While recently discussing ideal profit margins, I was reminded of this simple doodle from Comms professional Stephen Waddington:
— Stephen Waddington (@wadds) September 19, 2015
While it was designed with a PR business in mind I’d venture to say it is the ideal model for most mature agencies.
Indeed, there’s no escaping the fact that agencies are people-intensive businesses, so finding and retaining the best talent can put a limit on the pace of growth as well as margins.
Perhaps this is why some agencies invest time and resource into to developing a product or software solution that can scale more easily. In the tech sector, It’s not unusual to see SaaS companies with 80% gross margin – although taking this to net profit is something different.
Stephen’s example is clearly a rule of thumb; there will be agencies with both higher and lower margins, depending on a number of factors which I’ll touch on here.
The maturity of the market can have an impact on profitability, and Porters Five forces is a textbook classic for understanding this. New markets tend to have less competition, so margins can be higher until new entrants spot the opportunity. I saw this in the early days of search marketing, and I’m tempted to think it’s now the case with influencer marketing.
Different stages of agency growth tend to see different profit levels. On one hand, larger businesses benefit from economies of scale but there can be stepped changes in costs as you add new management tiers, new offerings or new office locations. Again, I believe Stephen was referring to a mature agency in his note.
If 60% of your costs are staffing, then the availability of talent (or lack thereof) is going to affect you. We’re still seeing heavy salary inflation in the digital sector and it may be a number of years before this slows down so don’t be surprised if that 60% moves north.
Client mix can impact margins for a couple of reasons: If you’re working for clients in low margin verticals don’t be surprised if your margins are also wafer thin; also international clients can expose you to currency fluctuations which can be positive if you hedge and negative if the pound strengthens.
Finally, your brand image and reputation can have a dramatic impact on pricing, and therefore profit margins. If you’ve focused on a specific vertical or an approach to become best in category then you can likely push that rate card and ultimately margins.
If you’ve discovered any great ways of boosting agency margins, feel free to share!