As an agency owner, understanding the cost of service is crucial for managing your business successfully.
We’re going to dive into why the cost of service is crucial for your agency so you have a clear understanding of how to manage your agency’s cost of service, allocate expenses properly, structure it the same as revenue, and create an effective organizational structure.
So, whether you’re a seasoned agency owner or just starting out, keep reading to learn how to optimize your profits and increase overall efficiency within your company.
Importance of Cost of Service for Your Agency
The cost of service for your agency includes all expenses related to the services you provide your clients—such as payroll, subcontractor fees, material expenses, and licensed software.
It’s important to understand what your agency’s cost of service is because it helps you determine your gross margin, or your net revenue minus the cost of service.
For example, if your cost of service is 60% or more, generating a profit will be difficult. On the other hand, a cost of service below 50% will lead to a healthy return on investment, and capital for reinvestment in the company will be within reach.
This metric is the most important one to know, as it determines how profitable your business is, as well as how much you have to invest.
Knowing your cost of service also helps you manage each of your clients and line of business profitably. By allocating expenses properly, including your executive team, you can get a true idea of the cost of servicing your customers. This information can help you make better decisions about which clients or products to focus on and which ones to scale back on.
Including Your Executive Team in Cost of Service
Allocating expenses properly is crucial for calculating the cost of service accurately. Leaders in the client service team should be included in this calculation—but where should you put members of the executive team when they are running a group?
We recommend including your executives in the budget for the group that they are running. For example, if you have a head of Client Service on your executive team, you should allocate them to the Client Service group rather than the executive team. This will give you the true cost of running that department, and help you manage each line of business profitably.
Structuring Cost Of Service
Now, knowing how to structure the cost of service attributes in the same way as revenue is essential for calculating it effectively. Adding key attributes like clients, lines of business, location, and team members helps you get a better understanding of your gross margin at an aggregate and detailed level.
If you want to measure the performance of one of your clients in terms of how much money they’re bringing in compared with how much it costs for your team to work with them, you can easily compare these two values against each other using reporting tools or a spreadsheet program.
The same goes if you are interested in understanding profitability across different lines of business or locations. Structuring both cost and revenue by lines of business and location makes it easier for you to get an accurate picture of where your agency is most profitable (or least profitable). You can also use this information to make decisions on which clients or products should receive more resources or be scaled back.
When structuring both cost and revenue by teams allows you to get a better idea of how productive your teams are relative to each other and identify areas where greater efficiency can be gained from cross-team collaboration. By doing this, you can ensure that everyone is working together towards common goals while still allowing teams some autonomy when needed.
Creating an Effective Org Structure
Building a scalable organizational structure is also a critical step in estimating your cost of service. To ensure an efficient hiring model and maintain quality services, there are four rules to follow when building your agency’s organizational structure.
Rule #1: The Power of One Leader
The first rule is that a manager can have multiple direct reports while a direct report can only have one manager. This means that each team or line of business should have one leader who has multiple direct reports underneath them.
For example, if your agency has five different lines of business, then it would make sense to have five separate managers with multiple direct reports below them in each line of business.
This will help ensure that all the individuals within each team are focused on the same goal and working together towards achieving success.
Rule #2: Finding the Ideal Sweet Spot
The second rule is that a manager should ideally have four to seven direct reports. Having too few or too many direct reports can be problematic because it decreases efficiency and lacks focus within each team, making it more difficult for managers to provide guidance and feedback in a timely manner.
It’s important that each manager is able to manage their team effectively so they can continue moving forward with their goals and objectives without any major delays or disruptions.
We believe that four or five direct reports are the perfect balance between being able to give your team direction while setting yourself up for scalability.
Rule #3: Seniority-Based Title Structures for Success
The third rule is that there should be a set title structure based on seniority level within your organization. For example, executives should be at the top level followed by directors, managers, analysts, etc., depending on what roles are necessary within your organization.
This helps ensure that everyone knows their place in the hierarchy as well as who they can go to for guidance or support when needed. It also allows you to better plan ahead for future hires since you’ll know exactly which titles need filling at any given time based on your current structure and needs.
Rule #4: Achieve Your Revenue Goals by Title Level
The fourth key principle is to assign specific revenue objectives for each respective position within the company. If a 50% gross margin is your desired outcome, then you must ensure that these goals are achievable by setting realistic targets.
For example, if you pay a manager $100k per year and an analyst $60k per year and you have five analysts reporting to one manager, then the total cost for that group is $400k—$100k for the manager and $300k for the five analysts.
Since your goal is 50% gross margin or better, you will want your revenue to be $800k or more. This means that the target revenue for an analyst is $160k per year ($800k divided by 5 managers) and the target for a manager is $800k per year.
By following these rules, agency owners can achieve a gross margin target of 50% while preserving excellent customer service throughout the company hierarchy.
Conclusion
Understanding the cost of service is essential for managing your agency effectively. By allocating expenses properly, including the executive team, and structuring the cost of service attributes the same as revenue, you can get a true idea of your cost of servicing per customer and manage each line of business profitably.
Plus, when you follow the four rules above, you can ensure you have a scalable organizational structure that helps you estimate your cost of service more effectively.
Remember, having a manager with multiple direct reports, having four to seven direct reports per manager, basing title structure on seniority level, and setting revenue targets by title is essential to achieving a gross margin target of 50% or better while preserving excellent customer service throughout your company hierarchy.
If you’re ready to jumpstart the process or need help determining your goals so you can gain a competitive edge in scaling your agency, check out an Engine demo.