The path to above-average profitability and sustained growth using the 50/25/25 Profit Model
Introduction
All agencies that wish to grow must do many different things well including:
Allocating staff and financial resources to client service
Pursuing sales opportunities (New business)
Building reputation and driving leads into the firm (Marketing)
Recruiting while also managing the careers of staff members (Talent)
Investing in future revenue-generating initiatives
Performing general administration
Finding sufficient resources to execute effectively against all of these activities while simultaneously earning a healthy profit separates the firms that grow over time from those that reach a revenue plateau and stagnate.
Assuming an agency wishes to make a strong profit, marketing communications industry experts have consistently recommended that agency leaders adopt the 50/25/25 model.
However, while this model will deliver short-term profitability, the agency’s revenue level may still plateau unless the resources are found to execute all key agency activities at a high level.
Defining the 50/25/25 Profit Model.
The model allocates revenue into three categories: people/labor costs (50%), overhead (25%) and operating profits (25%).
The 50% of agency revenue that is allocated to people/labor costs includes:
Staff member salaries (billable and non-billable personnel)
Payroll-related taxes
Freelancer costs
Professional development/Staff training (costs for developing staff knowledge and skill)
The 25% of agency revenue allocated to non-labor overhead includes:
Space costs (rent, parking, maintenance of the facilities and leasehold improvements)
Office management costs (office/kitchen supplies, phone, postage, computer network, leases for office machines, depreciation costs related to any owned assets-- furniture, office machines, etc.)
Consultants (non-freelancers such as an attorney, CPA, corporate coach)
All other costs (A/R write-offs, finance interest, recruitment, etc.)
Within these non-labor overhead costs, there are two key sub-ratios within the 25% allocated to this category:
Total space/occupancy costs of 8% or less of revenue.
New business and marketing costs at 3% of revenue.
The remaining 25% of revenue is allocated to operating profits. From this category, the agency pays any income taxes, annual bonuses and makes retirement plan contributions.
An agency that follows this model will realize above-industry standard operating profits in the short-term. However, this model contains some hidden traps that if not recognized could significantly impact the agency’s ability to grow top-line revenue.
Managing for growth under the 50/25/25 model.
As many owners have realized, the management of a growing agency is much more complex than simply managing costs to a simple formula. Any profit model must recognize that the agency requires adequate resources to service clients at a high level, be competitive in new business, consistently market the firm, recruit key talent, retain/develop that talent and take on some investment in the future (new practices, geographies, capabilities, etc.).
To properly position the agency for both consistently high profitability and sustained growth, the agency must take some key steps. If these steps aren’t taken, the agency may not be in a position to afford the staff required to execute all of the critical functions required for growth.
Align labor and overhead costs with your targeted profit.
The first step toward superior profitability is to ensure your agency revenue model is in alignment with labor and overhead costs as well as your targeted profit margin. If the agency is not making money on a micro level (by staff member and client), it will not be profitable on a macro level.
If the revenue model is incorrectly designed, the 50% of revenue allocated to labor will not be enough for the agency to earn the targeted 25% profit margin or perform all the necessary functions that lead to sustained growth. It’s important to ensure that agency billing rates, mark-ups and client-related investments are properly considered and calculated in your revenue model.
Equally important is to periodically (at least annually) review your revenue model to ensure it keeps pace with rising labor and overhead costs. Otherwise, it will be more difficult to maintain the 25% profit margin over time.
Set and use your hourly billing rates to maximize profitability.
As you analyze your revenue model, an important concept to consider is the hourly billing rate multiple for each staff position. The “multiple” is the relationship between the hourly billing rate and the allocated direct hourly cost (based on billable targeted hours and salary).
Most firms will find that the billing rate multiples at the mid- and lower professional levels will be three to five times (and could be as high as four to seven times) the allocated hourly cost. At the more senior levels, the multiple will be two to three times allocated hourly costs.
This type of analysis will guide the agency owner in allocating as much client work as is reasonably possible to the most profitable positions within the firm. The “leveraging” of client work to positions with higher multiples will increase overall agency profitability.
Adopt a capacity management system… and let it be your guide.
Once the revenue model is properly designed, the next important step is to develop a process for proactively managing the model. If an agency consistently over-services clients, then the revenue model is compromised. If clients are under-serviced, then the agency is not realizing all the revenue possible.
Therefore, the agency should consider development of a capacity management system that aids agency leaders in the proactive management of their largest expense item and revenue generator - people. A capacity management system has many benefits. It will:
Ensure that all agency functions receive adequate resources at the least possible cost.
Streamline labor costs by making sure that staff time is used efficiently to service clients so the agency is not carrying too many salaries and freelance costs are minimized.
Allow agency leaders to proactively manage against the over- or under-servicing of clients so that resources aren’t wasted… or client budgets don’t go unrealized.
Ensure that critical non-client service functions such as new business and agency marketing receive adequate resources and the firm can generate additional revenue opportunities.
The system also helps agency leaders manage the firm’s culture by identifying those employees who are either over- or under-worked and that adequate resources are expended on staff-wide training/development and the career management of key staff members.
You must develop the talent you need to grow. The CEO cannot do it alone.
Another critical step for growth is the development of a growth-oriented staffing architecture and hiring philosophy. Growth-oriented companies understand that in general revenue follows talent… and that development of a capable, deep, second-tier management team allows the agency to spread responsibility for growth throughout the firm.
Where the CEO is overly responsible for servicing large clients, driving leads into the agency and leading new business pitches, revenue for those organizations reaches a certain level and then flattens out. The growth potential for these agencies is constrained by how much the CEO can do well at any given time. These firms find that when the CEO is working a huge number of hours, the agency’s growth plateaus.
The CEO and organization must evolve so that the CEO is in a position to plan, direct and support the efforts of the organization (and not the other way around). This is accomplished by spreading responsibility for growth throughout the organization through the development a capable second-tier management team.
Most agency CEOs struggle with the timing of second-tier management hires. They want to wait until revenue increases. However, without the proper second-tier support, these CEOs may never see the revenue increase they’re waiting for. Agencies that wish to grow are generally prepared to make talent investments for the future. How best to make these investments should be driven by a well-designed staffing architecture and hiring philosophy.
Understand the triggers for where and when to invest in new talent.
In studying firms that have dramatically grown over time, it seems clear that some hires are required to drive growth and precede the acquisition of revenue while other hires service growth and can follow the acquisition of revenue. In other words, consistent ongoing growth doesn’t just occur – it’s something that is carefully planned for and managed.
There are certain hires that should be considered as investments that drive future agency growth with specific goals and accountabilities attached. Then there are other hires that can be made as a result of agency growth. Recognizing the proper triggers for each type of hire is critical to not only achieving growth itself but also consistent profitability.
The agencies that make senior hires for future growth and tie ROI expectations to them are generally in the best position to grow over time. The hiring of additional tactical mid-level and junior people (focused on billable implementation) can follow growth and should occur after incremental revenue is captured by the agency.
The goal: As other senior leaders begin driving new business wins, the organization becomes less reliant on the CEO to grow.
Don’t be afraid of adding talent before additional revenue occurs.
Some agency owners view the hiring of a second-tier leader as a large incremental expense and fear the short-term impact on their profitability. This is understandable as the salary cost is easy to quantify while the opportunity of future increased revenue may be difficult to visualize. However, they can often become so paralyzed by their fear of increasing costs short-term that they fail to build the second-tier team necessary for agency growth. This paralysis comes at the expense of increased revenue and profits long-term.
They shouldn’t be so afraid. The steps we’ve discussed above of developing a powerful revenue model and efficiently allocating resources will help the agency squeeze every profit dollar possible from the existing revenue. Those steps, along with ensuring there is clear growth accountability for each senior hire, may help agency leaders minimize their fear associated with senior hires as their investment is ramping up.
Consider the benefits realized by an agency that moves from over-dependence on the CEO for growth to the development of a deep, talented second-tier leadership team that spreads that responsibility:
The agency’s depth of knowledge and experience is much greater, which makes it more competitive in each new business pitch.
The organization now has a number of qualified senior people responsible for driving leads into the organization.
This agency now has developed the capability to drive more new business opportunities into the firm, greater bandwidth to professionally handle the increased number of leads as well as greater depth and knowledge that help increase the agency’s success rate in new business.
This is a powerful combination and positions the agency for dramatic growth and return on the investment in talented second-tier management.
Give your sales and marketing functions what they need to succeed.
Ensuring that the sales and marketing functions receive consistent resources and top management attention is yet another important investment necessary to spread responsibility for growth throughout the agency so that top-line revenue increases.
In many small independent firms, it’s common for the CEO to delegate marketing activities to account service staff members with time on their hands. As these people become more billable on client work, the marketing effort either stops or is transferred to another underutilized staff member. In either case, the marketing effort is haphazard and yields inconsistent results.
As a result, revenue stalls and the agency plateaus. The most productive marketing function has consistently dedicated marketing professionals. Costs are eventually more than covered by the increased leads that greater agency brand awareness and reputation generate.
To give your agency the best chance for growth under the 50/25/25 model, consider the marketing function separately from the sales function.
Marketing should be responsible for supporting the efforts of the agency’s practice leaders by developing tools for new business prospecting, building agency/practice reputation and driving leads into the organization.
Sales involves the handling of specific new business leads which includes qualifying the lead, deciding upon the pitch team and resources required, moving the lead seamlessly over to the pitch team, providing research to the team, developing the pitch strategy, presentation and supporting documents as well as managing salesmanship activities surrounding the pitch.
Recognize that the skills required to drive leads are different than those needed to develop a smooth process for moving leads through the various steps of the sales process… and ultimately win the business. The agency leader must ensure both functions are well designed, staffed appropriately and deliver results so the agency is in position to generate and win as many new business opportunities as possible.
As with the hiring of senior knowledge/practice leaders, developing well-designed marketing and sales functions and providing them with consistent resources should be considered an investment in growth with clear ROI goals attached to them. Periodically review how these investments are performing versus expectations to ensure you have the right strategy for each.
Prosper Group is here to help.
We have briefly touched on several issues of profound importance to the longer-term success of the core financial model. Many of these issues require greater depth of examination and more detailed understanding.
Prosper Group has years of experience helping agency owners with these challenges and solutions. Moving beyond the simple 50-25-25 formula and developing systems that both drive and support growth are critical to an agency’s success.