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Why aren’t Digital Agencies more profitable?

According to the latest Kingston Smith survey Digital Agencies are the least profitable of all in the marketing services sector.

They generate the lowest revenue per head (£72.9k compared to £106.6k for advertising) and turn in an all-time low operating margin of 4.7% compared to a benchmark of 15%.

This isn’t a one off either; the story was exactly the same in last year’s survey. Why should this be the case? Why are Digital agencies, literally, the poor relation? It’s not due to lack of control of employment pay rates or overhead costs so there must be market forces or operational weaknesses at work.

Here are my suggestions why this is along with some potential solutions.

Commoditised service

Without a significant voice at senior level in clients digital agencies could be left purely to deliver projects; a production house with someone else willing to undercut you on price rather than value.

Project versus Monthly Fees

Digital agencies tend to have a higher proportion of project fees to monthly fees than other sectors. Monthly fees may have a lower rate card but they safeguard against under recovery of hours.

Scope Creep

What makes the dependence on project fees so dangerous is that when fixed project fees are combined with a changing scope of work the under recovery of hours can kill the margin.

Project Risk

Digital projects can be complicated. Inter-linked processes, heritage systems, multiple platforms can make projects difficult to estimate up front. Get the initial estimate wrong and the odds on bringing in the project profitably plummet.

Resource

Maybe it’s an IT heritage thing but there seems to be a greater reliance on freelancers in Digital Agencies. Project fees + Scope creep + Freelancers = Lower margins.

Specialist versus Generalist

Trying to be all things to all clients will mean constant juggling between different skill sets unless your rates are so good you can keep enough people on payroll to cover all the different languages and specialities needed. I need a sarcasm emoticon here.

So much for the easy part but is there a solution? Can Digital agencies ever expect to bring in the same margins as Adverting or PR agencies?

It’s not going to be easy but there are some steps you can take to start improving that margin.

Proper recovery analysis. It’s vital you know if you are over servicing a client and if you are by how much and in which department. If you’re having to bring in freelancers it’s possible you’re losing money on some projects.

Risk assessment. The more complex the project, the more likely it is that something will go wrong and need additional resource to complete. Try to mitigate this up front with contingencies and clear discussions with clients about potential problems and the effect on budget. Document the risks so that you can refer back to them. Nothing a client hates more than problems popping out of the woodwork late in the day.

How much do you rely on freelancers? I’ve written before that I don’t think having freelancers is a bad thing but too many will eat into your margin. Think about how you recruit, retain and reward your staff and compare this overall cost versus the daily rate cost of a full time freelancer.

Early alarm system. You need systems to alert you early if you are over budget. No use having a wash up at the end of the project to discover the bad news; there is nothing you can do then.

Accurate forecasting – having a good idea what work is coming up will help manage what resource you need or what action you need to take.

Try to limit scope creep by having a detailed functional specification up front. At the very least make sure then any over servicing is a conscious decision based on securing/improving the client relationship.

Post launches services. Try to limit disruptive “bug fixing” to a fixed warranty period. Once the client has signed off you don’t have an obligation to offer indefinite support and maintenance for free. If it’s a commercially important site for the client offer a support contract on a use it or lose it basis.

Make sure you maximise any revenue opportunities such as Search or hosting.

Build up a roster of trusted freelancers/suppliers you can outsource fixed price elements to.

A step by step approach to find out what your revenue per head is, where you are over servicing allied to an accurate forecast are good constructive initial steps to take. Retaining your best people and giving them enough space to foresee and correct issues as they arise will improve operational efficiency.

The author specialises in improving the profitability of creative Agencies. If any of the above ring an (alarm) bell with you email him on simon@novemberfriday.wpengine.com.

How to prepare for a successful Procurement meeting

Person pressing head against wall“It usually takes me more than three weeks to prepare a good impromptu speech”

Mark Twain

Procurement meetings are a routine part of the Agency FD’s diary these days. Whether it’s new business or annual reviews they are part of the furniture now. I’ve written before about how important it is to treat this as a positive development but this isn’t to ignore the fact that this is a negotiation.

Negotiation is a skill in itself and requires a broad range of inter-personal skills. Most of these can be improved on over time with training and experience but in the short term there is only one way to improve the chances of a successful outcome and that is to prepare. And then prepare some more.

So far, so obvious, but I’ve been in too many meetings to miss the opportunity to repeat this. Preparation is your best bet to level the playing field. Your procurement manager has the purchasing power as well as the specialist skills. You have the detailed knowledge of your agency, your pricing and your operations. If it’s important enough don’t have the meeting until you know your subject better than anyone in the room

Only by being all over the detail will you be able to negotiate effectively. To do this you need to understand the following;

Operations. Unless it is a very simple, linear project there will be variables. Is it possible to alter the scope of work? Only by talking to the people doing the work will you be able to work this out. It’s not a spreadsheet exercise. One simple example of this was when we were able to cut the scope down from 3 templates to 1 master template plus amends. By changing the scope of work we were able to fit into the client’s budget but still preserved our margin.

Margin. It’s vital you understand the likely effect on margin. This has to be done on a marginal basis. What revenue will this bring in versus any additional costs? Don’t look at the cost per hour. Once you know your likely margin you know what you can and what you can’t give away. I also much like to talk to talk about fee reductions in terms of the effect they have on margin. 10% fee reductions can sound reasonable until you realise that could be over 50% of your net margin.

Documentation. If you’re properly prepared you will have plenty of spreadsheets, word documents or presentations to choose from. Think carefully about what and how you show this information. You have to tell a clear, convincing story. Especially if is a mixed audience I would try to keep detail to a minimum.

Negotiation. There are many simple rules about negotiation skills. I have some of them written down and laminated on a card in my wallet. Some of them I agree with, some not so much. Find what works for you and use that – being natural will always be more comfortable and more effective. However (apart from preparation) there is another golden rule which is always ask for something in return. If your client wants something, usually a lower price, then ask for something in return. It may be a longer term relationship, payment up front or a longer termination period. If you don’t ask you don’t get.

Realism. Don’t expect to “win” the negotiation. You are going to have to give something away. You need to be in control of what you give away and what you ask for in return. Both parties walking away happy is victory. Think about what your procurement manager needs to achieve and work towards that aim.

It’s a messy business sometimes and the answer won’t pop out of any analysis. You will need to think on your feet about what to agree to and what you need to time to think about. You will need an appreciation of procurement’s target and knowledge of how your agency can deliver that and still deliver a good margin. Square that circle and you’ve done your job well.

The author has spent a large part of the last two decades working towards procurement targets. Never really got there. If you need some help with procurement please email him on simon@novemberfriday.wpengine.com.

 

Budget setting – art or science?

This is my second attempt at writing this article. The first effort started off as a worthy piece about how the numbers and strategy needed to work together. By the fourth paragraph though I’d bored myself and I figured it would have done the same to anyone reading it even earlier.

This is odd as the budget is probably the most important document an Agency FD can produce but writing about it in a theoretical way seemed like preaching to the choir, worthy and all, but isn’t going to change any minds.

What I settled on as being hopefully more interesting is some do’s and don’ts drawn from my years of getting budgets wrong. This is no false modesty, every budget that everyone has ever set has been wrong from the moment the paper cooled from the printer. Budgets are not about getting a right or wrong number they are about the direction of travel. What repeat business do you expect? What is a sensible new business target? How much can you afford to spend on training versus marketing versus anything else you’d like.

It’s important to say here that this is about budget setting for independents. For group companies save time and frustration by asking Head Office what number they would like.

Assuming that you do have control over the budget process what are some of the obvious mistakes to avoid in order to make the budget if not correct then relevant for a little bit longer?

The most obvious mistake to avoid is to be very careful of a client budget which increases dramatically year on year, especially if a relaunch is mentioned. I’m not saying it’s not going to happen but it’s a warning flag – dig a little deeper, ask whether the overall budget including TV, direct, digital has been signed off. It’s very tempting to grab hold of this offering from the Account Director as it will go a long way to helping set an increased target. We all like a higher target but do your due diligence first. I’ll not make that mistake again.

The next obvious mistake is to avoid setting an unrealistic new business target. It’s tempting to add a little extra new business to support a target. Don’t set a new business target out of kilter with last year’s achievement. Even if the year before was a really good one for new business that was over a year ago, new business tends to be a form game with streaks of success or failure. It’s not sensible to forecast a radical change in luck/chemistry or whatever it is that affects pitch success.

I’ve struggled with forecasting freelancers too. It’s tempting to believe next year you will need fewer freelancers than this year. You can identify resource shortages and invest in new people but the odds are freelancers will remain stubbornly high. This is mainly down to the fact that these resource problems and potential solutions are constant and unless you are doing something radically different as a business, business as usual will apply. The same principle applies to recruitment as well. If your churn rate was 20% last year is it sensible to budget for a lower rate this year?

Another danger I try to avoid is either being too uniformly optimistic or pessimistic. There are always going to be potential upsides in client spends just as there are risks to forecasts. I like to look at revenue budgets with the possible upsides and downsides all together. That way I can make sure I’m not including all the additional revenue and assuming we won’t lose any business. Or vice versa. Life is not like that.

There is one difficult judgment that has to be made when there is a re-pitch for an existing client. If the result is not going to be known until well into the new financial year what do you do? I’ve faced this a number of times and the conclusion I’ve come to is that the odds on retaining the business are not good enough to encourage me to live with the results for the next year. I would assume you’re going to lose the client or prepare two versions, one for each outcome. One final idea on the revenue side is that whilst we usually forecast new business how often do we include a revenue attrition figure?

So, try not to get carried away with potential good news, be realistic about new business and freelancers, balance risks and think about an attrition rate and take the hard call to omit any clients which are re-pitching. Even if you take these steps your budget won’t survive the first contact with reality but it will be based on what has happended and will point in the right direction.

Despite the hard choices and the inevitable inaccuracies I’m a huge, huge fan of budgets. I do love doing them.  They are neither art nor science but it is a chance for the FD to have a real impact on the plans of their Agency. It is the platform to make choices about resource, costs, investments, operations. The more planning, the more analysis you do the more useful the budget will be.

The author, Simon Collard, has set budgets for marketing service Agencies for nearly 20 years. Despite never getting one entirely right his optimism remains undimmed. If you need help putting together your budgets and reforecasts please email me on simon@novemberfriday.wpengine.com.