Line Items Webinar Recording

Double Down on Profit: Key Metrics to Transform Your Agency

Unlock the secrets to skyrocketing your agency’s profits with our game-changing webinar on agency performance metrics. Join industry powerhouses John Morris, CEO of Engine BI, and Marcel Petitpas, CEO of Parakeeto, as they reveal the key agency profit metrics that can transform your digital or marketing agency from good to great.

Discover how focusing on the right numbers—cash flow, profit margins, and revenue growth—leads to unprecedented growth and profitability. John and Marcel share insider tips on boosting your agency’s profits, managing finances like a pro, and setting your business apart with unique value propositions.

Webinar Transcript

Another minute or two, and then we’ll get started. Everyone got some folks rolling in, some familiar faces. Brian Schmid in the house, Dr. Jeremy Weiss. It’s been a while. How are you, man? Nice to see you. I think we did a podcast interview like years ago, years ago. Joel, Eric, Jake, Miguel’s in the house. Daniel’s in the house. Miguel, nice to see you again. Mavi’s here, Don’s here, Josh Horton. All right, Mary, welcome.

All right, it is one o’clock. We’ll go ahead and get started. I’m sure we’ll have some more folks joining us. But hello, everyone. My name is Lirjon Fisniku, and I’m the VP of Growth here at Engine BI. I want to thank you all for taking time out of your day to join us for our line items topic today, “Double Down on Profit: Key Metrics to Transform Your Agency.”

I want to quickly walk you through today’s agenda. You’re going to be hearing from two people, the first one Jon Morris. Jon is the founder and CEO of Engine BI and chairman of Fiscal Advocate. He founded both after he started, scaled, and sold one of the largest independent digital agencies, Rise Interactive. The second speaker you’re going to be hearing from is Marcel Petipas. Marcel is the founder and CEO of Parakeeto, where he helps agencies track the right metrics and improve profitability. After we hear from them, we’ll then have a Q&A before concluding.

Before we jump into all that, I do want to go over some housekeeping items for those of you who don’t know Engine BI. I’m also going to quickly walk you through what it is that we do from a housekeeping standpoint. If you’d like, just like I’ve done on my screen here, you can right-click on your avatar and rename it, first name – company name, just so we get a sense of who’s who in the room. But I also will periodically, throughout our time here together in the chat, be sharing a link to a Google Sheet where, if you’d like to network with others in this call afterward, you can submit your information. You can type it in there and then connect with the folks after the call. And then for the Q&A, I just ask that you please hold off on any questions until we get to that segment, at which point you can speak. You can choose to raise your hand using the Zoom functionality, or you can type your question in the chat.

Now, who are we? Some of you might be familiar with us, some of you might not be. Essentially, Engine BI helps marketing agencies grow their cash, profit, and revenue. We’ve built a proven system that combines our philosophy and processes for building and managing your strategic goals with software that lets you measure and track your investments and returns. Engine BI provides the hidden insights, revealing the reasons for your performance while also providing crucial benchmarks from across the agency industry. In short, we help you to understand which areas you should be spending your time and money to generate the greatest returns. We want to see agencies like yours grow faster, smarter, and have fun while doing it by turning decision-making into a science for you.

With that, I’m going to hand it off to John. John, the floor is yours.

Thank you so much, Lirjon. You got to stop sharing so I can share. Here we go.

So, true story. I founded Rise Interactive, my last agency, in 2004. I was preparing for a business plan competition at the University of Chicago, and one of the feedbacks I was given when I was presenting to a friend my final presentation was that she was so bored she wanted to stab her eyes out with the pencil she was holding. My coach said that I was way too soft-spoken and don’t smile enough. So, I feel bad that you guys have to listen to me for the next 20 minutes, but I’m hoping I’ve improved a little bit since then.

A little bit of background on me. As Lirjon mentioned, I am the founder and CEO of Engine BI. It is focused on helping agencies make better decisions to improve cash, profit, and revenue growth. I also am the founder and chairman of Fiscal Advocate, which is a fractional CFO company that helps specifically only agencies manage their finances to get better insights. I have written an ebook called “Decision-Making Science for Agencies” that dovetails a lot of the philosophies between both these companies, and all of this was really born out of my experience at Rise, where I grew it from just me to about 250 people, and then I sold it three years ago. Rise today is approaching 500 people, so still scaling nicely.

Here is the first thing that I want you guys all to realize: there are two versions of you. There is the version of you that is your historic version, which is you are an expert in some element of marketing, and at some point, you decided that you want to take that expertise and start an agency. That means that you are also an entrepreneur. At some point, you really need to decide, are you going to be a marketer, or are you going to be an entrepreneur? My job is, if you want to focus on the entrepreneurial side, to help you think about the decisions you need to make to make your agency more profitable, to scale it, and grow it. If you do your job well as an entrepreneur, you will really no longer be a marketer; you will run a company that happens to do marketing. When I left Rise, I was not in the day-to-day of any of our clients. So, I just want you guys to think about that. And by the way, if you want to be a marketer, there’s nothing wrong with that. If you want to be an entrepreneur, there’s nothing wrong with it. But you have to understand that you really have to pick a path at some point.

Now, if you are focusing on being an entrepreneur and running your agency and trying to run it better, in my opinion, there are only three numbers that matter. So, what you want to do is really think about how do you spend your time and your money to increase the cash relative to monthly overhead. Cash is one of the most neglected areas. I have all sorts of data, and every single one or the vast majority of the clients that I work with do not have enough cash in the business. So, you want to grow your cash. Whatever your monthly overhead is, you want to grow that. You want to make sure that your profit margin—so your EBITDA divided by revenue—is continually growing, and you want to make sure that you have really solid year-over-year revenue growth. Those three things equal what we call a CPR score: cash, profit, and revenue. The idea is that in those combined metrics, you want to see that your CPR score is growing on a regular basis. That is your North Star, and if you’re making improvements in those three metrics, every single thing else falls into place.

So, I want to share some benchmark numbers. Some of them are numbers that I recommend, and some of them I have learned from others. The first one is revenue growth of 20% year over year or greater. I just had to our mastermind group for Engine BI a speaker that specializes in M&A. He said that the number one way to increase the multiple of your agency if you’re looking to sell it is to increase your year-over-year revenue growth. The second number is your gross margin. Now, this one always requires a little bit of explanation. I want you to think of your net revenue, which is the revenue that does not include any pass-through. So, if you have media, it doesn’t count minus your cost of service, which is what you spend on your people, your freelancers, your technology that all relate to doing client work. So, your net revenue minus your cost of service equals your gross margin. You want that to be 50% or greater. I can tell you that if it’s over 50%, you will have enough money to invest in your business and be profitable. If it’s between 40% and 50%, you’ll have to choose, am I going to be profitable, or am I going to invest in my business? And if it’s less than 40%, you will lose money.

The next thing I want you to think about is all of your expenses that do not relate to client work, and you can bucket them into three areas: sales and marketing, operations and finance, and executive. You’ll see that those three combined equal 30%. By bucketing your expenses in these three areas, you now know that the average agency spends 8% of their revenue on sales and marketing. I personally want you to have a competitive advantage, so I want you to think about how you spend more than 8% on sales and marketing so that you can not be the best-kept secret. You can build your brand. You can scale your business. On the operations and finance side, I want the opposite. I want to make sure that you’re investing in your infrastructure. So, operations is HR, legal, corporate IT, and general administrative expenses such as facilities. You get 15% of your revenue or less that’s focused on that. Then your executive team is generally a CEO, a president, an executive assistant for them, any memberships, any clubs, any travel, entertainment that’s specific to that leadership team, and that is 7%. That will give you 20% left for profit. So, if you have 50% gross margin minus this 30%, you have 20% remaining for your EBITDA.

This is my own recommendation. There are 120,000 agencies just in the United States, and the vast majority of the companies I talk to do not have a real differentiator. A differentiator is not a tagline. It is not something that comes out of marketing; it becomes your DNA. So, the idea is that if you decide to specialize, let’s just say in a vertical, and I’m going to go after architects, well, I want you to be able to then say, “What do I need to do to be the best at servicing architects relative to anybody else?” And the idea is that you’re going to invest in R&D so that every year your product and service gets better for that specific audience that you’re trying to serve. You know, 77% of the companies I benchmarked spend zero on R&D, and of the remaining 23%, they spend maybe 1%. This is a recommendation, not a benchmark number, but I think it’s a really important number.

The last one, as I talked about before, is really focusing on growing your cash. Whatever your monthly overhead is, let’s just say it’s $100,000 a month, I want you to have a minimum of two times that number, so that it would be $200,000 that you would have in the bank account. Now, what I also want you to understand is the difference between profit and cash. Believe it or not, there are three definitions of profit. So, there’s EBITDA, which stands for earnings or profit before any interest on debt, any taxes you pay, any depreciation on physical capital assets, or any amortization on soft assets such as software. Then there’s operating income, which is earnings before interest and tax, and then there’s net income, which is your profit after everything. Then you’re going to have owners’ withdrawal and capital investments, which are more balance sheet items, and that’s going to leave you with how much cash you have. So, it’s just important to understand that you want to really understand what you’re doing in these numbers and make sure you’re hitting the benchmarks when I talk about that 20% is generally this top-line level of profits.

Now, I’m going to speak a little bit about cash. The first thing I want you to understand is that you need to have a bank account. I generally recommend at least two bank accounts, maybe three, that serve different purposes. The first bank account is designed to pay all of your working capital. So, this is to pay your taxes, your bills, and your employees. If you have a minimum of one month’s payroll plus 35% of your last three months’ profits, you will always have enough money to pay your taxes, your bills, and your employees. So, that’s account number one.

The second account is your savings account. This is your rainy-day fund, but it’s also your investment fund. In here, I want you to have a minimum of two times your monthly overhead; that’s what I just talked about. But you can see, sometimes I want you to go up to six months, and that really depends on if you have retainer versus project revenue. If you have major customer concentration—you might have a client that’s 70% of your revenue. If you have any major capital improvements—so you just signed a lease and you’re going to have to go buy furniture and do buildout, so you need more cash for that. Do you have a strong pipeline or a weak pipeline? Are you growing or not growing? You know, it’s very common that people will have partners, and partners might be of different ages, and one person wants to exit and one person wants to keep going, so you might need to buy them out. All of these things factor in whether you should have two to six months’ worth of cash at a minimum in terms of what you’re trying to achieve there.

The last one is anything that has passed through that you have a fiduciary responsibility for your clients to manage on their behalf. I’ll give you a real good example: media. Let’s just say you’re a digital agency; your clients write you a check, and then you have to go pay for Google’s media on their behalf. I want that to be completely separated from your operating account, your savings account. It is not your money, and you need to make sure that you treat it as their money, set aside, and you’re never using that to run your business.

The other big thing, I was in a Facebook group that was very specific for agencies, and this was posted, and so I like to show this because if you have no cash or you haven’t built up your cash, this might have been the perfect digital marketing agency for you to buy. But because you didn’t put cash away, you weren’t able to take advantage of that opportunity. These opportunities will come all the time. Sometimes you’ll be reactive and they come your way; sometimes you’ll be proactive and you’re seeking them out. But by building your cash up, you get to take advantage of these investment opportunities.

Now, I already mentioned this before, but I really want you to just understand these are standard agency metrics. I didn’t create these; I’ve been told them by people who worked for the major holding companies and ran them, and they learned it from other people. If you go talk to people who are looking to buy agencies, you’ll very commonly hear 50% goes to gross margin, 30% gets to run the business, and then 20% in profit. Now, I personally am obsessed with gross margin. When I was at Rise, we had a project that I called Project 60%, and the idea is I was working really hard to go get a gross margin to 60%, because if you get your profit margin up higher, you have more money to invest in the business and put more in your pocket. We had about a 25-person product development team; it’s now up to 55 people. But what we would do is we would time-track everything. We would look to automate chunks of time so that we could improve the gross margin.

Now, I want to give you a real-life example. There are two companies in the same market doing the exact same work, and one has a 23% gross margin and one has a 60% gross margin. Their clients are very similar; almost everything about them is identical other than these gross margin numbers. You can see one lost $100,000 and one is making a million dollars in revenue. So, focusing on your gross margin can be huge to the impact of your organization. There is kind of a holy grail number, and that holy grail is 20% year-over-year revenue growth and 20% profit over revenue. What I find is really interesting, this is in a totally different industry, is this concept of the Rule of 40, which is if you’re in the world of SaaS, what they’re looking at is if your revenue growth rate plus your profit margin equals 40% or greater, you’re doing a good job. So, what that means is you might be growing at, let’s just say, 100% a year and have a negative 60% profit margin, and you still equal the 40%. In the world of SaaS, private equity will look really fondly on that because you’re a Rule of 40 company, and that’s why oftentimes you’ll hear about these companies that are losing money on a regular basis. It’s because their growth rate is so high that they feel comfortable justifying that contribution margin.

Going into this concept of revenue growth, profit, and cash, what I want you to start thinking about is there are not a lot of numbers that you need to manage to really see how you’re doing as a business. The whole idea is to simplify your business and to manage as few numbers as possible, not as many numbers as possible. Just for this presentation, I’m only going to dive into revenue growth, but let’s just look at the three numbers that matter as it relates to revenue growth: how are you doing at acquiring new business, how are you doing in terms of retention of your existing customers, and how are you doing in terms of upsells? Under new business, there are only three numbers that matter: how many opportunities per month do you get, what is your win rate, and what is your average order value in terms of the size of the deals you win? If you understand these three metrics, then you can understand where you should be spending your time and energy.

I’m just going to use Engine BI as a good example. We’ve been tracking since 2020 how many opportunities per month we generate, and it’s generally between five and eight a month. Sometimes we’ll be a little bit lower, sometimes a little bit higher, but we have a real good idea. We have a real good idea of what our win rate is, and we have a real good idea of what our average order value is. But then you can start asking strategic questions like, “Well, what do we need to do to get over 10 opportunities a month? What do we need to do differently? Can we keep the same cost per acquisition, or does the media become less efficient or the market become less efficient? What can we do to improve the win rate? What can we do to increase our average order value?” Understanding just these three metrics can have a really powerful impact. On the upsells, it’s the exact same: what are your opportunities per month, your win rate, and your average order value? So, you can get a really good idea of how you’re doing in those specific areas if you understand what you need to do to generate more opportunities from your existing clients, what you need to win them, and how you can get that higher order value.

One thing I’m just going to add real quickly is on the retention side. There are two numbers I want you to know. The first number I want you to know is what I call churn. Churn refers to how many clients you had at the beginning of a period versus how many you had at the end. Let’s use an example: if you have 100 clients on January 1, 2023, and you have 90 clients of that original 100 by the end of the year, you would have a 10% churn. The next number I want you to know is your revenue churn. Let’s say you lost 10 clients, but those 10 clients represented 5% of your monthly recurring revenue (MRR). In that case, you have a 5% revenue churn.

The next two definitions I want you to understand are attrition. Oftentimes, people will talk about a really high or a really low churn number and think they’re doing a good job, but the reality is some of their clients might not have been up for renewal. So, let’s say you had a bunch of clients that were in a one-year agreement, and we’re going to do the same analysis. You had 100 clients on January 1, and then you want to know how you did by April 1. Well, what you want to analyze is how many of those clients were actually up for renewal. Let’s say there were 30 clients up for renewal of the 100, and you lost six of them. In this scenario, your client attrition is 6 over 30, so it would be 20%. And let’s say those 30 represented 50% of your revenue, and you lost six clients, which represented half of your revenue. Then you would have a 50% attrition rate on revenue. So, you can see just what’s up for renewal is a really important metric to understand. It’s not just how many clients you lost, but it’s how many clients you lost that were up for renewal that really matters.

2024 is around the corner. It is one month and one day from now, and you all should be going about your annual planning. When you put your annual plan together, I really want you to have four goals. The first is a revenue goal. That revenue goal should be bottoms-up. You should be looking at every single client by month, by line of business. You should make sure that your profit is well-defined in terms of what’s your cost of service, what’s your sales and marketing, what’s your executive, and what’s your operations and finance. You should look at your current cash goal and have a cash goal by the end of the year. You should lock those in and have them solidified. But then I also want you to have this infrastructure goal, and this infrastructure goal is basically saying you want your business to be better at the end of the year than it is at the beginning of the year. I want you to be strategic about the investments you’re going to make. You get up to four at the most. That could be, depending on what your problem is, like if you have a churn problem or an attrition problem, you might want to invest in the onboarding of new clients, or you might want to invest in some type of new reporting feature that is going to help your clients be stickier. If you have a scale problem where you just promised your sales team you’ll stop selling, or sorry, you just recommended to your client service team that you’ll stop selling because they can’t keep up with the demand, you might have a recruiting problem and need to invest in your recruiting. The answer should be focused on your revenue, your profit, and your cash KPIs, but then you’re going to determine what numbers you want to improve and what investments you need to make.

You just lastly need to understand that it can’t be a goal unless you put a budget against it. So, you need to make sure that you are actually investing real dollars to achieve those things. I can’t tell you how many people I’ve gone through this exercise with, and they said, “You know what, I really want to go own this target audience.” I asked, “Well, how much are you going to budget for it?” They replied, “Oh no, I’m just going to focus on doing more of it on my own.” I responded, “Well, then you’re not really serious about it.” Let’s say you wanted to build your brand within a specific target audience. Well, you’re going to have to spend money to sponsor their trade shows. You’re going to have to travel to meet with them. You’re going to have to go to their networking events. You’re going to have to put a content or thought leadership strategy to reach them—all sorts of things you’ll need to do to make sure that you actually achieve those infrastructure goals. You should ideally plan an original budget and lock it. Once again, you have one month and one day. Ideally, by December 31st, your 2024 plan should be done, but you should revisit that every quarter. So, in 90-day increments, did you come up with the right goals? Are you on track with the goals? What do you need to do to make changes so that you feel good about what you’re doing for the remainder of the year?

So, a few key takeaways. The first one is there are two versions of you. There is the marketer, and there is the entrepreneur. You can be one of them. I don’t feel like you can really be both of them. Great. If you want to be a marketer, then you need to find someone to really run the business. If you want to be an entrepreneur, then you really need to understand the benchmark numbers and what’s driving your success. That is by focusing on the CPR score—everything as it relates to cash to monthly overhead, profit margin, and revenue year-over-year growth are crucial to your success. You really need a budgeting and forecasting system like the one I outlined above that allows you to make sure that you understand what your revenue, your profit, and your cash goals are for the next year, that it’s grounded in data, and that you are actually investing in the infrastructure so that your business is in a better position going into 2024 than it is today. With that, I thank you all, and I’m going to turn it over to Marcel.

Alright, thanks very much, John, and I want to invite everyone to just in the chat show some love to John Morris, the entire team at Engine BI who did a lot of work to get this event together. I’m really excited to be here and excited to dive in. So, thank you, John, and let’s show them some love in the chat here—some fire emojis, some rocket ships, whatever you got for John.

I’m going to go ahead and share my screen and dive in. Alright, so for those of you that don’t know me, my name is Marcel Pipa. As John mentioned earlier, I’m the CEO and founder of a company called Parakeeto, where we help agencies measure and improve profitability. I want to try to articulate the problem that we solve and why it’s relevant as an extension to everything that John just explained, which by the way, for those of you that have been following Parakeeto for a while, is perfectly aligned to exactly what we talk about at a financial level. Really focusing on gross margin—we call it delivery margin, but that doesn’t matter. Conceptually, it’s exactly the same thing, and those ratios that you’re trying to hit on a financial basis in order to get to a healthy agency, all that stuff we’re perfectly aligned on. I don’t know that that’s because John and I are smarter than anyone, that’s just kind of the unequivocal truth of what it means to be successful in this industry running this business model. But here’s the challenge that I hear a lot from clients that get on a call with me: we get these financial benchmarks, we do our budgeting and planning process, and we often have our financial reporting touchpoints in our business. What we often find is, well, we’re not achieving these benchmarks that we want to be hitting, and the important question is, well, why is that? What we find is that there’s a real challenge that agencies face trying to connect the dots between the three important departments that really determine the financial outcome of the business. The first, of course, is the finance department. They’re responsible for keeping track of all these things, showing us what our performance looks like, and reporting on that. Then you have sales and leadership. They’re the ones that are going out, getting work, and charting the path for the agency—where we’re going to go, what kind of services we’re going to offer, who we’re going to sell to. And then really importantly, ops and delivery. They’re the ones that have to make the decisions every day about people, projects, and time that are going to influence the financial outcomes. Here’s the thing that really is difficult about making decisions day-to-day in the agency: all these three things are interconnected, but how do you connect the data? How do you connect the concepts so that you can see how the impact of a decision in any one of these three areas impacts the other two? That is a challenge. When I ask a firm whose job it is to sit in the middle and do that work—to determine the framework by which these concepts come together in a consistent way, and to be the one collecting this data from all these stakeholders, making sense of it, and then distributing clarity back out to each of these departments so everybody knows exactly what to focus on, exactly how to execute—when I ask whose job that is, I get one of two answers: it’s nobody’s job, we didn’t even know that was supposed to be somebody’s job, or one of these three stakeholders is being asked to do it. The problem is, it’s not their job, it’s not within their scope, it’s not within their expertise, and inevitably, this tends to slip through the cracks. So that is why Parakeeto exists. Our mission is to really articulate the framework for how to bring these things together, and our business exists to sit in the middle and solve this problem so nobody has to waste their time figuring out what’s going on—that’s our job—and everybody can focus on execution. It requires you to still have strong leadership and strong process in all three of these areas, but the magic is in bringing those things together.

What I want to focus on for today’s presentation is the extension on all of the financial benchmarks that John has just talked about and how to connect the dots between that financial performance and the day-to-day operations of the business and measure that using three incredibly simple numbers that you’ll probably already have heard about, but hopefully we’ll make a little bit more sense of. I’ll try to be quick about this so we can leave lots of room for Q&A because I think we have a rare opportunity here with John and I to really get into the nuances for Q&A. I also want to just thank Tate, Jeremy, Miguel, and Andrew for showing us some love in the chat, especially for John.

Alright, so let’s jump in. Delivery margin is what we call it; gross margin is what John calls it. For all intents and purposes, these are the same things. I’m just tired of arguing with accountants over semantic issues that are not relevant to the problems we’re trying to solve for clients. But gross margin, delivery margin—it’s all the same. The formula for us is agency gross income, which is the same as net revenue as John described it earlier. It’s your revenue minus your pass-through expenses minus what we call delivery cost. John refers to this as cost of service. Again, same idea. This is what it costs you to get the work done for clients divided by agency gross income.

So, if you have a firm that collects a million dollars in fees after pass-through, spends $400,000 on their delivery cost or their cost of service divided by 1 million, this firm has a 60% delivery margin or gross margin. So the question is, you look at your financials and you find that, hey, we’re not achieving that target that we want. Let’s say you should be at 1 million in the denominator. Oh yeah, you’re right, you got me there—1 million in the denominator. Okay, so let’s say you’re looking at your financial statements and you’re not getting that 60%. You’re getting 40%, you’re getting 30%, you’re getting a number that’s substandard relative to where you want to be. The question is, what do you do about it, and how do we connect the dots between the financial performance of the business and the decisions that you make every day about operations that are leading to this? There are really only three ways to influence this number.

The first is average cost per hour, which is a proxy for delivery costs. What average cost per hour measures is, for every hour that we purchase from our team, on average, what does that time cost us? This is essentially going to be representative, on a payroll or salary team, of the average salary that you’re employing. If you use freelancers and contractors, there’s going to be a much more direct line here. So we’ll talk a little bit more about average cost per hour.

The second lever, which is related to agency gross income, is what we call average billable rate. This asks the question, for every hour that my team spends doing work for clients, regardless of how we bill for it—whether we bill by the hour, whether we bill on flat rates, we do value-based pricing, whether it’s projects or retainers—how much money on average do we earn for every hour that we spend getting things done for clients?

Last but not least, utilization, which again, regardless of how we bill, measures what percentage of the time that we buy from our team is utilized for things that create revenue for the business. These are the things that influence delivery margin or gross margin. You can see here that these two are related to agency gross income. So this is increasing the amount of revenue that your team can generate with the same cost basis. An average cost per hour is a proxy for delivery cost, which is a function of lowering what it costs us to earn that same amount of revenue.

I’m going to quickly go through each of these and how to think about them and how they impact things, and then we’ll go to Q&A. Starting with average cost per hour, this is a really simple metric, and here’s why we’ve designed our framework the way that we have. I want to take a quick moment to do this caveat: I’m not here to tell you that the way that we measure each of these metrics is the right way to do it, but what I am here to tell you is that the way we measure these metrics is consistent with one another. To me, that’s the important part. There’s no sense in measuring a whole bunch of metrics if, when you now compare how they impact different areas of the business, they are not mathematically consistent with one another. So just know that when I explain the way that we measure these things, it’s because it plugs into a larger system and all these things are consistent. If one goes up, we know exactly how that impacts every single other metric in the system because we’ve thought through all of those dependencies. So if it’s different than how you do it, that’s okay. But just think about this in the context of how you measure everything else.

When we look at average cost per hour, we look at this in a really simple way. It’s payroll over capacity. The way we define these things is payroll is the amount of money that’s getting paid out to whatever subsection of the business that you’re measuring. This could be one individual, it could be a group of individuals, this could be for a week, a month, a quarter, or a year. You just want to look at the total payroll, and that includes all of the costs of employing that person. Then you divide that by their capacity. This is all of the time that you’re purchasing from them in that employment contract. For most people, this is 2080 hours per year. That’s 40 hours a week multiplied by 52 weeks a year. I know there’s a project manager in the room right now that’s having an aneurysm—I’m not forgetting about vacation time and paid time off and non-billable time and all the time they’re not going to spend on client work—but we want to reflect the cost of that in the rest of the system. So this is a simple, easy metric. This is how we calculate average cost per hour.

You can see here, this is an example of how we measure this. A strategist costs $120,000; their average cost per hour is almost $60. This intern is much less expensive; their average cost per hour is lower. When we start to blend these things together, it results in different average costs per hour. The reason this is important is because if we’re targeting, let’s say, a 70% gross margin on an hourly basis or on our average billable rate, you can see that the minimum rate that we need to achieve is vastly different depending on what our cost basis is. So if you’re in a situation where you feel like you’re really constrained in terms of scope or in terms of price, then average cost per hour might be a really important lever for you to pay attention to and start thinking about how do we get more of the work done on individual projects or types of work accomplished by people who are less expensive. The way we typically do that is by lowering the level of judgment that’s required to complete a given task, a given deliverable, a given workflow. That’s typically done through the investments that John talked about in improving technology, improving processes, improving the documentation of how we do things, so that if a strategist is doing 100% of the work on something, maybe six months from now, after we make those investments, half of that work can get done by an intern. In aggregate, that should lead to materially lower payroll, and if we use a lot of freelance labor, we should feel that efficiency right away.

So that’s average cost per hour—that’s the first lever. Frankly, this is my least favorite. I think it’s the least exciting; it’s kind of the hardest one to solve, and it’s just not that material in terms of impact. What I’m much more interested in, and the things I tend to focus on more with clients, are average billable rate and utilization because these tend to have a really, really big impact, and they’re much more fun to work on, frankly, and they don’t involve us having to try to push down the cost of our team.

Let’s talk about average billable rate for a moment. The way that we calculate this is we look at our agency gross income and we divide it by what we call delivery hours. I’ll qualify those terms: agency gross income, again, is what John referred to earlier as net revenue. So this is revenue minus the pass-through expenses that you collect. Again, we can look at this for any subsection of the business; it’s always calculated the same way. It could be a single project, it could be a group of projects, it could be for a week, a month, a quarter, a year—it doesn’t matter. The same thing is true for delivery hours—this is any time spent on client work. I don’t call it a billable hour; it might be the same as your definition for a billable hour, but I don’t care if the client was billed, I don’t care how the client was billed, I don’t care what the billing model was. All I care about is how much time was spent working on whatever it is we got paid for, and that’s the math for this metric. So again, you can see how you can measure any area of the business and you can do it over any time horizon, and we’re normalizing the calculation here.

Here’s an example of how we might use this metric: we might compare a few different projects to each other. If I asked 10 agencies what their most profitable project was, without knowing the average billable rate, almost all of them would say the same thing: they would say, “Well, obviously it was the website—look how much money we got paid.” But you can see here from this example, this was the least efficient at earning them revenue. The brand design here was just kind of run-of-the-mill, and then the funnel build—what a dark horse.

We got paid $30,000, but we gave $20,000 away in pass-through. But the $10,000 that was left over—man, we really didn’t have to spend a whole lot of time to earn that, and this earned us an average of $200 an hour. When we blend this across, we end up with $115. This sounds crazy—it sounds like it’s almost too easy to be true—but if you think about it, if you double your average billable rate, all things being equal, you’ve just doubled the amount of revenue that your team can bring in without changing anything else.

Now, there are two ways that we can improve this: we can either increase our price—that’s obvious, lots of people talk about that, but we have to do that without relatively increasing our cost or the amount of time that it’s going to take—or we can decrease the time it takes us to do things without relatively decreasing the costs. This is where efficiency comes in. Both of those are perfectly legitimate levers to improve our average billable rate, and again, to the extent that we can increase that, we increase the amount of money that people make.

Tate, you asked a great question: does anybody else call AGI gross profit? I would say that just about everybody that works with an accountant, their gross profit on their P&L is actually representative of their agency gross income, which is very misleading. So that’s a good insight—it’s a good question—but it’s not actually your gross profit, right? If we think about what the definition of gross profit is meant to be, if your accountant is using cost of goods sold to isolate your pass-through expenses, that’s probably okay, but that thing that’s called gross profit is not really gross profit. It’s actually your agency gross income, so just be aware of that.

So here’s a little hack: we talked about gross profit and delivery margin earlier. If you know your average billable rate and you know your average cost per hour for any given area of the business—this could be by project, by client, by time period—you unlock what I call Kirkland brand delivery margin or Kirkland brand gross margin. You can plug those into the margin formula and you can start to get a directionally accurate sense of how profitable different areas of the business are without having to run all of this through your finance department. This is a really efficient and inexpensive way to start measuring the business.

So that’s average cost per hour and average billable rate. The last thing I want to talk about here is utilization. This is what we call the dark saber of agency metrics. Utilization—can’t spell today. Okay, so utilization, again, really, really simple. We want to look at delivery hours. Again, this is not billable hours—I don’t care if the client was billed, I don’t care how the client was billed. All of the time that was spent on a client engagement or on client work in a given period of time for a given group of people, divided by their capacity. Again, capacity is defined just like earlier as the total amount of time available, and we’re not stripping out things like holidays, paid time off, vacation time, etc. So this is 2080 hours for somebody, and I know the project manager in the room is like, “But Marcel, what about vacation time, paid time off, etc.?” We want to leave that in capacity because otherwise, we’re not going to see the cost of that reflected here. The more time off somebody takes, the more non-billable time somebody has in their role, the higher their utilization rate is going to be. That’s a false positive. It tells us that the more time off somebody takes, the better our profitability is as an agency, and that’s the opposite of what’s true. So it would be ridiculous to calculate this this way. We’re factoring all of those costs in when we set our delivery margin target.

So that’s how we calculate this. The added bonus here is it’s much easier to measure and there’s fewer data points to track down. The way that we would look at this—here’s an example of a report where we might run this on an individual basis, and I won’t spend too much time on this, but as a general benchmark, there isn’t actually a benchmark on this, but if you can’t get your agency’s team, when you look at everybody on the team, to at least a 50% utilization rate on an annual basis, you’re going to have to charge more than average to be profitable. That’s just the reality. You can have as low a utilization rate as you want, but you need to find a way to compensate for that, usually through higher earning efficiency. What that looks like on a weekly basis is usually about 15 to 20% higher than your net annual target. That’s where we’re factoring in for drop-off—that’s things like time off, holidays, sick days, etc. So that’s the agency model.

But here’s what I want to close on to really illustrate an example here. Let’s imagine we have a small agency. They have five employees. That means they have 10,000 hours of capacity. In all three of these scenarios, this is exactly the same. Let’s say that their cost of sale or their delivery cost, as I would call it, is $300,000, and let’s say that they spend $150,000 on overhead. In this first example, they’re utilized at 50% and their average billable rate is $100 an hour. In this example, they can earn $500,000 in agency gross income or in net revenue, as John calls it. So that means they have a 40% gross margin or delivery margin. In this example, if you’re doing the math, their profit is just 10%.

Now, if that same agency—all they did was increase their utilization rate to 60%, their average billable rate stayed the same—they would now earn $600,000. Their gross margin now is 50%. But of course, if you’re tracking the math, their profit margin is now actually much better than 10%. They’re not just going to gain the efficiency that they gained from this improvement in gross margin, they’re now going to gain even more than that because their overhead hasn’t changed, assuming that it hasn’t changed. So they have the choice now—they can let all of that flow through to the bottom line or they can invest more in the business, as John mentioned before. Because their gross margin is improving, their optionality in the business is improving.

In this last example, they improve their average billable rate and maintain their delivery margin, or sorry, their average billable rate. Now they’re at 60% delivery margin, doing $750,000 in agency gross income. If they choose to, they can let all that flow to the bottom line—they now have a 40% profit margin on their agency gross income. So that is how powerful these simple operations metrics that are inexpensive to measure are for controlling the fate of the financial outcome. You can see how the math here is really simple. Capacity multiplied by utilization multiplied by average billable rate equals agency gross income. So you can start to connect the dots between the decisions we make about our team, people, time, and projects, and how that’s actually going to influence the feasibility of our financial outcomes. I just wanted to illustrate that and try to connect those dots a little bit. With that, I’m going to turn it back to Lirjon, who’s going to be facilitating Q&A. Thank you for being here, and I’m really looking forward to taking some questions.

Thanks, Marcel. That was very informative. Give Marcel some love in the chat, everybody. Hopefully, you found that helpful. As he mentioned, we are now at the Q&A portion. If you have a question for Marcel or for John, feel free to either unmute yourself and speak up. You can also use the Zoom functionality in terms of raising your hand, or you can type there in the chat. With that, I’m going to open it up to the group to see if you have any questions. While we wait, I think there might have been one question submitted ahead of time that we can address.

Yes, let’s see. Let me pull this up. I have a question too while you guys look that up if you want. Go for it, yes, Sarah.

Okay, I actually have a question for both, but Marcel, let’s start with you. When it comes to delivery hours, we don’t time track here as an agency. Is that a mistake, and is it something that we need to be doing? Also, as it relates to those delivery hours, it’s not sort of set for each project, right? Like even when you’re tracking the time it takes to do a website build or a PR program, every client’s different, the scope is different. It’s not sort of set-it-and-forget-it for each type of product that we sell. How do you figure that out?

Yeah, okay, two good questions. So the first one is, should you be tracking time? I think if you want to have this level of insight and control into the business, there’s no other way to do it. Even if you were going to try to do project-based accounting and so on, the only way to attribute the cost of your team is by having some model for time. But I think the misconception with time tracking is that timesheets are the only way to do it, and that’s not necessarily the case. You could use your resource plan as your source of truth for time tracking and use daily stand-ups to capture material changes to resource plans. That’s feasible if your team only works on a small handful of projects at a time or if individuals are not spread out across a lot of different places. So keep in mind that there are different ways of tracking time. But my philosophy and my point of view is that, yes, I think that time tracking is really important if your prerogative is trying to really optimize for the success of the agency and protect your team, frankly, from working a lot of evenings and weekends and overtime. Without a feedback loop, how are you going to keep track of how material the difference is between your assumptions about how long a project takes to do and the reality of how long it takes to do, which relates to your next question, which sounds like it’s, you know, we’re trying to predict how long it’s going to take to get things done for clients, but sometimes we just can’t, and sometimes it takes a lot longer. This is exactly why I think time tracking is important and why the definition of a delivery hour is so important.

Again, in these metrics, what’s important is how much time did it take you to do it, and what we want to start looking at is where there is a big delta between what we expect and reality. So in this example, using these metrics, you might run an average billable rate report and see that we thought we were going to make $150 an hour on this client, but we spent a bunch of extra time that we weren’t anticipating, so we actually made $110 an hour. When we ladder that up to the agency level, if all of our clients performed that way, we would come in under our agency gross income target by $500,000 this year. That’s how severe this problem is. Closing that loop is what creates the buy-in that’ll actually get the team wanting to do this because now they can see, okay, this is actually why this matters, this is why it’s important for us to pay attention to these things, and how it impacts us. Is that helpful at all, Sarah?

Yes, it is. I mean, we have standards in terms of, like, how, depending on the vertical of the business and the work that they’re doing within those different project teams, how many clients they’re able to service at any given time. So there’s some framework, right, that exists there. It’s just not, I think, at the level of detail that you’re mentioning. And then I think my other question for you, John, is a little bit more granular. So I’m sorry, this may seem a little bit silly, but I’m caught on the churn, and I just want to make sure I get this number right. So as it relates to the churn, like, if you’re just tracking your starting clients in January and where those have landed, let’s say, at the end of March or beginning of April for if you’re looking at a quarter, right, you’re not adding into that any clients that you’ve added, correct? You’re just looking…

Exactly. It’s only the clients that started at the beginning of the period that you want to track from a churn standpoint.

Yep. Okay, thank you.

And just to give you my view real quickly on time tracking, please. I agree with Marcel to a point. I think it’s a matter of when do you start time tracking. I’m just going to share my screen and just give a quick example. You can get a lot of insights just by doing cost analysis as opposed to time tracking analysis. So I mentioned to you guys before that I want you to have a 50% gross margin. So at any point, does this show concerns to you when you look at this data? Anyone want to mention what month they start wondering what’s going on?

For May. May, okay. So we go from 59% to 43% gross margin. Now, when you look at the revenue, the revenue is going up by $334,000, but your cost is going up by $40,000. So now you have to ask, well, what is going on that all of a sudden we’re going from $52,000 a month to $92,000 a month? If you scroll down, you can see that your SEO has gone from $21,000 to $56,000. I’m just going to take your revenue here, and you’re going to see that your revenue went up $20,000, but your cost went up $35,000. So when you look at your gross margin, you can see that you have too much cost in your SEO department. The reason why I bring this up is time tracking is messy data. I can give you all sorts of stories of people who, you know, manipulated the data to just not have to do it. Cost data is 100% accurate as long as you assign your cost properly. So in this scenario, you know you need to bring cost out of your SEO group. So you can sit there and say, you know what, I don’t get $56,000, I got to be at $37,000 in order to stay at a 50% gross margin.

So I did no time tracking, but by managing it to the dollar amounts, I automatically improve my utilization. I automatically fluctuate all the numbers that Marcel just showed you without having to do time tracking. Now, what I can’t tell you from this data is why did I increase the expenses to $34,000? Did I go win a bunch of projects that weren’t profitable and I had to overstaff to support them? Is it because I have not enough direct reports to a manager? Do I have senior people doing junior people work? So eventually, you have to get down to a more granular basis, which is where time tracking could come into play. What I could also tell you is the more things that you add to time tracking, the more inaccuracies and the more manipulation of the data. So one of my favorite stories, we had about 200 employees at this time, is an employee would come in on Monday and he would do all of his time tracking for the entire week. So every single client, every single week had the exact same amount of time for the exact same projects. And, you know, he was hoping in the law of large numbers of being 200, one of 200 employees, that we wouldn’t notice the fact that he was lying about the data. So you have to understand that time tracking is a directional number. It is not 100% accurate. So the things that I would look out for are, like, burnout numbers, like this person’s working 80 hours a week and this person’s working, you know, 30 hours a week. Why is that happening? I would use it for a gauge of profitability of a project, but I’m a much bigger fan of assigning cost as opposed to time tracking.

Super helpful. Thank you.

Sure.

Thanks, guys. We do have a question that was submitted beforehand. The question is, what’s your recommendation for training someone in an internal ops role to understand, manage, and report beyond delivery data and take ownership of full agency financials?

Who wants to take this one first? Marcel, you want to take it first?

Yeah, and it kind of ties back to exactly what John just described, actually, which is that the first line of visibility is going to be financials. That double-clicking is kind of exactly what the process should look like. You identify that you have a gross margin problem, but then the next important question is, well, why is that? Then it’s about trying to learn how to connect the dots between finances and operations. So I think the most important thing from my perspective, and of course, I’m really biased about this because this is kind of the whole thesis behind our company, is you’ve got to develop your framework or adopt a framework that already exists that maybe was created by a company that has been thinking about this non-stop for six years on how to relate the financial performance of the business to operations. If you’re coming from operations and you’re trying to understand finance, that’s going to be such an important way to make sense of that and connect the dots between how these financial targets and budgets that we’re setting, how we’re doing things like acre revenue, right? Like what John described is dependent on things being done correctly, and there are a lot of asterisks around this, right? So how are you acre revenue? If you’re doing it based on invoice dates, it’s not going to be accurate. If you’re doing cash-based accounting, it’s not going to be accurate. How are you attributing the cost of your team? If you’re trying to do that based on time tracking data, it’s not going to be accurate. How are you assigning all of your costs? How is your chart of account structured? If you have a framework for how those things impact operations, then it’s much easier to make sense of that and to interpret those things, and to also make sure that those things are maintained over time. So I think that that’s the biggest thing, is make sure you have a framework for connecting operations data to finance data. I think what John and I have laid out here is a really simple, straightforward framework that follows a lot of the best practice. It’s a simple framework for finance and it’s a simple framework for operations, and they’re consistent with one another.

Just to add on to that, so Lirjon, read the question one more time. I just want to make sure I answer the question thoroughly.

Yep, let’s see. What’s your recommendation for training someone in an internal ops role to understand, manage, and report beyond delivery data and take full ownership of agency financials?

So first of all, I would put this role in finance. I think that when you look at what Marcel was talking about, the services he offers, someone—let’s just say you hire Parakeeto to help you with those insights—someone has to make sure that they own helping him in terms of getting all the groups coordinated together and working together. So I think the first thing is our S-E-L-Q-A framework. What I would just say is you guys have to make a big decision that you’re going to run your business in a data-driven manner. So that would be my number one thing to do, is make sure that you embrace a data-driven approach to running your business. Then you need what I call scorecard operations. You need to make sure that scorecard operations are important to you and that you’re going to budget for it. Then you have to figure out—I generally would recommend that ownership being on the finance side and specifically in a department called FP&A, which stands for Financial Planning and Analysis, that would work with Parakeeto or similar services to provide insights that go beyond just delivery but to the entire business from sales and marketing to the client teams, etc., so that you can run your business intelligently and effectively.

Awesome, and I know we are at time here, so I do want to be mindful of everyone’s schedule. I thank you so much for joining us during our hour here together. If you do have questions afterward for Marcel and his team or John and the team here at EngineBI, feel free to reach out to us. I have shared in the chat—I’m going to put it there one more time—a networking Google sheet if you’d like to network with folks offline. Again, thank you so much, and hope you all have a great rest of your day. Thanks, John. Thanks, Marcel. Thanks, everyone.

Thank you so much.

Opt-In to Receive Invites to Future Webinars and Events

Receive invites to local events in Chicago?