Whether you own a creative agency and oversee operations or you are an operations professional of an agency, I’m certain there are many questions you are plagued with daily. Do we need to hire more people? What kind of skills will those people need? When do we hire them? Will we still have the money to make this hire if we don’t get our next pending contract?
Without data, operations professionals are tempted to make gut decisions in order to answer these questions. Sometimes, you may answer those questions correctly. Other times, you may end up making a mistake. That’s why marketing agencies need to be tracking agency performance metrics that will unveil the answers through data.
Marcel Petitpas is the CEO and founder of a company called Parakeeto. Parakeeto specializes in helping digital marketing agencies and consulting firms measure and improve their profitability. He joined us on a webinar recently and discussed five agency performance metrics you should be tracking for improved profitability.
Everyone Working as One with Clear Data
Before we dive into the five agency performance metrics you should be tracking, we need to go over the importance of everyone in the agency measuring these metrics correctly and consistently. For sales, operations and delivery, and finance to be working together towards one common agency goal (which based on the title of this article is likely increasing profitability), everyone needs to be working with the same metrics and using the same definitions for said metrics. Having disjointed agency KPIs (key performance indicators) or metrics will prevent your team from troubleshooting where issues are arising and cause some major confusion.
To start this process, we need to determine which metrics we will be tracking. We suggest the agency performance metrics listed in the next section. Define those metrics with your team so they are clear to everyone, and no definitional questions linger. Also be sure to work on catching errors when they occur.
You might be wondering if all of this is really necessary. Here is an example Marcel gave as to why it is important for departments to measure progress through the same metrics and keep definitions concise.
Let’s say operations and delivery are hitting their utilization targets. Projects are on budget, and sales continues to hit their quotas. Yet, net income is 15% lower than expected. Why? It’s likely because your metrics haven’t been clearly defined to your team and each department is likely not measuring each metric the same way. Definition and concept of utilization, capacity, and billable hours (and what counts as a billable hour for that matter) all need to have been clearly communicated to everyone on your team. This might take time to educate your team, but the alignment will be time well spent. Your agency’s profitability depends on it.
In my experience, it can be hard for our clients to wrap their heads around a different way of measuring certain operational metrics. We make sure that we are aligned with our clients on these on the front end of our relationship. Without doing the upfront work to confirm alignment in this regard, we will struggle move forward because these measurements are critical to the success of their agency and future profitability. This foresight enables us to make informed decisions promptly, allowing us to navigate and avoid potential obstacles as we advance towards achieving agency objectives.
The Metrics You Should Be Tracking as a Team
There are multiple metrics you should be tracking in order to determine the current financial health of your agency. Let’s start with revenue and gross income.
When you look at your income statement, you should be seeing total revenue (how much money is coming into your agency from all sources) and gross income (revenue less pass-through expenses). This gross income metric is how much your agency actually earns and is your starting metric to determine your profitability.
Next, you need to determine delivery expenses, also known as, direct costs or cost of goods sold. It costs money to earn money due to the process of delivering services through the use of tools like software. That’s what we are trying to capture here. What exactly does it cost us to deliver services?
By isolating this cost, you can determine your agency’s profitability accurately. Delivery expenses should be removed from your gross income to determine your true gross profit.
Be sure to separate payroll and software expenses so you can isolate what is a labor cost versus “tool” cost. From this point, you can calculate your profit above the delivery expense as well as your delivery margin, or gross profit. Aiming for a delivery margin of 50% or higher ensures a healthy agency. To calculate delivery margin, just subtract delivery expenses from agency gross income.
Three Levers to Improve Delivery Margin
Rather than cutting random overhead costs to increase profitability, Marcel suggests improving your delivery margin (sometimes referred to as profit margin or gross profit). There are three ways to do this:
- Average cost per hour: This lever is calculated by dividing loaded payroll by capacity. To use this lever effectively, you should aim to lower your average cost per hour. One way to do this is to focus on one specific type of work. Create a system that decreases the time to perform that type of work while not increasing the cost to do so. You might find that a technology drastically decreases the amount of time it takes your staff to perform a certain task. This may outweigh the cost of the technology itself. The time this technology would save you could be utilized by your team to perform more client work leading to more profit.
- Average bill rate: To calculate your average bill rate, simply divide agency gross income by delivery hours. This metric allows agencies to assess how efficiently they are earning revenue regardless of the billing method used. Marcel emphasizes that using delivery hours is better than billable hours to ensure that efficiency and value creation are truly reflected in your agency metrics.This metric is especially helpful to open up conversations with your team about efficiency and its impact on profitability. By analyzing your average bill rate across different projects, you can identify which areas of improvement and potential agency growth are available. Is one team performing a certain service faster than everyone else? What might they be doing differently that the other teams can be trained on?
- Utilization: While utilization can be a touchy subject due to its misuse in some settings, it is a vital metric to measure the efficient use of your team member’s time. To calculate utilization rates, divide delivery hours by capacity. Using delivery hours instead of billable hours gives a more accurate assessment of time spent on work allowing you to see the true costs incurred by your team according to Marcel.
Measuring utilization exposes where inefficiencies might be taking place from non-billable time like work conferences, holidays, time tracking, etc. Unused capacity is directly equal to wasted resources. Marcel puts it this way: “This is such an important piece of the puzzle because you could be profitable on every single project, but if your team’s sitting around and you’re paying for a bunch of unused payroll, it’s still not going to be healthy in your delivery margin.” Uncovering underutilization and solving that problem will lead to higher profits when fixed.
For example there could be a time tracking software that is more streamlined and would prevent wasted time that your team could use towards client work. Maybe you find that a conference your team goes to isn’t providing the continuing education rewards you expected, and a shorter more detailed conference would be better for your team. These are just two examples of how analyzing utilization could reveal lost time, and therefore, lost profitability.
One of these agency metrics alone won’t give you a glimpse into the financial health of your agency, nor will one metric help you improve the profitability of your agency. It’s best to measure all of these metrics and use a combination to help predict the future profitability of your agency and make changes to avoid pitfalls in your growth strategy. It’s also important to utilize cash flow forecasting and scenario planning to plan for profitability and see real-time data on your agency’s health.
If you have any questions about optimizing your plan to achieve agency goals, you can sign up for a free consultation with one of our Virtual CFOs. A virtual CFO can help you determine your ideal pipeline size, explore how to expand your customer base, improve the financial health of your agency, and much more.
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