Posts

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.