The Numbers Game: The Secrets to Optimizing Your Agency's PerformanceSep 14, 2023
This likely surprises no one in our industry, but agencies are complicated businesses to run. They require sophisticated business strategies and a unique understanding of the agency business model to maintain profitability and efficiency.
Coincidentally, many agency owners start their business with incredibly strong creative and strategic skills, but have little to no experience running a business. Often, they start the firm after leaving a corporate or agency job as subject matter experts, not agency business model experts.
This blog entry will break down the critical numbers that empower owners and executives to run an agency by the numbers and understand benchmarks required to meet or increase profit and revenue in a meaningful way.
Capacity equates to how many hours each team member has available to work. In an agency, or any professional services field, the team’s time is essentially the company's "inventory," and therefore, the top resource to manage. This is true regardless of whether the agency prices client work based on hours or not.
Capacity planning is a critical internal process that determines the team resources available and required to deliver quality service to clients.
Proper capacity planning is necessary to:
- Ensure the agency isn’t bringing in more work than it can fulfill while maintaining high quality service and results
- Make informed decisions around hiring new employees, bringing on contractors and sourcing vendors to meet client needs
- Reduce burnout among team members, which leads to decreased productivity, morale and quality of work
- Prevent having too little work for the team, which tanks profitability and can lead to decreased morale as well
We conduct comprehensive audits of agencies at all sizes, and see that firms of every revenue stage struggle to have a clear line of sight into the team’s real-time capacity. The larger an agency grows, the more critical capacity planning becomes. Without the right tools and processes, it can easily take agencies dozens of hours every month (and even every week!) to manually calculate capacity. This is one of the top challenges that agencies approach Advocation to solve.
While many agencies can get away with manually calculating capacity through spreadsheets as they grow, this often creates bad habits around capacity planning that have cascading effects as the company grows. Today’s technologies make it easier than ever to have clear visibility on capacity. Teamwork is the top tool we recommend, as it is specifically designed for the agency business model and pairs capacity planning with project management and time tracking in one tool.
For more on how agencies are using technology, including Teamwork, to streamline operations, check out this blog post.
Utilization is simply the calculation of the total hours the team has available to work divided by billable client hours. In other words, utilization rates are billable versus non billable hours. This is also one of the most important numbers to consider for an agency's profitability.
Utilization rates and capacity planning go hand in hand. For example, if the team is at capacity with too many non-billable hours, profit margins will inevitably suffer.
When agencies are not tracking and monitoring utilization rates effectively, one of two possible scenarios can occur.
- Agency teams end up with too many non-billable hours. This means that the company is covering the hard cost of too many employees straight from their profit margin instead of allocating those team members to revenue-producing work. After helping agencies get this problem under control, we've seen firms move from flat profit margins to at least 20% in as little as six months and 30% and beyond in a year’s time.
- Agency teams end up with utilization rates so high that they can't be maintained. When utilization rates are too high, agencies are unable to maintain a compelling culture, make time for important team activities like professional development, effectively execute business activities like marketing, and often can’t retain staff due to burnout.
Utilization rates are not one size fits all. Target utilization rates vary based on the size of an organization, revenue, growth goals, and other factors. However, utilization rates of 95%+ are becoming less and less acceptable. The expectation of staff spending this amount of time on billable work is unsustainable, and is a top contributing factor to burnout and attrition.
Client Budgets & Over Servicing Rates
A discussion about agency math cannot be had without breaking down budget management. There are three non-negotiable processes an agency must have in place for effective budget management.
- A process for accurately scoping client projects, with clarity around deliverables, timelines and budgets. Without setting these expectations, agencies often end up working far outside of the client’s scope of work and therefore, budget.
- A process for monitoring and managing client budgets day-to-day with clear owners who are accountable for keeping client work within budget.
- A system for hosting retrospective and post-mortem meetings to review budgets that went over their original target. The goal is to identify modifications that need to be made to future scopes to avoid repeating the same mistakes again.
Unmitigated overservicing is a top issue agencies face and happens when the above processes are not in place. Agencies rarely realize what an impact overservicing has on their bottom line until the issues have been corrected and profit margins increase.
Budget management is never perfect, but aiming for a 10% margin is generally a great place to start. More commonly, we see agencies overservicing at the rate of 30-50% and beyond. To put it into perspective, an average 30% overservicing rate across the agency is the equivalent to working from mid-September to New Year’s Eve for free. If that's not a compelling reason to rein in overservicing, what is?!
Client & Company Profit Margins
When accurately managing the above numbers, profit margins quickly become a non-issue for agency teams. However, it is key to have a clear understanding of target delivery margins when it comes to client work.
It’s common for agencies to target a profit margin on client work equal to what they want the company’s net profit to be. However, the margin on client work also needs to cover overhead and other expenses inside of the agency.
It can be difficult to define a “good” net profit margin, as each agency has different goals when it comes to growth. Many agencies come to Advocation with a net profit margin of 0-10%, which creates a very unstable business. With these margins, there isn't enough cash flow to hire, offer raises, or stay competitive in the market. Most owners operating within these margins are stressed about covering payroll each month. When agency management is guided by the process shared above to manage capacity, utilization rates, client budgets and profit margins, it is common for the agency to see a 30%+ net profit margin
Agencies often seek help with business management because they want processes to grow and scale. Owners and executives are typically surprised to find that revenue is not what they need to focus on when managing the agency’s numbers.
The level of efficiency in which an agency earns revenue is far more important than revenue alone. We regularly see firms with $500-600k in revenue that are managing the business by the numbers have higher end-of-year profit than firms five to ten times larger that are not.
Ultimately, the financial success of any agency comes down to how closely it manages the business by the numbers and how efficiently the team is delivering the work.