Cons: This model is dependent on what your client is doing in their company and what they feel is valuable to their organization – which varies from client to client.
The best pricing model for your agency really depends on your business model. There are pros and cons to each. Knowing what models exist can help you determine if you’re using the best one for your business.
Next up: Profit margins.
While there may be slight variations in profit margin based on the specific type of work your agency does (video production vs. SEO, for example), 20% is what all agencies should aim to achieve. This is what is recommended by the Agency Management Institute and Second Wind Associations and what I typically suggest to the agency owners I work with aim for.
Oh no. My margins are really skinny. What do I do?
This is where I see a lot of agency owners really start to panic, but knowing what’s really happening here is what is going to help you fix these problems. So take another deep breath.
First, you’ll want to understand why your margins are low. This isn’t an exhaustive list, but it’s a good starting point:
- Not scoping projects correctly,
- Not understanding and documenting client requirements correctly,
- Over-servicing clients, which includes too many revisions, trying to satisfy all clients or clients that aren’t a fit, inexperienced staff working on the job and not providing quality work, and more,
- Lacking a standardized business process with checks and balances in place to catch bottlenecks and over-servicing (for example, not tracking time, not double-checking SOWs before they’re sent out, no approval processes for time & materials invoices, etc.),
- Unrealistic expectations for the margin.
There are a few things you can do this quarter to start improving your margins. You’ll want to set up metrics for job, client, and staff profitability (if you don’t already have that data). Review jobs and clients where profitability is below 10% profit margin and understand the cause for the higher cost (or lower revenue).
Then, take action afterwards and use data, not your gut, to make decisions. Review your pricing – are your clients all on historical rates? Have you done any price increases? While it might be an uncomfortable conversation, if you’ve given your team raises, prices need to go up.
Ok, it’s time to think about the process.
I know. You’re squirming. But let me tell you a story about an agency I worked with. They won some initial business with a huge client. They overserviced on that initial project and won the rest of the client’s marketing budget. They began pouring all of their resources into the client, continuing to overservice them.
Eventually, the team started to flag that they thought they were doing more work than the client was paying for. The owner didn’t doubt them, but he said they couldn’t go into their biggest client, saying they should pay them more based on a gut feeling.
They implemented processes to track the work they were doing and started collecting the data to support their hunch. After they had the processes in place and the data to back up the claims, the agency presented to the client, asking for more money.
“They were surprisingly more understanding than I expected,” the agency owner told me.
It’s hard to argue with data. Plus, if a client is okay with your people needing to overwork to meet their expectations, it’s worth asking yourself if they’re the kind of client you really want to be working with.
So look at setting up a process that will help you keep tabs on high-level metrics and notify you when there is a potential issue or opportunity.
You might want to know that while agencies with strong processes in place typically have profit margins of 20% or more, those without usually only see a 5% to 10% margin on their work.
Don’t be proud. Get some help.
I’ve seen even the most financially and process-fearful agency owners get a handle on their agencies’ profitability. I know you can do it.
That said, it is worth recognizing your limitations and bringing in support where you need it, especially since, as you grow, reviewing this data monthly is recommended so you can spot issues early.
Maybe you need a business partner who is profit-focused or an operations expert who can help you implement processes. Maybe it’s time to look at software or tools that can help you streamline your processes and measure and track the metrics you need to make insightful decisions in real time.
Be honest with yourself about where you’re lacking and what would help.
Bringing your team into the fold
Once you’ve done the uncomfortable work of getting yourself up to speed on your agency’s finances and path to profitability, it’s time to bring your team into the fold.
Many agency owners get confused when I suggest sharing budgets and financials with their teams. You don’t need to share margin details. What’s important is that you share budgets, so your teams can start to understand what types of things lead to lost or wasted time and money.
They can start to see where they can make an impact. The best way to do this is to help them understand the business consequences and tie new processes to outcomes that mean something to them. Explain how working more efficiently to deliver projects of the same quality under budget can free up the dollars needed to finally hire the new designer they’ve been asking for or the new tool they’ve been wanting to use.
Was that so bad?
Getting into the nitty-gritty details of your pricing model and profit margins may not have been what you envisioned when you dreamed of starting your own agency.
But getting more comfortable with regularly reviewing these aspects of your business is a sign of maturity. And in my experience, it’s usually an indication that an agency is going to make it.
Once these processes are in place and the right people are there to support you, you’ll be amazed at the time and energy you’ll get back.
I hope these tips helped, and please call me when you’re back in love with your work again and let me know how often you’re reviewing your agency’s profitability – that will be satisfying enough for me.
Jimmy Wu is Director of Sales at Function Point