How to Increase Agency Profitability and Make Smart Growth Decisions
Would you like your agency to be more profitable? Have you analyzed which of your clients are profitable and which engagements are losing money? You may feel you’re doing everything right but still aren’t profitable. However, it could be just a case of learning how to assess each client’s profitability and raising prices on legacy clients. Today’s guest shares ways you can learn about agency profitability and increase your profit margin.
Russell Benaroya is the owner of Stride Services, a digital agency that provides outsourcing, bookkeeping, accounting, and CFO services for digital agencies. They provide timely, accurate, and actionable data so business owners can make decisions based on hard facts. In this episode, he shares some steps to assess whether a client is profitable, why you should look at your service as a product, and much more.
In this interview, we’ll cover:
- How to make smart, profitable decisions to grow your agency.
- 3 Questions to determine why an account is not profitable.
- 2 Steps to evaluate if a client is profitable.
- Raising prices for legacy clients.
Sponsors and Resources
E2M Solutions: Today’s episode of the Smart Agency Masterclass is sponsored by E2M Solutions, a web design and development agency that has provided white-label services for the past 10 years to agencies all over the world. Check out e2msolutions.com/smartagency and get 10% off for the first three months of service.
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How to Smart, Profitable Decisions About Prospective Clients
For Russell, the agency space is at an interesting point where agency owners are starting to learn more about the type(s) of clients they serve. It’s important they understand each engagement and the level of profitability it brings to the agency. It is a moment of opportunity and transition where agency owners must be informed and armed to make smart decisions.
How can you make smart decisions for your agency’s profitability?
Financial information isn’t particularly telling for many agency owners. It doesn’t tell them anything about how to act around a particular engagement. Russell believes you have to keep peeling back the layers to get to the information that really matters. Basically, you need data on how much revenue you’re making for a client but also what costs, time, and direct expenses are you putting into the client?
With this information, you can assess whether or not they are profitable for the agency. If the answer is no, then why and what can be done about it? This investigation leads to taking action at the client level.
2 Steps to Assess a Client’s Profitability
Russell’s agency uses these two techniques to help agencies that need to assess whether or not a client is profitable:
- Viewing financial and time data in one place. Let’s say you’re using Harvest for time tracking and have some direct expenses sitting on Quickbooks online. Russell and his team bring that into a unified environment and quantify the value of the time put into an account. Once they put that information together, it becomes easier to see the client or engagement’s profitability.
- Understanding the shadow bill rate. This is especially relevant for agencies on retainer-based agreements or monthly recurring revenue (MRR) subscriptions. The shadow bill rate is a fairly easy calculation that takes into account the monthly recurring revenue and what you would be billing if you charged hourly a rate equal to the resources needed for that client. That ratio is what Russell calls the “win for all” and it’s an indication of whether or not your MRR is sufficient for a level of profitability.
3 Important Questions to Measure Agency Profitability
If you had to track just one metric in an agency, Russell recommends it’s the golden metric: the “win for all” ratio. He feels it is the single most important metric that forces you to ask yourself:
- Did we price this client incorrectly?
- Do we have process issues affecting our efficiency?
- Are there issues on the client side keeping us from being effective?
This is the biggest driver for assessing profitability and becoming self-aware of what’s standing in the way.
How to Increase Prices to Legacy Clients
There are many reasons your “win for all” ratio may be low; pricing is just one of them. If that is the case, it’s time to ask yourself how many clients you have on legacy pricing. It’s common for agencies to have more than a few clients at almost half under current prices. There’s a huge opportunity cost there.
As humans, we avoid conflict which makes it hard to increase prices. Instead, most people start to over-service clients to make sure they’re very happy and then increase prices. However, this is not the right way to go about it and involves spending more resources on that client.
Russell says agency owners need to have a “state of the relationship” discussion. This allows the opportunity to understand how the client views the work and then explain it’s time to increase prices.
What’s the best way to approach a client and make the account profitable?
It is particularly hard to support a client who is out of scope if you don’t have the data. Once you start the conversation, clarify there’s a difference between what you originally agreed upon and what you’re doing now. That means you’re operating out of scope. Going forward, try to look at your agency services as a product… And a product has standards. When you articulate those standards and the tasks associated to create that product it will be easier to evaluate if your actions are within the scope of that product or not. It’s an objective way to be unemotional about the work.
Measuring Profit Margin of a Healthy Digital Agency
If you’re an agency owner interested in measuring your clients’ profitability, you can start by measuring the gross margin. Gross margin is revenue minus direct costs associated with serving that customer. Typically, you want gross margin to be between 50% and 55%.
If you’re in an investment year that number is lower. However, growth investments are very important for the future of your agency, so keep that in mind before freaking out over your income statement. It is a variable that is dependent upon if and when you want to sell your agency.
One mistake Russell sees agency owners make is not taking a good salary for themselves in order to increase their margin. This isn’t a good idea and becomes just an artificial achievement.
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