What do the most profitable businesses have in common? They’ve dialed in on a winning formula that results in happy customers, steady growth, and, of course, revenue and profit. They’ve created a repeatable process to acquire, onboard, serve, and delight their customers, driving referral business and starting the cycle all over again.
In a recent interview on the Conquer Local Podcast, Parakeeto Co-Founder and CEO Marcel Petitpas shares his insights on how agencies can zero in on what that winning formula looks like for their businesses.
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What does profit mean?
Profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question, according to Investopedia.
Any profits earned funnel back to business owners, who choose to either pocket the cash or reinvest it back into the business. Profit is calculated as total revenue less total expenses.
But how can agencies ensure that they’re not only exceeding their profitability threshold but surpassing it with enough of a margin to allow for sustainable growth?
Questions to ask before diving into the numbers
According to Petitpas, before agencies dive into metrics gleaned from using tools like time trackers, agency CRM reporting, and project management software, there are some foundational questions they should be asking first.
To ensure an agency is choosing the right path to become one of the most profitable businesses in the agency world, they can ask themselves:
- Who do we need to hire and when? Do they have the skills we need?
- What if we close this deal?
- What if we don’t close this deal?
- What if this deal starts two weeks later than planned?
- Are we making money on clients and projects, and if so, how much?
- Which clients or types of work are most and least profitable for us?
- Are we scoping projects properly?
- Did this take as much time as we thought it was going to when we sold it?
We see these questions from agency leaders, operations managers, and teams often. Unfortunately, it’s really painstaking for them to get some numbers together to support that conversation and make them feel like they’re making objective decisions as opposed to just using their gut.
Recommended Reading: Project Estimation, Done the Right Way
Sometimes, winning the work isn’t the hardest part of the job
To rise to the occasion and join the ranks of the most profitable businesses in the B2B space, agencies not only have to become a master at winning new business but also realize it’s everything that happens after the sale that will determine whether or not a customer is going to continue to contribute to their bottom line.
There’s a lot of complexity to finding the answers to the questions agencies have. You’re dealing with humans, you’re dealing with time, and it can feel like the business is happening to you instead of for you.
If agency owners can get into a place where they can be looking ahead in their decision making, it’s a game changer, according to Petitpas.
Digging into solving and answering the questions above will:
- Make the business more enjoyable to run
- Help to set better expectations for clients
- Ensure agencies are not asking their team to stay late to hit deliverables as often
- Gain better visibility into the future profitability of the business
Why agencies should focus on their best-fit customer
Becoming laser focused on the clients that make the most sense for your business can help offer clarity in other areas of the work as well. Petitpas suggests this foundational work can help steer agency acquisition efforts and even inform your pricing strategy.
“When it comes to pricing, should you be lenient or should you be aggressive and stick to your guns at the risk of losing the client? There is math that you can look at to determine where on that spectrum you exist,” explains Petitpas.
Petitpas outlines two scenarios:
- The agency is making one dollar an hour on a project. If utilization is low, it’s better to make one dollar an hour than to make nothing and let those hours go bad.
- If an agency is forecasting capacity and high utilization, they might determine that losing a deal wouldn’t be as detrimental. At that point, an agency may take a different approach to whether or not they choose to take on that job.
What I see happening often is that agencies are relying on their gut instead of what the numbers are telling them, and they end up in a rut of systemic discounting when it’s not necessary and it ends up causing indigestion, which feels like starvation and has the same effect on the bottom line
The key metrics agencies need to track
Agency owners can get easily overwhelmed looking at a wealth of data and determining which Key Performance Indicators (KPI) they need to be paying attention to the most. Petitpas suggests a list that he says has helped dozens of agencies reach profitability:
1. Agency gross income (AGI)
Agency gross income is calculated differently than total agency revenue. According to Petitpas, agency owners should strip out any income that could be considered “pass-through.” While pass-through income is revenue an agency is collecting from a client, the income is simply being passed on to a third party in the end. Examples of revenue that wouldn’t be included in AGI include:
- Digital ad spend
- Print budget
- White-label partners
Expert Tip: Exclude contractors from AGI if they are doing work that isn’t core to your business. However, if you’ve outsourced work to a contractor because you simply don’t have capacity and you are treating them as an extension of your internal team, you can bring them under your AGI umbrella.
If agencies are looking for a number that represents AGI on the current profit and loss (P&L) statements, Petitpas says gross profit is likely a good place to start.
2. Agency delivery margin
The next metric agencies should be identifying is called delivery margin. This metric includes shared delivery costs, like subscriptions or tools, that are not necessarily needed for a single project but that a delivery team needs to carry out the work. Combining delivery costs with the delivery team salaries will get an agency to their delivery margin.
“When compared to your AGI, generally you’re aiming for a delivery margin of 50 percent or higher on the P&L at any given period of time,” Petitpas says.
3. Agency overhead
Agencies will want to ensure they’re not spending more than 20 to 30 percent of their AGI on overhead costs like:
- Administration spend
- Sales and marketing spend
- Facility costs (rent, internet, phone, etc.)
Agencies should target a spend of 8–12 percent of your AGI on admin, 8–12 percent on sales and marketing, and 4–6 percent on facilities.
Expert tip: Agencies should review the above metrics on a quarterly or even monthly basis, when they receive reports from an accountant or bookkeeper.
4. Average billable rate (ABR)
More easily accessible than delivery margin, ABR can give agencies a quick snapshot into the profitability of any given segment they want to examine on a weekly or even daily basis. Here is the formula to calculate ABR:
AGI for any project, client, or period of time
# of billable hours worked
$10,000 AGI / 100 billable hours = average billable rate of $100 per hour
This metric very quickly gives agencies insight into which clients have higher and lower average billable rates. It will tell leaders how the rate is trending over time. If agencies have a good idea of what their average billable rate is, they can get a better sense of what the delivery margin is during a certain time period or for a particular project.
5. Agency utilization
To calculate utilization rates, Petitpas suggests looking at the total amount of time a person has and compare that to the billable hours they logged.
John Smith has 2080 hours available in a calendar year
John clocked 1400 billable hours
John was 67 percent utilized during the time frame
Utilization targets for the purely billable members of an agency team should sit around 75–95 percent, and targets for the entire team should hover around 60 percent for the year.
6. Scoping accuracy
“Agencies need a feedback loop to tell them when they were out in left field when they put a proposal together. Maybe it took twice as much time or maybe the development portion of a website build was way off. If so, then there’s no way for agencies to tighten that up and make it more accurate over time,” Petitpas says.
At the end of each project, agencies should measure how close they came to the assumptions they made at the beginning of the project. They should be aiming to fall within 10 percent of the initial scope.
Agency owners rely on this gut feeling of discounting that often becomes systemic and impacts the bottom line in a big way. This approach often isn’t scalable and will leave agency owners worse off than when they started. By implementing the checks and balances above, agencies can reduce uncertainty and build a repeatable decision-making process based on data rather than assumptions. In turn, agencies can join some of the most profitable businesses on the data-driven decision path.
About Marcel Petitpas
Marcel Petitpas is the CEO & Co-Founder of Parakeeto, a company dedicated to helping agencies improve their profitability by streamlining their operations and reporting systems. In his work as a speaker, podcast host, and consultant, specializing in agency profitability optimization, he’s helped hundreds of agencies around the world improve profitability and cash flow in their business. Follow Marcel on LinkedIn.