The Salad Days are Over (For Many an Unsuspecting Agency)
“They were my salad days, when I was green in judgment”
Cleopatra (from Shakespeare’s Antony and Cleopatra)
For all intents and purposes, the last decade has provided a remarkably strong and accommodating business environment for most marketing and digital agencies, especially for those that were newly formed in the period. Even COVID proved a “boon” for many companies whose clients required a rapid acceleration of their digital transformation initiatives. This certainly doesn’t mean it was easy, and there were certainly many sleepless nights, but it didn’t take a deep organizational maturity or unique solution offering to grow profitably during this time – and many agencies generated healthy cash flows despite a lack of organization rigor. Understandably, many business leaders never felt the need to optimize their performance because business was strong, and these were the salad days – “a youthful joyous time of innocence and inexperience1“
A recent Wall Street Journal survey of economists2 showed the probability of a recession in the next 12 months at 44% (up from 28% in April and 18% in January). In May of 2022, inflation was 8.6%, which is the highest rate in the past 40 years.
Clearly, the growth-conducive market in which we have all been operating is changing, and this means that it’s very likely that your business is facing market forces that no one at your company – or even in your network – has ever experienced in their entire working career.
Companies that have been returning $1M+ a year to their shareholders (owners) have undoubtedly been doing something right. However, there is a very good chance that these organizations have been built to thrive in the incredibly favorable business environment of recent years, and they have not spent enough time building the organizational capabilities and associated rigor that will be needed to survive, or perhaps even flourish, as their previously lucrative market transforms.
The salad days are over for many firms, and how they work at maturing over the coming 12 months will determine their longer-term prospects for growth and potentially even survival. To help in the cause, we have created a list of 10 operating tenets that agencies need to do well in order to succeed in the coming months and potentially year(s) of economic change and uncertainty. There are others of course, but if an agency – newly intent on performance optimization – adopts these pointers, they will quickly start to see things about their business that they can improve upon.
We have grouped the tenets into 2 broad categories, but as each contains a decent amount to consider, we have placed the Building for Culture section in a second article:
- Building for Scale: The financial/operations best practices that will provide a platform to deliver more efficiently.
- Building for Culture: The changes to the way business is conducted that will provide durability to the organization.
Building for Scale
Given that an answer to a tougher market is always to be as efficient as possible, the pointers here are centered around the idea of knowing where things are going well, and where they are not, and to get more out of under-pressure resources.
1. Manage a P&L.
Many smaller agencies focus on cash rather than margin. If cash is generally increasing, shareholders are pleased and there isn’t an inclination to understand profitability levels for different activities / solution offerings. Hence, loss-making or inefficient activities are often undetected because shareholder distributions are healthy. In this new era of change, a business that doesn’t recognize where they are inefficient (or loses money for a few months without knowing) will struggle as the cost of these missteps has increased substantially.
Running a P&L means actively managing (on an accrual basis) the business P&L. Month-End Close should take a week and it should be reflective of the earned revenues and costs of the period, not an amalgamation of unrelated items and timings that is only available several weeks after the period ended. There is a trade-off between accounting accuracy and usefulness of results. We feel strongly about closing the books quickly, with accruals where needed, so that decisions can be made in a timely manner and the accounting team can go on to more productive work.
To provide the focus and information needed to mature an organization, an entity level P&L with $10M in revenue and 60 people should ideally be more than a single operating P&L and should perhaps, have different P&L owners, compensated on the P&L performance. To improve performance, different activities, or practices should be measured and evaluated separately.
2. Measure What’s Important.
Many agencies don’t have a set of KPI’s by which they measure themselves, so they have no idea if things are softening, or problems are occurring, let alone increasing.
Understanding category KPI’s and those that are unique / particular to an agency is a critical step to managing a business. Recognizing the benchmarks for performance provides a means of understanding operational maturity, quality of solution delivery, estimation, talent capabilities, areas of opportunity for automation, etc.
Defining and consistently measuring KPI’s over time provides an indication of potential issues, and opportunities for early intervention well before they manifest themselves in the P&L, or ultimately in cash flows. They also serve as a means of building on progress through operational improvement initiatives. While this may seem intuitive, after all “How can a business run without well-defined KPI’s?,” the reality is that most sub- $5M EBITDA agencies struggle with defining performance criteria and consistency in measurement.
3. Build a Plan.
Operating on an ad-hoc basis is fine when the business is rolling in, but in more difficult times leadership (owners) need to understand where they are in relation to their operating goals. A full-year Financial and Operational plan will help guide the agency regarding rates, hiring strategies, investment in IP, salary increases, etc. and provide visibility to where the agency will end up in a few months’ time. Scenario modeling without a plan is effectively an exercise in futility.
From the Plan, target KPI’s can be derived and measured as noted in item 2 above. These will also be a far more meaningful comparison than trying to find “industry benchmarks”.
Pro Tip: Don’t worry much about KPI-levels as compared to industry targets, rather focus on setting (increasing) KPI targets in the plan and improving company performance to reach these targets over time.
4. Transition to Value-Based Pricing.
As a result of the acceptance of agile methodologies and society’s subscription-based everything, buyers in all industries are nowadays far more open to purchasing services in a block of time (agile sprints, fixed numbers of hours/resources) than they were a few years ago. From a delivery perspective, this increases the effective utilization rate of resources and reduces the inefficiency of non-contiguous assignments – both of which help efficiencies and margins
There used to be a Professional Services adage that immature firms do Fixed Price work but move to T&M when they realize they lose money on it, and that eventually move back to Fixed Price when they have matured enough to have built the reuse artifacts and methodologies to make the relationship between value and effort non-linear.
While Fixed Price projects are far less common than they used to be, the more sophisticated agencies have evolved the principle to Value-Based Pricing – where their client deliverable (say, x leads, y% decrease in cart abandonment or z level of conversions) is set at a fixed price. A good methodology and toolset allows these firms to deliver client value far in excess of the effort required to the self-sustaining benefit of everyone involved.
Firms that do not evolve from a direct relationship between hours and value are going to find a weakened market extremely difficult to weather. Even if market demand were to remain strong, relentless pressure on salaries will prove detrimental to the firms who can’t scale the relationship between effort and value – caught between reduced margins and the inability to pass along rate increases without becoming expensive when compared to a value-based agency.
5. Build Intellectual Property (IP)
As touched upon in the above point, a means to differentiation and scale that is decoupled from billable hours can be found in IP and Reusable frameworks. Although the ability to automate routines and generate insights has been significantly democratized over the last several years, agency adoption has been sporadic – often foregone as clients have been willing to pay for manual services at a time that agencies simply didn’t have the capacity to take on such internal development initiatives.
During the COVID lockdowns, many agencies felt little impact to their business and continued to grow as before. However, we have noticed that there were a small number of firms whose business did drop off so they deployed their (PPP supported) capacity to significantly building out their IP – which is paying considerable dividends for them today. Counter-intuitively, many of the firms who were hardest hit by the pandemic are today best positioned to thrive during a market downturn.
Recognizing that the salad days are over, tools to reduce the direct project effort must be built. Below are a few possible ways to think about agency IP:
Reusable Artifacts: Are standardized and incorporate the company’s best practices and experiences. These are the simplest form of IP and might include:
● A questionnaire or checklist.
● Data maps or dictionaries
● Price & Scoping Models
Automation Assets: Tend to be technology-driven assets that remove the manual aspect of common/recurring tasks:
● Data load and cleansing (ETL) routines
● Rules, Exceptions and Analytics engines
Software & Products: Are the most complex and expensive of IP forms, but also the most scalable and attractive from an acquisition perspective precisely because they provide scale.
● Software Applications (simple local apps to multi-tenant SaaS products)
● DevOps monitoring or utility tools
● AI/ML Predictive models
While this array of IP might sound intimidating, there is no getting around the fact that this is what the more sophisticated agencies are working on today. If this is a somewhat terrifying prospect, then it’s time to rethink your strategy for the next few years.
The Salad Days are Over (For Many an Unsuspecting Agency)
We hope that this Part I of the article has made the case for a pro-active re-think of business efficiency and operations. Companies that don’t adapt to tougher economic times are going to struggle to retain the clients, reputation and income streams they are currently enjoying.
Join us for Part II of the article to discuss re-thinking company attributes.