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Agency Profitability Management w/ Marcel Petitpas

marcel petitpas

Ryan Stewart

I build, grow and sell digital agencies. Most recently, WEBRIS, a 7 figure SEO agency.

26th October 2020

0 Comments

Timestamps:

  • 1:18 Is your product specifically focused on agencies? 
  • 1:51 How did you land in this space?
  • 3:45 Is this something that you work with start-up agencies to build a foundation? Or is this more for scaling agencies?
  • 6:12 Many agencies are not able to pin down a problem when they realize that they’re not making any profit. What do you think is causing that problem?
  • 9:48  There are so many opportunities to hire people nowadays. How does that impact that number?
  • 10:15 Since agencies tend to be people-based business, hiring and staffing tend to be a really essential number. Do you give suggestions to your clients on who they should be hiring along with their price range when you’re discussing numbers?
  • 13:40 A lot of these problems are hinged on pricing. What’s your opinion on raising prices?
  • 15:03 Is there a specific pricing model that you prefer to use?
  • 19:46 How do you know how much to estimate if you don’t have the hours on the backend? How do you fix that if you don’t have that set up properly?
  • 28:46 Do you have insights on staffing ratios within a digital marketing agency?
  • 39:20 The relationship between detail and complexity as it relates to time tracking.

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1:18 Is your product specifically focused on agencies?

Our best agencies tend to be the one that are focused on creative or marketing. We found that when it comes to agencies that are focused on software development or something similar to that, the complexity is so high and you just need a lot more human touch to get an estimate right.

1:51 How did you land in this space?

My first business was an agency. I was doing virtual reality services for real estate agents. That’s when I first encountered these problems such as running up against cash flow issues, not being very profitable, having thin margins, etc. I ended up walking away from that business because I realized that I wouldn’t be able to sell at a price point that would allow me to scale.

After leaving, I got really interested in software and ended up working with a friend of mine. I was helping him out in his agency, he was doing software development. Eventually, we kind of came up with this thesis that other businesses are struggling with how to answer basic questions about their businesses without having to spend a lot of time on spreadsheets. That’s when we came up with the idea for Parakeeto.

3:45 Is this something that you work with start up agencies to build a foundation? Or is this more for scaling agencies?

Usually, people start to reach out to us when they start to feel the symptoms. Right around 10-12 employees mark. They have figured out how to sell, they’ve started scaling, and they’ve already figured out one channel that works for them. This made them confident to sell more work. Until they realized that they’ve been busier than they ever been, but they still don’t have any money in their bank account.

The second growth ceiling tends to hit the 25-30 employee mark. At this point, the founders usually have to install an executive leadership team. This is when they face another whole set of problems that require some data in order to solve it in an informed way.

Those are the two main sticking points that I ended up working on. We focused on clients within those first two growth ceilings.

6:12 Many agencies are unable to pin down a problem when they realize that they’re not making any profit. What do you think is causing that problem?

There are a couple of things.

First, there is this disconnection between revenue and profit. When agencies are scaling, they often focus only on revenue numbers and they’re not thinking about the gross margin to generate that revenue. They’re not designing their operation to have a high gross margin from the beginning.

When you design a project, you should always make sure the selling price will leave you with a margin that is between 50% – 70%. What that means is once you’ve taken out the ads spend, print budget, and all the money that does not actually belong to you (that’s passed through revenue), you’re left with a certain number. I like to call it your Agency Gross Income. That’s the amount of money that your agency is responsible to earn.

What you want to do is do the math on what it is going to cost you to earn that amount of money. That’s usually the combination of your Staff’s salary. You need to figure out how much of their time is the project going to take, and the cost of their time. You can calculate this by taking their fully loaded salary and dividing it by the number of hours that they’re committed to in their employment contract. Make sure that when you add up all the hours, you’re still setting yourself up for a margin of 50%-70%. That’s step number one.

The second thing is you want to set up the tooling to be able to check if the assumptions you make when you sell your work to your clients are realistic. The fundamental truth is everybody’s agencies are built on assumptions. That set of assumptions is the scope of your client’s work and what’s it gonna take to get that stuff done.

All the decisions that you make for the agency will be based on the assumptions that you made about that scope. So if you’re not able to get somewhat accurate assumptions, all of the infrastructures of data that you need to make your decisions are going to be unreliable.

10:15 Since agencies tend to be people-based businesses, hiring and staffing tend to be an essential number. Do you give suggestions to your clients on who they should be hiring along with their price range when you’re discussing numbers?

I think the big consideration around this is thinking about should I go elastic or non-elastic with my workforce. It’s basically deciding whether I should use contractors or employees. The main difference between the two is that with contractors I’m only paying them when I have work, while I still have to pay my employees whether I have work or not.

If you use employees, it is super important to design your projects to have a high gross margin. It should be easy to do that since employees are typically a lot cheaper than contractors. But on the downside, you might only get them to be “billable” 65% of the year. You need to structure your business to accommodate for the fact that you’re going to pay them to take vacation, holidays, and the time when you don’t have a full roster for clients. That’s the consideration when you’re hiring salaried employees.

If you’re still struggling to figure out how to consistently get clients for your agency, then it probably makes sense to go to an inelastic workforce or contractors. You’re probably going to pay a bit of premium for their time and lower your gross margin. But that’s probably okay because you don’t have to pay them when they take a vacation. You only pay them when you have work. If you can find these contractors from cheaper countries (without sacrificing the quality), it will be even better.

One question that I also get quite often is about when you should transition from using contractors to hiring employees full time. Basically, you want to see their total annual salary and find out whether you can 2.5 times more revenue from that.

13:40 A lot of these problems are hinged on pricing. What’s your opinion on raising prices?

I think that most of the time, you can solve a lot of these problems by just raising your prices. However, you want to be careful about that. If you still haven’t gone back and addressed some of the fundamental problems (such as not being good at scoping client works, being constantly over budget, and not having a good process for the work), you’re still going to run into a lot of issues.

You need that fundamental bedrock process of being able to accurately scope what it’s going to take to get work done coupled with pricing increase and maximizing efficiency. That’s where you’re going to end up in a place where you can be both very profitable and very scalable. A lot of people think that there’s a trade-off between those two. But in my experience, you can get both if you have the right systems and data in place.

15:03 Is there a specific pricing model that you prefer to use?

Yes, I’m a big fan of value-based pricing. Especially for digital marketing agencies, where there’s not going to be a lot of uncertainty or risk around the type of work that you do. I think it’s a great way to go because you’re able to start detaching the price that somebody pays you from your cost basis.

I really like value-based pricing for most businesses. But, I think there’s a time when this will not be a good approach. It’s when you are innately doing something that’s very complex and very risky. Software development is a perfect example of this. Most of the time, it is hard for software developers to put price based on value because you can’t really know what it’s going to take to get something built until you’re doing it.

If it’s impossible for you to scope your work, then I would move to something like an hourly model or a team leasing model. But if you’re doing SEO or digital marketing, you have a fairly normalized scope of work. There’s a very low risk on that kind of deliverable.

19:46 How do you know how much to estimate if you don’t have the hours on the backend? How do you fix that if you don’t have that set up properly?

To find that out, I use a fundamental model that I called Agency Profitability Flywheel. The flywheel consists of 4 parts: Estimates, Cost & Time Tracking, Meetings, and Process Improvements.

There are two keys we need to consider to create our estimates. We need to make it standard, and we need to make it simple. If the way you scope work and structure your estimates is changing all the time, then you have a moving target that you’re trying to hit when you’re setting up your tooling for everything else in the business. You need to standardize the way you make your estimates. Create a model for it.

The next system that we want to install is cost & time tracking. For our industry, time is going to be 65% of your P&L. It’s your largest variable cost. Here’s the key: you want to create a feedback between the estimates and the cost & time tracking. The purpose of time tracking is not to play ‘big brother’ to your employee.

The sole purpose of time tracking is to make sure that your assumptions about client work are accurate. Make sure that both your estimates and cost & time tracking are aligned.

Estimates and cost & time tracking will give you your first feedback loop. We usually call it Quantitative Feedback. The second feedback loop is called the qualitative feedback loop. It consists of Meetings and Process improvements.

During the meeting process, we evaluate the projects that we did in the past. We evaluate which projects were doing well and which projects were a failure. We’ll find a way to analyze what caused the success or the failure. The results of these meetings will lead to Process Improvements. Try to include your team involved in the designing and development of your process improvements. This will make it easier for them to follow and maintain the new improved process.

28:46 Do you have insights on staffing ratios within a digital marketing agency?

I’m going to answer that purely from a financial perspective. How you structure your team depends on how the services that you have and what expertise are required to service your clients. Based on a profitability perspective, we need to figure out a way to get our billable team to a place where they’re utilized at 65% -75% on an annual basis.

If you can hit that utilization number and you’re at an average billable rate that is 2-3 times greater of your average cost per hour, then your staffing ratios are good. You can also take a look at your P&L. You’re in a good place If you can hit 40% – 60% gross margin annually.

If you want a tool that helps you model this, I have one in our agency profitability toolkit. It’s called the agency model generator. You can put in your team, how many hours they work, how much you pay them, and what you expect their average billable rate would be into that generator. It will calculate how much revenue you need to make and it will help you figure out how much revenue you can spend on different areas of your business. You can check it out at https://parakeeto.com/toolkit

39:20 The relationship between detail and complexity as it relates to time tracking.

One of the big mistakes that I see people make all the time is being too detailed on their time tracking. They try to get to a level of granularity that is completely unsustainable for their team and their operations manager.

There is this relationship between insight into people and insight into the process. You need to find a happy medium between the two because the more you add details into your time tracking, the more complex it is for your team to follow through the process.

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