What is an agency fee structure?
An agency fee structure is the amount charged to a client as part of a business agreement for external marketing services and how that fee is broken down into services and/or deliverables. This is the primary revenue stream for agencies (i.e. how they make money).
There are many ways to approach structuring agency fees, but I’ll explain the approach that has worked for my digital marketing agency, Salted Stone. And by “worked” I mean to say that -- from a high level -- Salted Stone has been able to hit (or come close to hitting) acceptable target margins in each of the past five years. We may win or lose on a specific project, but this framework has resulted in consistency on a macro level.
Agency Fee Structures
An Agency Fees structure can be broken down into two main buckets: project-based and retainer-based work.
Project-Based Fees
Project fees are easier to calculate than retainer-based fees. There are variables that can influence profitability associated with project-based work even if the fee structure is spot-on, but these variables are fewer and easier to account for.
This may be the result of our agency’s genesis. Our evolution to retainer-based fees is relatively new. Nonetheless, I believe that there are generally fewer variables to control associated with a project that has a defined beginning and end point assuming that the scope of work is also well-defined.
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For the sake of disclosure, we aim for 20% net profit on our projects. This formula has helped us to achieve it:
(1.25 * (3 * Hourly Cost Basis * Estimated Number of Hours) * )
- Take the hourly cost of each production-oriented employee and multiply it by three. This is the hourly rate that you want to be charging for that employee. (Do not include administrative personnel, such as project managers, in this process).
- Estimate the number of billable hours associated with each employee. Multiply the hourly rate by the estimated number of hours.
- Add 25% to the project. This provides a buffer to account for variables like scope creep, underestimation, “oh shit, something terrible just happened” moments, etc.
To illustrate:
Depending on the project (e.g., if it is a competitive bid process, a small company, etc.) you may not be able to charge the full 3x cost basis multiplier or for the 25% buffer. We’ll go as low as 2.5% on the multiplier and eliminate the buffer altogether in some cases. In doing so, we know that we’re sacrificing our target 20% margin.There are some additional considerations when estimating a project in this way:
There are several variables that have the ability to influence the effectiveness of this approach:
Accurate Time Estimates
If a project or a phase of a project is significantly underestimated, it can derail the entire scope. If a project that was estimated at 200 hours winds us taking 400, it will be difficult to salvage.
Inefficient Labor
The project fee structure above assumes approximately 80% team member productivity. If employees are only working 4 hours out of an 8-hour day, even a perfectly estimated project will wind up taking longer than it should, and margins will suffer a result. You’re paying a salaried employee for 8 hours of her time, irrespective of how many they're giving you in return, and you lose on the agency labor rates.
Scope Creep
This is oftentimes the most difficult variable to control because it involves managing the client. It is important to be as detailed as possible in an SOW to ensure that there is legitimate and clear grounds for change orders should the client introduce work activities that were not accounted for in the original scope.
Administrative personnel are accounted for in this project fee structure but should not be billed directly to the client. These fees are accounted for in the 3x cost basis multiplier. So project managers who are involved in the project are having their cost basis covered by the production-oriented team members. It is best to spread the cost of administrative personnel across as many projects as possible.
Retainer-Based Fees
Estimating fees associated with retainer engagements is more challenging by virtue of their generally front-loaded work cycles and what I consider to be a more flexible deliverable set.
Front-Loaded Work
Our setup process for an inbound marketing program can be quite intense. A thorough and comprehensive process, resulting in the launch of the client’s first campaign, can take upwards of 180 billable hours. This would involve a turnkey approach where we’re handling everything associated with strategy, design, tech, and content workflows.
We’d generally aim to spread this out over the course of two months (i.e., we launch the client’s first campaign at the end of month two). Using $100 per hour as a baseline rate, this would result in $18,000 of billable hours for a marketing fee before the client ever has a campaign launched.
This is not something that most clients are going to be comfortable with, which creates a bit of a conundrum: How can the agency protect its investment of hours while still providing a palatable price tag to the client? Our solution to this problem has been in the way that we structure our contracts.
Essentially, our basic contract would read something like this:
- Setup (Months 1-2): $18,000
- Ongoing (Months 3-12): $24,000
- Total: $42,000
- Amortized into 12-monthly payments of $3,500
We then allow the client to terminate the contract after the first 30 days with 30 days’ notice. This ensures that the first two months of the program (setup phase) are protected. And the contract contains language that if the contract is terminated early, the fee schedule reverts to an unamortized schedule. The client is then responsible for the unamortized fees through the date of termination.
This is how we protect the heavily front-weighted investment of hours.
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Flexible Deliverables
Logistically, there are different sets of tasks and deliverables that are better emphasized at each stage of the Attract > Convert > Close > Delight process, depending on where the client’s needs are most evident. For instance, there’s little reason to be focused on a campaign aimed at converting leads into customers if the client’s site is not even generating any visits. At that stage, it would be better to invest every ounce of energy into content creation and promotion to generate the requisite eyeballs.
But a client’s needs evolve alongside the results of an inbound program. Once the eyeballs are on the site, the focus shifts to optimizing around lead generation. And once the client is bursting at the seams with leads, the focus shifts to converting them into customers. And if the client has tons of customers, the focus may shift to retaining, cross-selling, or upselling them.
So how does an agency calculate 12 months of fees in advance when it has no ability to predict with a meaningful sense of accuracy how quickly the client’s needs are going to evolve? This is a real challenge.
Retainer-Based Fee Structure
In a retainer-based agency model, the client pays in advance of work performed on an ongoing basis. The fee structure can be defined according to a secured number of hours, expected work to be performed, performance level, or a combination of the three.
Here's a quick breakdown of each:
- Hour-Based Retainer: The client pays in advance for a number of hours. Usually, it's the client's discretion how those hours are used.
- Deliverables-Based Retainer: The client pays for a specified number of deliverables per month (or other time period). The hours are not reported to the client, though the agency should keep margin in mind.
- Performance-Based Retainer: The agency gets paid based on agreed-upon performance milestones. This can be risky as the agency is taking a gamble that their efforts will pay off, but it can work favorably in some cases, resulting in a win-win for the agency and the client.
- Hybrid Retainer: The retainer uses more than one of the above methods in its structure to determine the fee schedule.
At Salted Stone, our approach is generally very unscientific and is largely based on what a client is willing to pay given certain bottom-line thresholds that we cannot compromise if we want to be able to do the job right.
We know, for instance, that we’re going to blog a minimum of two times per week. And we know our average cost for a blog post. We know that we’re going to generate a minimum of four content offers over the course of 12 months, and we know our average cost to produce a content offer. We know -- at least loosely -- how long it takes us to strategize, to design, to implement, to report, etc. And so we generate proposals that start with the minimum thresholds as a floor and then add-on as we believe the client’s budget, need, and tolerance will permit.
Example Deliverables for a Retainer-Based Fee
As a baseline, we use the following as a minimum deliverable schedule:
- 4 Content offers
- 4 Total campaigns
- 2 blog posts per week
- Daily social media posts
- Associate CTAs, landing pages, workflows, lists
- Conduct monthly reporting
We find that this is the minimum service level required to provide true value for our clients, and the basic retainer agreement for this level of program would begin at $3,500 per month.
Invest in Your Clients
Truth is, we are a boutique outfit, and client retention is extremely important to our growth. The net impact of this reality is that, in many cases, our packages and estimates and forecasts are worth about as much as the digital paper that they’re written on: We’re constantly over-servicing accounts relative to the agreed scope of work so that we keep our customers happy: Happy customers pay their bills and contribute to organizational growth. I’d never want to be accused of being penny rich and dollar poor. I’ll gladly lose money today for a greater payout tomorrow.
As long as your agency is making money on more jobs than it is losing money on, you’ll have the opportunity to refine your own methods for managing agency fees over the course of time.
Editor's note: This post was originally published in November 2014 and has been updated for comprehensiveness.
