When it comes to running an agency, there are so many data points that you can look at that may or may not help you with your agency-generated income (AGI) and profitability. The thing is, some of these data points might mean nothing if you look at them in the incorrect context. We live in volatile times. Inflation is still high. There currently is no resolution to the debt ceiling issue which, if not settled by June 1st, could cause markets to act in a way that isn’t to any of our benefits.
All that to say: What you measure matters.
Of course, there are still some agencies out there that don’t measure any metrics at all. They’re just flying by the seat of their pants. How can you possibly know what is going on with your agency if you aren’t taking a closer look at the numbers? Some agencies think that if they run a profit, that’s all they need to know. But what about in a disruptive market? What do you do when the work dries up or you lose clients because they also have less money than before? Not measuring your metrics is like running a restaurant and not considering food costs.
Consider the concepts of delivery margins and delivery costs. These are two important data points to know. Delivery margins — accountants call it a gross margin or a contribution margin — are the costs to earn one dollar of adjusted gross income (AGI).
How much it costs you to earn AGI as a whole are considered delivery costs. Payroll is the largest piece of the delivery-cost pie, but there are other things factored in, such as licensing fees or stock footage library costs. But your payroll is one of the most important pieces of data that you have.
When it comes to this so-called delivery payroll, you must understand what you’re looking at. This is the foundation for an agency's profitability. You can go and try to cut your overhead all you want, but half the time that's not the problem. It's about the ratio of cost in your delivery team to how much income they can generate. If that's healthy, everything else tends to take care of itself.
There are ways to improve your delivery margin. The first thing you can do is decrease your cost (much easier said than done), which isn't feasible a lot of the time. So how does an agency get its team to make more money with the available capacity that it has? One lever for that is your average billable rate and another is your utilization.
Imagine a team has 10,000 hours of capacity. If they're doing a 50% utilization, that's 5,000 hours per year that they are earning revenue for the business. And if they earn $100 per hour, then that team can earn $500,000 in AGI. If the average billable rate at 5,000 hours per year increases to $125, now all of a sudden that same team is earning $625,000. That's a massive improvement. That could be the difference between losing money and being very profitable.
Take it a step further. If a higher billable rate is combined with a 60% utilization, the agency goes from 5,000 to 6,000 hours of utilized time at that $125 rate, and now they're making $750,000 in AGI. That's a 50% increase relative to the earlier example. The team hasn't changed, the payroll hasn't changed, overhead probably hasn't changed — all that happened was the optimization of two vital metrics that too often go overlooked by agencies of all sizes.
In the end, understanding metrics can help you increase profitability without ever taking on a new client. The trick to this is understanding the important parts of utilization. If you can increase billable hours and employee utilization in a meaningful and intentional way, you can increase your profit margins.