Managing Your Agency For Profit
How to enhance and protect the pricing and profits for your agency.
Prosper Group was recently asked by the PR Council to present to its members the results of the Council’s 2023 Membership Benchmark Study and also provide Prosper Group’s observations and recommendations based on those findings.
During our work, we found some issues that significantly impact agency profitability. The purpose of this article is to share our recommendations on pricing and client budgeting.
Why it’s so important for agencies to have an aggressive pricing model.
Strong, consistent profits are essential to the long-term viability of your agency (as well as its market value).
Unfortunately, there are always significant pressures on profitability including:
Clients who wish to negotiate/reduce your pricing structure.
Overservicing accounts (too many agencies do this) which reduces your profits.
Relentless increases in salaries, benefits and operating costs.
Economic downturns (we may be experiencing one now).
Financial guidelines for running your agency for a premium profit.
There are well-established financial ratios which agency owners must keep in mind to keep costs under control and consistently generate strong profits.
Most importantly, people costs (pre-bonus pool) should not exceed 50-55% of net revenue. Firms with many specialty roles struggle with this. Agencies with the most pricing leverage will be below 50%.
Space costs should be 6% or less of net revenue. Selling costs should be 3% or less. Keep overservice (which not only reduces profits but commoditizes the agency) to 5% or less of the fee.
Recover subscription services and IT investments via a 4-10% surcharge on the fee budget.
Profitability goals: For strategy-led, niche-focused public relations firms, your goal is a pre-bonus operating margin of 25-35%. Advertising agencies are closer to 15% (due to having many specialty roles and also low pricing for media buying). Generalist PR firms are in the 15-20% range. Strategy-led PR firms, public affairs and lobbying lead the pack with 35-45% margins.
Several recommendations for pricing and improving profitability.
As an overall philosophy, agencies should have an aggressive starting point in constructing their financial models in order to place the firm in the best negotiating position with clients. (Note that niche agencies usually have more pricing leverage than generalist agencies.)
For example:
Increase your rates annually to keep up with increases in salaries. (Both the PR Council and PR Week report that salaries rose 7-8% in the past year.) If you don’t, profits will inevitably decrease.
You should implement your rate increases each September for all new budgets so that you’re not stuck with the old rates for the upcoming year with clients won in Q4 of the previous year.
To the degree possible, build surcharges into budgets. Data and research subscriptions are expensive. Investing in IT is even more so. Develop a strong rationale for these surcharges that you can use for justifying them to client procurement departments.
Don’t forget to negotiate crisis rates with your clients. Ensure they’re applied when appropriate.
Bill rush charges for creative/digital project work if the delivery dates are moved up.
Make sure that you’re billing for travel time and marking up out-of-pocket expenses.
The importance of billable targets and multiples.
There is a direct and inescapable connection between salaries, billable targets, billable hourly rates and profit. Your target billing rates must increase with salaries or profits will suffer.
Begin by setting targets for annual billable hours as high as you think can realistically be achieved while keeping staff motivated and energized. A higher target will result in greater profit and lower cost per client hour since salaries are fixed.
Then carefully set the multiple for each level of staff. (Multiples are applied to the cost per client hour for each role in the agency to create the billing rate for that hour. The multiple must take into consideration people costs, agency overhead and desired contribution to profit.)
Sample client hour multiples by role for strategy-led, niche-focused agencies could be:
Owner/Salary X 1
Executive VP/Senior VP X 2
Vice President X 3
Account Supervisor/Account Director X 4
Senior Account Executive X 5
Assistant Account Executive/AE X 6-7
To arrive at your agency’s multiple by role, simply take the average salary by role and divide that figure by your average billable target by role. This gives you the average cost of a client hour for that role. Then divide your billable hourly rate for each role by the average client hour cost for each role.
Best practices for protecting your pricing model.
1. Avoid retainer billing if possible unless you have mastered managing retainers.
For most agencies, fixed monthly retainers make it all too easy for mission creep to occur and for the agency not to recognize that as it’s happening. Many staffers assume that all agency work falls under the retainer.
For some firms such as public affairs, lobbying or agencies with deep financial skills, fixed retainers can lead to premium billing due to under-service. These firms have mastered premium retainers and generally do less work than the retainer amount. However, most small to mid-sized PR firms don’t have the financial skill required to effectively manage retainers.
As an alternative, some agencies might want to consider a minimum monthly retainer where 60% of the average monthly billing is billed on the first of the month. Reconciliation and billing of any overage of hours takes place at the end of the month along with any expenses incurred. The benefits of this approach to the agency include 1) reliable cash flow and 2) it forces smaller agencies to carefully review all activity in order to actually bill all of its billable hours.
2. Ensure that you have a highly effective process for client budget assembly and approval.
Larger budgets should receive greater internal scrutiny before the budget is presented to the client or prospect. Agencies must make money on their largest clients in order to have superior profit margins.
Also make sure that budget protections are built into every scope-of-work. (Read our in-depth thinking on developing stronger SOW documents here.)
Your budget assembly and approval process should always include:
Zero-based budgeting.
Being built tactic by tactic, role by role, hours times rates.
Adequate time provided for strategic counseling and reporting.
Footnotes for major budget assumptions.
Total fees and expenses (and a comparison to client budget guidelines).
3. HOW you present the budget makes a big difference in getting it approved… or not.
When presenting budgets to clients or prospects, make it clear that these budgets are informed predictions of the future but no one can predict the future with 100% accuracy. Therefore, a reasonable degree of flexibility should be acceptable.
Accordingly, always present budgets in ranges and not fixed dollar amounts. Further protect yourself by including two footnotes in every SOW:
This budget is an estimate with a possible variance of +/- 10%.
The agency reserves the right to move money between budget categories.
If your calculated budget is higher than the client’s guideline, first present the core SOW/budget to demonstrate that you’ve listened (and are very careful in how you spend clients’ money). Then present supplemental budgets with compelling explanations of their importance to the client’s success. Let the client decide whether success or the budget is more important.
4. Instill and maintain rigor throughout the billing process.
The two watchwords for billing are scrutiny and accountability.
The account lead should be responsible for reviewing and approving all activity with a careful and experienced eye directed in particular towards:
Identifying and minimizing mission creep.
Seeking incremental billing opportunities.
Overservice hours should require an explanation to a very senior executive. Chronic overservicing should have some impact on the account leader.
Read Prosper Group’s thinking on best practices for the billing process here.
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Prosper Group exists to help the owners of independent marketing communications agencies achieve their ambitions and maximize the value of their life’s work.
Our team is comprised of former agency leaders and owners who focus their deep experience on implementing proven proprietary methodologies across our three practices of agency performance, owner exit planning and M&A transactions in order to drive owner and agency success.
To learn more about us, please visit the Services page in our website.
