How to make money in the agency business: five business models
An agency business is based on bringing together talented people to solve problems for clients. The difference between the combination of salary and overhead costs is profit.
As an agency owner or manager you've four basic levers to manage your agency machine:
- Pricing - this is a scale between time served and aligning fees with value delivered
- New business - Win or turn away business based on staffing capacity
- Staffing - Hire or fire to deliver against workload
- Overhead - Manage infrastructure, sales and marketing costs
Staff and overhead are the only two costs that you can proactively control, and only then within the constraints of contractual obligations.
Managing clients and creative talent can be challenging but agencies aren't complex businesses. There's limited capital outlay, and no distribution, inventory or supply chain to manage.
Within the parameters outlined there are five types of agency that deliver varying levels of profitability.
#1 Sole practitioner - an individual working alone will typically work from home with no infrastructure and no staff costs. It's a high margin business that will generate a decent income but it isn't scalable.
#2 Agile agency - a sole practitioner typically hires freelance staff to deliver projects. Staff are a variable cost and typically work from their own premises. It's a good way for someone with a strong network to scale beyond a freelance business and generate a decent income.
#3 Traditional agency - the most common business model. Staff are matched to work and charged at an hourly rate based on outputs. These are people intensive businesses but are scalable and generate a decent margin.
#4 Arbitrage - a combination of #2 and #3 in which agencies provide an integrated service beyond their own skill set by managing third party vendors typically adding an arbitrage and project management cost.
#5 Value based - these agencies are high margin. They disconnect outputs from fees and charge on the basis of the value delivered to the client. This is typically measured in terms of business performance such as cost or time saved, or leads or sales generated.
Staff cost ratio
The fundamental relationship between staff costs and income in an agency business means that it is straightforward to model. There are very few moving parts.
Everyone should understand how the agency makes money and how they personally contribute to the process. In a high performance agency this will be a key performance metric.
I shared a sketch via LinkedIn and Twitter of the breakdown of costs in an agency last week. It caused much excitement and debate.
In a traditional agency staff costs including non-fee earners are 50 to 60% of income; overhead is 15 to 25%; and the balance of 15 to 35% is profit.
When Steve Earl and I ran Rainier PR, a 25-person tech PR agency we aimed for 55/25/20. We hit 30% profit when the agency was working optimally and invested a chunk of profit in freelance staff and bonuses to avoid burn out.
Overhead costs are activities that relate to the cost of running the business. Finance, marketing, tools and infrastructure appear under this line item. Depreciation of fixed assets such a computers also appears here.
People and new business pipelines
The greatest challenge then in running an agency is balancing talent with income. Managing a pipeline of good people and future income are important tasks.
Account management and sales are much underrated agency skills.
Clients inevitably come and go as their needs fluctuate and change. A good client director will spot both opportunity and risk.
Likewise a strong sales person will qualify potential clients quickly, understand win rates and be able to predict staffing needs six-months out.
Cashflow and debt
Finally a word about debt. Poor cashflow will cripple even the best business.
Staff and overheads need to be paid 30 to 60 days before invoices for work are settled by clients.
You either need reserves or an understanding bank to cover this period.
Ensure that invoices are settled quickly. Sound financial management is critical in any business.
Agencies aren't complex business, its clients and people that make them that way.