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June 16, 2016 // 9:00 AM

How Agencies Can Prepare for the New Overtime Pay Rules

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The agency industry has long relied on a culture of long hours. Employees, veterans, and TV shows romanticize the late nights spent finalizing a pitch, the spark of an idea fueled by lack of sleep that won over a client, and weekends spent creating noteworthy campaigns.

Now, new limitations set by the U.S. Department of Labor hope to curb this culture of overwork, or at least uncompensated work, by updating the overtime pay rules. The new guidelines raise the threshold for employees eligible for overtime pay from $23,660 to $47,476 and will affect 5 million employees.

The updated law is meant to protect salaried employees, many of whom are working so many hours that they end up making less than the standard minimum wage.

But it will be especially harmful to agencies whose business models are built around getting paid for people’s time. This ruling effectively makes those people’s time more expensive, which may only exacerbate the growing pressure from clients on agency margins and reveal the serious problems with how agencies are compensated.

The Details of the New Overtime Pay Rules

Historically, overtime pay hasn’t been an issue. In 1975, 60% of workers in the U.S. qualified. However, now that number is just 7%. Confounding the problem is the fact that work has become an always-on activity for many. People have their work email accounts synced on their cell phones, which most people say are never more than 5 feet away from them. People are given laptops, and businesses have provided more remote and flexible work options. In addition, overtime regulations haven’t been updated since 2004, when the average wage was around $35,000

In less than six months, anyone making less than $47,476 -- either salaried or hourly -- who works more than 40 hours per week is eligible for overtime pay. In addition, anyone making over $47,476 may qualify for overtime pay if the job duties are not those of an exempt category as defined by the Department of Labor

The update also includes a provision where the threshold will be updated every three years so that it remains at the 40th percentile of full-time salaries in the lowest-wage region.

These updates will go into effect on December 1, a tight timeline for agencies to figure out how serious an impact it will have on their business practices, including hiring, processes, compensation, agency pricing, and clients -- and then how to comply.

The Impact on Agencies

The 4A’s estimated that around 30% of its members’ employees would be impacted by the updated rules.

“The profit margins many agencies make are dependent on junior-level employees, whom they don't have to pay as much, working long hours. That's what enables the whole financial model,” said Paul Roetzer, the founder of Cleveland-based PR 20/20.

It also could cause more difficulties for small- and mid-size firms.

“It’s going to have a disproportionately higher impact on agencies that are smaller because there are fewer places to find margins when you have fewer people to make that gap up,” said Sharon Toerek, a marketing law attorney and the principal of Toerek Law.

Other problems to consider include: 

1) Administrative Costs

The new threshold will cover many more employees, which in turn increases the number of administrative issues. The agency will need to track employee time of anyone who is paid less than $47,476. This means creating processes around time tracking, paying for a tool, monitoring time, updating billing and payroll, and any additional time spent by administrative team members and financial/HR consultants.

2) Learning Opportunities

Right now, Toerek thinks agency owners are more focused on the “numbers shock” and the cost to their businesses, but she is as concerned about the reduction of training and mentoring for junior-level employees.

These recent college graduates are the ones most likely to have starting salaries below the threshold. If an agency requires these employees to stop working at 40 hours per week to avoid the overtime costs, then these employees’ focus will need to be solely directed at billable hours. For higher level employees, there’s not enough margin built into their effective hourly rate to make it worth their time to mentor, and without the support of junior-level staffers, they may have to take on more work responsibilities.

This is one area where overtime regulations can be confusing. Training can be considered nonpaid work, but it has to meet specific requirements, such as being voluntary, taking place outside normal working hours, and preparing the person for a future position but not his current position. Travel time is another area of concern. (Employers should refer to the Department of Labor’s guide for more information on these issues.)

3) Talent Issues

Finding, hiring, and retaining top talent is a top concern for many in the agency industry. According to a recent survey by the 4A’s and LinkedIn, turnover at agencies grew 10% faster than the rates in competitive industries, with people citing the major reason they left as the lack of advancement in the industry. In addition, the report found that “the average first year agency salary is $45,000 less than in the technology sector.”

Agencies have typically taken on junior-level employees and given them opportunities to learn by working on different types of projects and for different brands. It’s an industry that trains up, in many cases.

Without the time to do this, and with salaries lower than other industries that don’t have to manage difficult or risk-adverse clients, it may become even harder to compete.

4) Competition

This leveling out of mid-range salaries may also impact the way some agencies position themselves and define their competitive advantages.

Toerek said that she wonders how this will impact the ability of agencies from smaller markets that have used their ability to maintain lower hard costs, supposedly passing these savings on to the client, to draw the attention of prospects.

The Compliance Options for Agencies

Once you understand how your agency will be impacted and by how much, there are a few different options and changes to consider to ready your team for December 1.

1) Raise employee salaries that do not meet the threshold to $47,476.

A straightforward solution is to make sure all employees meet the threshold. But it’s not that easy. If junior level employees are now making as much or close to the salaries of mid-level and more experienced employees, that could cause issues, not to mention be a huge hit to revenues all at once. To create the same type of hierarchy in salary, agencies would have to raise everyone’s wages. That eats directly into margins.

This option also might cause agencies to hire employees where they feel the starting salary is commensurate with experience.

“Part of me thinks this is a benefit to the industry -- that we’re putting in safeguards to protect and give people long-term careers in the industry,” Toerek said. “But it's also making it harder to get into the industry. From working with lots of small- and mid-sized agencies, I know that none of them can afford to take too long a view of this. If I had to pay somebody over $50,000 anyway, then maybe I'm not going to hire as many junior people.”

2) Bring employees onboard at a lower starting salary.

Another option is to start people out at a lower starting salary, which would give the agency room to pay for overtime. The ruling does allows for nondiscretionary bonuses and incentive payments to satisfy up to 10% of the salary requirement.

3) Shift overtime work to senior employees.

Agencies could take the route of shifting more work to higher paid employees while instructing those who make below the threshold to keep work confined to 40 hours per week.

4) Rely on Freelancers

Another option is for agencies to rely more heavily on outsourcing work to freelancers who can fill in capacity issues created by the 40-hour limit.

5) Raise Rates and Pass the Costs to Clients

The least likely option, but most attractive, is that agencies can raise their rates to account for the additional costs in either salary or overtime pay. Even though clients will also have to comply with the ruling, it’s unlikely they will want to pay more for the same thing.

“To raise your rates you have to be delivering value,” Roetzer said. “You have to be able to connect what you're doing to financial results. But if you're not changing any value, the value equation isn't evolving, all you're saying is, ‘Hey, we have to pay our people more. For you to get the same level of service you've always gotten you have to pay more.’ That is not going to work.”

The value of an agency’s services should be above the price of those services which is above the cost of those services -- this is where the art and science of pricing come into play. Too often, agencies rely solely on cost plus a markup to define their price. So when costs go up and value has had little to do with the price, the agency’s margins and relationships are at risk.

“Get them to pay for your value, not for your cost,” said Greg Linnemanstons, president of Weidert Group. “We compete with people in more expensive markets, and we don't ever talk about their cost structure versus ours. We talk about our expertise. That's what people are buying, that's what they care about. They don't care about my cost. I don't even ever really want to go to the conversation of my cost; that's irrelevant to my client.”

He continued: “I guess without sounding arrogant, I would tell those people who have been selling on price that that is a dangerous value proposition to begin with, and if this weakens it, now you know why it's dangerous. You can be defeated by it if you don't have a stronger value product.”

How Agencies Are Reacting to the Overtime Overhaul 

So how are agencies handling the news of these new regulations? For starters, many are unaware. I reached out to multiple agency owners who hadn’t heard of the update to the overtime pay law. Others, as reported in Campaign, are concerned about the additional costs to their agencies and the complexity of the issue.

Linnemanstons of Weidert Group, an inbound agency located in Appleton, Wisconsin, that employs around 17 people, says that the updated regulations will affect the agency, but he is not too worried about figuring out a solution as everyone, including him, tracks their time.

“We're not a sweatshop,” he said. “Some of the traditional agency models do have an aspect of sweatshop mentality where they know that if somebody really wants to be in the industry, they can impose incredible hardships on them. People will still sign up, and they'll accept the jobs, even though it means incredibly low pay and very long hours.”

However, he was concerned with the broad reach of the law and how it fails to account for cost of living differences. “In general, we don't need more government regulations, but I do understand how this affects business in the big cities where talent is taken advantage of,” said Linnemanstons.

However, in the end, he doesn’t believe it will affect his revenue significantly.

“We've never positioned ourselves as cheaper because we are in a small town,” he said. “We’ve always tried to charge as much as we can.”

He said Weidert Group will have to make some changes to payroll and how it handles overtime tracking and payment, in addition to more reporting he suspects his business will have to do to remain compliant.

For Ryan Malone, the founder and CEO of SmartBug Media, he believes the law will actually benefit his agency -- and possibly the industry.

“When I looked at this I thought this is fantastic because from a competitive standpoint, I know that a lot of our competitors either rely on really cheap intern labor or fresh-out-of-school labor,” Malone said. “It's the classic agency sweatshop model, and they are going to have to change all of their systems and hiring practices to account for this. We really don't have to do anything as we hire more senior people and our agency culture was built for quality of life and a 40-hour workweek. Quite honestly, if we pay a couple hours of overtime because our team is doing the right thing for the customer, who cares?”

SmartBug Media employs 27 full-time remote employees and has built its model around working a “fair day” from wherever employees want to -- Malone wants to build an agency people want to work at forever. He realizes this is an audacious goal, but it’s something he's passionate about achieving. This includes making sure training and development are a key part of an employee’s work week, equitable pay, flexibility, a focus on work-life balance, and room for growth.

“One of the premises that we started our company on was you should be able to go to work with people that you care about, admire, have intellectual respect for, learn from, and have a good time with,” he said. “At the same time, there are things in life that happen to you like volunteering in a kid's school, or caring for a sick grandma, or wanting to train for a triathlon that you only get to do one time. We believe you can do all that stuff and not be in a sweat shop. You can work a fair day, and at the end of the day, you can shut down your computer and be gone for the day.”

At PR 20/20, Roetzer has been considering the issue for a few months now. All employees track their time, so his first step was analyzing the historical data to find out how many hours people work and if and how any employees would be impacted by the new threshold and overtime requirements.

Most of his employees work 40 to 45 hours per week, with approximately 60of that time agency-wide going to client work. He’s focused on the agency time outside of client services, as it relates to the rule change.

“They [employees] are required to do a certain amount of professional development work and a certain amount of contribution to agency marketing,” he said. “We may just need to scale back what's required of them outside of client work. The question becomes how much of those other things we're asking outside of client work still fits into the 40-hour requirement or how much of it do we just make an elective.”

He suggests that agencies that don't have historical data on employee work hours begin tracking their time now in order to better understand the impact of the updates rules and make smart adjustments prior to the deadline. 

For Salted Stone, the new overtime law won’t affect the agency as it currently doesn’t employ anyone whose salary is below the new threshold. Because of its location in Monrovia, California, the agency wouldn’t be able to attract talent by paying below $47,000. Managing partner Mike Skeehan says most of his 20 employees work between 45 and 50 hours per week, which includes time for training and various other non-billable activities.

But this wasn’t always the case. In the early days of building the agency, he, his partner, and the team were putting in a lot of hours for very little pay.

“People should be compensated for their efforts,” Skeehan said. “But it hurts startups, it hurts the hungry ones. It's going to benefit agencies like Salted Stone as we’re going to have to look over our shoulders less at the young and up-and-comers. Those aren't going to be able to stay staffed in the same way they did in previous years.”

There is concern though, as the onus is on the employer to put safeguards to make sure employees don’t work more than 40 hours per week, even if they want to put in extra hours. And there isn’t yet clarity around how the law will be enforced. What will an audit of a company look like? Agencies that don’t make it a strict rule that employees making less than the threshold have to stop working at 40 hours could put themselves at risk if the employee becomes discontent in his work and makes a claim that the company owes him pay. And how do you stop employees from checking their emails and doing work outside the office?

At PR 20/20, Roetzer said they are already discussing putting a process in place for an employee to follow to get approval to work more than 40 hours in a week. But he too is worried about how liable his company will be if an employee doesn’t adhere to the agency’s rules around working overtime and the gray areas around what activities count toward overtime, such as networking and training.

“I think it's going to have a much more negative impact on the agency world than a positive one in the short term,” Roetzer said. “There are just no quick fixes unless you don't rely on junior staff production for your financial stability. If your agency is one where people are already making over the threshold, you're great -- nothing is going to change. That is not the majority of agencies. People are going to have less production time. They're going to be able to do less client work. They're going to make smaller margins. The negatives to it are going to be significant.”

How is your agency preparing for the updated overtime rules? Let us know in the comments below.

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