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You Bake With The Flour You Have (Danish Proverb)

It’s a homely image. After all baking is a lovely thing. Everyone loves baking. It also makes some sort of sense. A touch obvious maybe.

Less obvious is the connection to my favourite subject, Agency finances.

I always thought there was a kernel of an idea there, if you’ll excuse the pun, that could illustrate the important point of maximising your profits whatever the size and shape of your Agency.

This became a lot clearer during a meeting I had recently with an Agency owner. It was a new business meeting so I was on my best behavior and trying to impress. I needed something more than my ongoing obsession to make sure everyone knows the importance of the compensation to revenue ratio.

They described their problems with their clients who were price driven and paid a flat project fee. There were substantial 3rd party elements – both freelancers and suppliers.

Thrown into this difficult mix were competitors who would undercut their prices (and suffer a loss if necessary) for the promise of future, more profitable, work.

My proposed, improvised, solution was to use their numbers (I always want to use numbers) to figure out their strengths. How much of their work went out to freelancers. Was there enough to hire in more cheaply? For skills they could not or did not want to bring in-house could they get a better deal by offering volume? Could they approach their clients with a sliding scale volume discount scheme that would help them secure the savings they needed whilst getting the better service from their preferred agency partner?

The meeting ended with smiles so the ideas weren’t too far off the mark. Food for thought at worst; a solid plan to improve margins up at best. Not revolutionary but a better combination of proposition, buying and selling approaches.

Walking back to the tube after the meeting it struck me this was just a better way of baking with the flour you had. Every agency has assets. They could be cash, they could be intellectual property or they could be a range of strong client relationships.

Too often we do what we did before. Before some Maverick dropped some yeast (I suspect whilst making beer) into their flour and noticed some interesting results all bread was flat. Suddenly we had loaves.

Whatever our assets I convinced we can do something better than we did before. Make our cash work harder for us. Leverage our client relationships to guarantee work volumes and lock competitors out. Use our IP to work smarter. Drop some yeast into the mix if things aren’t working.

Too often we overlook the assets we have and look longingly at those we think we need. Sure it would be nice to have a Head of Artificial Intelligence and that might help you become more profitable. Might. What definitely will is maximising your existing assets. Start by baking with the flour you have.

 

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.

What connects the Sistine Chapel, Dinosaur Feathers and Revenue Maximisation?

Occasionally my interest in etymology, history, science and finance align to illustrate a principle that applies as much today in marketing services finances as it did to the great Renaissance artists.

OK, that’s a huge, huge lie. Occasionally I shoehorn them together to make a point that might seem mundane without a different angle.

These interests, with a little imagination and goodwill on your part, come together when the concept of a spandrel is expanded from its original architectural meaning to be used in evolutionary biology. First, some definitions.

In architecture a spandrel is the roughly triangular space between an arch and a wall. The arches used to support great domes gave rise to these spaces and many artists used these spandrels as a canvas. Michelangelo’s Sistine chapel springs to mind. Full of spandrels in fact.

In evolutionary biology a spandrel is the adaption of one characteristic for another purpose – the best example of which is the use of feathers by dinosaurs to fly rather than their original thermoregulation use (kept them warm to you and me).

As an aside there is a fascinating argument about whether music is a spandrel of speech in human development or vice versa.

Whether it is the by-product space of architecture or dinosaurs finding that feathers also enable them to glide from tree to tree the common factor is that the process has thrown up an unplanned opportunity.  The original feature can be developed into something unexpectedly valuable. By now, you might have a clue where I’m going.

The finance part of this thought came to me when I was sitting in on a meeting about a social media strategy which was made up of many different and interlinked elements. One project amongst many was about blogger engagement which caused some faces to light up as this was exactly what would excite the client far more than a complex social strategy. Put front and centre it was sold in. The other social stuff won’t be far behind.

This illustrated nicely to me the point that somewhere tucked away in every agency process there is a spandrel or two waiting to be discovered. It could be something you do but haven’t considered charging for like post launch support or a little gem tucked away in a larger process that clients would willingly pay for if only they knew about it. It could be the data collected along the way or, the holy grail of spandrels; it could be a technical development which can be resold. If you look hard enough there will be a spandrel in your agency. Find it, package it and sell it and you’ll have linked dinosaur’s feathers, Michelangelo to your agency process and maximised your revenue along the way.

If you need a hand to find your missing spandrel the author has spent the last 18 years unknowingly looking for them. Email him on simon@novemberfriday.wpengine.com if you’d like him to help maximise your agency’s revenues.

The 4 R’s of being an Agency Finance Director.

There are many ways to look at Agency profitability. From the top down you can look at revenue to resource ratios. From the bottom up you can look at actual versus estimated costs.

The first approach in my opinion is too removed whilst that latter can be too detailed. With a hefty nod to the 3 R’s of my school days I think the following R’s brings together a way of focusing on profitability that brings together the top down and bottom up approach so that the Agency FD can have a positive impact on the margin.

 Rates and Recovery

Under recovery of hours is the silent killer, it’s the equivalent of high blood pressure for Agencies. Work more hours than you can charge and watch your margin dwindle away before your eyes. Recovery rates by department, by client gives you an incredible insight into estimating accuracy and operational efficiency.

It also gives you the perfect tool to talk to the only people who can make a real, short term change to company profitability; whoever puts the estimate together. They need to know if  creative or production is regularly undercharged. You need to tell them and help support the client negotiation that might follow.

Under recovery may also be the result of operational inefficiency and you will need to work with department heads to understand if it is our under estimation of time or inefficient delivery that is the problem.

The importance of rates is self evident. However the interplay with recovery is interesting. Rates should always be backed by a salary cost/overhead/margin calculation (but ultimately determined by negotiation). In the cost calculation though you must make an allowance for unrecovered time, typically using 70% as a benchmark for time to be recharged.

The effect of recovery on margin becomes very clear when you do this calculation. A healthy 20% margin at 70% utilisation/recovery becomes a less than impressive 7% at 60%.

One effect of this basic maths is that it can cover up an issue with recovery. When I first started banging on about recovery it became very clear, very quickly that high margins didn’t necessarily mean high recovery. In fact high margins that relied on a more generous rate card nearly always covered up a recovery problem.

Either subconsciously or knowingly high rates encouraged over servicing and therefore low recovery. Maybe this is the right thing to do but I would always, always advocate knowing what your over servicing is. At the very least make sure your client is aware. There may come a time when there will be pressure on rates as well as an expectation of continuing service levels.

Risk

Life is full of risk. Each new project or new client has a risk. A project may overrun or a client not pay. A project which falls squarely into the core competence of the agency is low risk when compared to a more complex project that requires new skills or methodologies.

The Finance Director needs to be proactive in assessing risks. Credit checks on new clients should be taken and significant new projects assessed for risks. Factors which affect project risk are straight forward; new technology or project management methodologies increase risk as does the size and complexity of the deliverables. Timelines are important as well as the experience of the project team.

Steps to minimise risk at the outset will help preserve margin in the long run. Making sure that senior management is aware of the risk is vital if they are to sign off the upfront investment that might be required to ensure the risk is minimised.

We should always learn from our mistakes and never again will I let, say, a major website build go ahead without thinking about how it could go wrong and what we can do to make sure it doesn’t. The loss in margin spent correcting early mistakes in planning far, far outweigh the additional initial cost.

Resource

Having the right number of people with the right mix of skills doing the right things at the right time is the very definition of success. Get one of these factors wrong will have a knock on effect that will result in lower margins.

Look for constant use of freelancers. If you always have freelancers for core skills maybe you need to recruit. If you need freelancers for specialist skills then is there enough volume of work to recruit or would they enable the rest of the team to work more efficiently?

You should also look at the seniority and experience of the team. Too senior and either your margin or your competitiveness will be affected. Too junior and too much weight will be placed on the team lead.

Managing agency finances is a juggling act. I think these 4 R’s help manage them a little more effectively. Assess risks upfront, monitor recovery rates and review resource levels and you will have a positive impact on the margin.

The author, Simon Collard, has managed finance departments in the Marketing Services sector for 18 years. If you would like a chat if you need some help or advice please contact him on simon@novemberfriday.wpengine.com.