For all intents and purposes, the last decade provided a remarkably strong and accommodating business environment for most marketing and digital agencies. Even COVID proved a “boon” for many companies whose clients required rapid acceleration of digital transformation. But it didn’t take deep organizational maturity or a unique solution offering to grow profitably during this time, and many agencies generated healthy cash flows despite a lack of operational rigor. These were the salad days: a youthful time of innocence and inexperience that the harder market conditions ahead will quickly expose.
The Changing Environment
Companies that have been returning strong distributions to shareholders have undoubtedly been doing something right. However, there is a very good chance that these organizations were built to thrive in the incredibly favorable business environment of recent years, and they have not spent enough time building the organizational capabilities that will be needed to survive, or even flourish, as their previously lucrative market transforms.
The growth-conducive market in which we have all been operating is changing. This means that businesses face market forces that no one at the company, or even in their network, may have experienced in their entire working career. How agencies work at maturing over the coming period will determine their longer-term prospects for growth and potentially even survival.
Building for Scale: Five Financial and Operational Imperatives
Given that the answer to a tougher market is always to be as efficient as possible, the following pointers are centered around knowing where things are going well and where they are not, and getting 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. Hence, loss-making or inefficient activities often go undetected. Running a P&L means actively managing on an accrual basis, with Month-End Close taking roughly a week and reflecting earned revenues and costs of the period, not an amalgamation of unrelated items.
2. Measure What’s Important
Many agencies don’t have a set of KPIs by which they measure themselves, so they have no idea if things are softening until problems manifest in cash flows. Defining and consistently measuring KPIs over time provides an indication of potential issues and opportunities for early intervention well before they appear in the P&L.
3. Build a Plan
Operating on an ad-hoc basis is fine when business is rolling in, but in more difficult times leadership needs to understand where they are relative to their operating goals. A full-year financial and operational plan guides decisions around rates, hiring strategies, investment in IP, and salary increases, and provides visibility to where the agency will end up in three to six months.
4. Transition to Value-Based Pricing
Firms that do not evolve from a direct relationship between hours and value will find a weakened market extremely difficult to weather. Even if market demand remains strong, relentless pressure on salaries will prove detrimental to firms that cannot scale the relationship between effort and value. The most sophisticated agencies have evolved to value-based pricing: where the client deliverable is set at a fixed price, and a strong methodology delivers that value at decreasing marginal cost.
5. Build Intellectual Property
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, agency adoption has been sporadic. The firms that invested in IP development during quiet periods are now reaping the benefits. Counter-intuitively, many of the firms hardest hit by market disruption were positioned to invest most aggressively.
The salad days are over for many firms. How they work at maturing over the coming period will determine their longer-term prospects for growth, and, in some cases, survival.
Part II of this series covers five Building for Culture tenets: the changes to the way business is conducted that provide organizational durability.