Increasing profits should be a primary financial concern for all businesses, including marketing agencies. According to industry benchmarking data, marketing agency averages a net profit margin somewhere between 6.0% and 12.0%, which means there’s plenty of room for growth. For the agencies we work with, generally the bogey is a 15.0% net margin.
No agency is powerless to overcome poor margins. That’s an area where a CPA like me can help. Consider several methods that can help lift lagging profit margins.
Gross Profit vs. Net Profit Margin
Gross Margin
Gross margin can either be shown as a dollar figure, so a nominal figure, or a percentage. You may also find gross margin referred to as gross profit or adjusted gross profit. Presented as a nominal figure, the formula is:
Gross Revenue – Variable Selling Expenses = Gross Margin
Depending on your agency’s niche, “variable selling expenses” can also be referred to as “passthrough expenses.” The key here is these are expenses which would not exist without the presence of revenue, hence, they’re variable.
To calculate the gross margin percentage, the formula is:
Gross Margin / Gross Revenue = Gross Margin Percentage
Why is gross margin important?
If the agency sells another dollar of services, how much of that will it get back, not including fixed costs? This is a key metric to understand, especially when you’re selling new business.
Gross margin: buyer beware
Gross margin is important for you to track and benchmark against yourself over time. When looking at industry data be careful, though. Agencies operate very differently across the industry. For example, some agencies use a lot of contractors instead of hiring full-time employees. Contractor expenses are generally included in the gross margin as opposed to the net margin because they’re variable. You’ll only hire a contractor if you have a project to deliver for a client. This can make one agency look like they have a low gross margin, even though they have a solid net margin, when compared to the industry. Speaking of net margin…
Net Margin
Net margin, on a nominal basis, is calculated as:
Gross Margin – Fixed Expenses = Net Margin
Like gross margin, net margin can also be expressed as a percentage. The calculation is as follows:
Net Margin / Gross Revenue = Net Margin Percentage
Generally, net margin is calculated pre-tax.
Net margin is essentially your net income. Unlike gross margin, net margin is not going to vary based on the setup of the chart of accounts. Net margin includes all of the expense accounts, whereas, gross margin is only going to include the expense accounts which are deemed variable with sales by management. In other words, gross margin can almost be whatever you want it to be.
Strategies For Increasing Your Marketing Agency’s Profit Margin
Benchmarking
Benchmarking against the industry is a rational way to find areas of improvement. The key benefit of the practice is that it allows your enterprise to discover the precise areas where you’re under — or over-performing — in the industry.
Learn To Have Consistent and Evolving KPI Development
Which are the KPIs that your organization should you always pay attention to first? If you don’t know off hand, it’s time to give the subject some thought.
You’ll need to develop a system to establish goals and KPIs that are specific for your company. That’s a challenging proposition, but it helps lay the foundation for the future. You can’t possibly earn your highest profits unless you know the numbers.
Be Careful About Freebies
You may be tempted periodically to throw in a free service. It’s possible you’ll figure the client is paying a hefty amount and the task won’t take long. However, it’s a dangerous practice that results in fewer dollars in your pocket. If this type of generosity ever becomes an ingrained practice, you will have a tough time sustaining growth. It’s better to nip it in the bud early, to focus attention on increasing revenue, client satisfaction and innovation.
From a selling standpoint, offering things for free is a sign of weakness. Customers will sense that you’re overanxious to sell and may back off. That’s why low prices is a double-edged sword. It hurts credibility while depressing both the top and bottom lines.
Track Anything and Everything
Any work or materials must be in your costs, or you will lose sight of profitability. Profitability should be tracked in total, but your agency should also consider tracking profitability by client and service. You’ll need a reliable platform and integrated apps to keep an eye on everything. It’s worth making integration a central tenet because that’s what makes data management and analysis powerful. This is why cloud accounting is so powerful – data integration.
Here are three ideas you can implement right now:
- Make sure every revenue transaction in your QuickBooks file has an associated customer
- Make sure every variable expense has both a vendor and a customer associated. This, plus the above, will allow you to measure profitability and margin by customer and project.
- Measure and track your team’s capacity. The best way is to leverage timesheet data, however, it’s not 100% necessary. David C. Baker has a great model in his book, “Financial Management of a Marketing Firm”, that doesn’t require timesheet data.
In reference to the last point, contractors are generally going to be less expensive than hiring a full-time employees. Employees are expensive and you have to pay them regardless of whether or not you have billable work for them. Tracking and managing capacity, along with some financial modeling, will help you determine whether it makes sense to hire an employee or utilize a contractor.
Pay Attention to Data and Bill For The Value You Deliver
Measure the results you deliver so your clients understand the value they’re receiving, and so you can be adequately paid for the value you are delivering.
Pretty simple, right?
Pay attention to the data within your agency and also within your industry. In doing so, it’s helpful to work with professionals who will help you make the most of that informational power. Find somebody who can give you good data or help you compile data. That person also needs to be able to explain what that data is telling you, and can help you make strategic decisions based on that data.
Data is the new currency. The more data you have, the better your ability to make strategic decisions that are data driven, the more profitable you’re going to be, and the more competitive advantage you are going to develop. That is information, that is power, that is something that you can use to drive your margins higher.
Utilize annual plans
Agencies tend to be very heavy in software expenses. Most vendors allow you to either pay month-to-month or in an annual lump sum. A lot of times, the annual lump sum is 10-30% cheaper than the month-to-month plan. The software company is incentivizing you so they have predictable cash flow and access to cash now.
If you utilize an annual plan, those savings will hit your bottom line almost immediately. When should you utilize annual plans?
- When you know you’re going to use the service for at least a year. It’s core to your operation.
- You don’t have cash flow problems.
- The savings outweigh the cost. For instance, if you have the option of paying the annual plan, but it’s only a 10% savings, and you’re also carrying a business credit card balance with 20% interest, it may not make sense to go with the annual plan. Use the lump sum of cash to pay down the credit card balance and utilize the monthly software plan.
Make Justifying Value a Core Principle
Indeed, customers will always look for the best deal. You will need to maintain competitive pricing to pick up new clients. However, if you can justify the value you bring to the table, you will be able to attain higher prices. Clients who are looking for a better price are not accepting your value proposition. Quantifying the value you drive is an effective way to justify your pricing.
Nobody is price conscious. Everybody is value conscious. Companies that charge the lowest prices do so when a service is undifferentiated or can’t deliver value.
Patience and Focus Will Win the Day
It is important to keep track of margins in any business, and marketing agencies are no exception. Not only should you keep track of your agency’s net margin, but focus on gross margin, too. The way you setup your chart of accounts will impact the latter, but not the former.
Benchmarking marking agency profit margins is a worthwhile exercise, however it’s not an end-all-be-all. Instead, it should assist in providing context around what “good” looks like, but not define it.
Finally, it may be a good idea to talk to a CPA like me to make sure your accounting system is setup properly and also to identify areas of opportunity to increase your profitability.
For a more in-depth look at how you can maximize the profit margins of your marketing agency, check out the below episode of YouTube Live. In this episode, I also show some benchmarking data that you can use to compare your agency to the industry.
