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Why You’re Killing Your Agency’s Profit Margins (and How to Make It Stop)

When you run a marketing agency, your year-end financial statements are the sum total of the decisions you made during the past year. But those statements are simply a tally of all the smaller decisions you made throughout the year.

Every client project and retainer is an opportunity to either help or hurt your bottom line. Small daily decisions on client projects can snowball until it’s too late and you’re looking for a new job yourself.

There are actually several things that most people who work in marketing -- regardless of the specific type of work -- do on a recurring basis that will hurt them in the long run. As a business consultant to owners of digital marketing agencies, I help clients avoid making many of these common mistakes.

But it’s not enough for me to say what not to do. There’s a psychological component -- you’re doing these harmful things for a reason.

That means that to change your ways you first need to understand why you aren’t making better choices.

5 Mistakes Agencies Make on Every Project

1) You do free, out-of-scope work, and you don’t tell the client the request was out of scope.

Why you do it: No one likes saying “no,” and it often feels easier to just “do it” and move on.

What you should do instead: Tell the client when her request is out of scope (OOS). And tell her if she is getting free, out of scope work.

Don’t give free out-of-scopes unless there’s a strategic value to doing so. And when you decide there is a strategic reason to do work for free, be sure to tell the client -- if she don’t know she is getting a good deal, she will expect it every time.

As you’ve surely seen, “one easy change” tends to turn into more changes, and they’re rarely easy. It may be uncomfortable to say something’s OOS, but that’s one phone call -- versus working late again because the free changes turned out to be more of a commitment than you expected.

Need help saying "no"? Use my “Reason-Options-Choose” (R-O-C) framework. That is, cite a reason why you’re saying “no,” give the client two to three options, and let her choose.

For example: “Sure, that sounds like a useful change. Since that approach wasn’t part of our original scope, I looked at what it would take to do it. I estimate that to be an additional $3,000. Would you like me to send you a change order, or would you prefer to defer that to Phase 2?”

2) You don’t track all your client time.

Why you do it: You probably hate timesheets yourself, and you don’t like forcing your team to do them all the time, either.

What you should do instead: Track 100% of your client-facing time, both billable and non-billable.

It’s painful but necessary. If you do time and materials billing, you can’t bill the client correctly if you don’t track all the time spent on the project. And if you bill on a “fixed bid” project basis, you’ll want to measure whether you’re over or under your estimate (more on that in No. 4).

If time-tracking is really a burden, one option is to only track 100% of everyone’s client-related time (including travel time and sales support time), and input one catch-all time entry a day (or per week) to cover non-client time (internal meetings, professional development, etc.). That’s not ideal, but it’s better than nothing.

3) You skip post-project debriefs.

Why you do it: You don’t want to re-live what went wrong, and it’s hard to track down a “we’re done!” client for feedback.

What you should do instead: Do team debriefs (AKA “post-mortems”) after every project to transfer lessons from people’s heads into your agency’s institutional memory.

When surgical room teams debrief regularly after operations, they work faster and make fewer mistakes. If you’re committed to being a learning organization, debriefs are an important part of continuous improvement.

When you do a debrief (also known as a post-mortem or an after-action review), you’re transferring lessons learned from your team members’ heads into your business’s institutional knowledge bank. If you’re not capturing what you learn from each project, you might as well be a lineup of freelancers that changes on every project. You’ll only make the same mistakes over and over again.

Want to do an efficient post-mortem? Meet for no more than an hour. Have a detail-oriented person take notes while a good speaker/listener facilitates.

Focus on three questions:

  • What worked?
  • What didn’t work?
  • What should we do differently next time?

If a contractor was on the project, pay her to be on the debrief. Her feedback has value as well.

4) You keep underestimating projects.

Why you do it: You’re an optimist -- plus you worry if you don’t cut the estimate, you’ll lose the sale.

What you should do instead: Commit to improving your estimates each time.

Improving your estimates will help your profits faster than raising your rates. Why? Because going 50 to 100% over budget (without getting paid for the overage) costs you more than you’d ever make by raising your rates 10 to 20%.

So, how can you create better estimates? Call in backup.

If you are handling sales, get a reality check from someone else; if it’s not you, have whoever handles sales do so. This could be an experienced project manager or another designer, developer, or strategist who has experience working on this type of project. Get their opinion before you give firm numbers to the sales prospect.

Don’t reinvent the wheel -- have a library of common estimates. Creating overall estimates will still take time, but you can have off-the-shelf estimates for things like styling an interior page template, configuring a client’s analytics account, or doing an initial marketing automation configuration. Then, if you find something you estimated at 12 hours has taken 16 hours the last three projects, you update the library of estimates for next time.

And if everything you do is truly from-scratch custom? The novelty may be fun, but perhaps you should consider specializing more so you can learn from past projects. Otherwise, it’s hard to get better.

If you’re worried a prospect will reject a high estimate and you’ll lose the sale entirely, consider giving her two estimate options -- a barebones choice that fits her budget and a “better” option that delivers the scope (at a typically much higher price). Then, she can make a choice.

5) You cut your prices (without cutting scope) during the sales process.

Why you do it: Beyond wanting to win the sale (No. 4), you figure once you get your foot in the door, you can always “make it up later,” like loss leaders in a supermarket.

What you should do instead: Accept that you’ll never “make it up later.”

The “we’ll make it up later” loss-leader pricing approach doesn’t work in digital marketing.

In my nearly two decades in the industry -- as a web designer, marketing consultant, sales and marketing analyst, web project manager, director of client services, director of operations, and now as a business consultant to digital marketing agencies -- I have never seen the “we’ll make it up later” approach work.

Inevitably, something goes wrong.

Perhaps the client isn’t happy, or maybe they like you but have less money than you expected -- and they don’t want you to do phase 2 (i.e., no more revenue so no way to recover the lost profits).

Perhaps you assume a regional nonprofit will refer you to other branches and to its national organization, but then you find they don’t have that kind of political pull.

Or perhaps you work with a client on one project and ultimately dislike working with her so much that you’d never work with her again, no matter how much she paid you. (I’ve seen this more than a few times.)

Your goal should be to make a fair profit on each project by itself, without getting carried away at the promise of a future that almost certainly will never come.

What Happens When You Don't Break the Cycle

From my experience advising agency owners, I totally understand why you keep doing those five things. You’re exhausted -- and the idea of pushing back against a demanding client or scheduling yet another non-billable team meeting or having yet another daily task is the last thing you want to do.

What Happens Next Year

But if you don’t make some or all of these five changes, you’re going to get to the end of the year and your accountant is going to say, “Your revenue grew this year, but your profit margins dropped. I dug into your profit and loss statement, and I can’t figure out why profits dropped -- it seems to be an overall trend. What happened?”

Your Risk Should be Rewarded

Yes, you’re probably taking a salary for your work. But that’s only part of the equation. A key part of owning a business should be to make a reasonable profit, to reward you for the risk you’re taking and the stress you’re facing every day.

If you’re not making a 10 to 20% profit margin, you might as well work for someone else. You’ll make a similar salary but with a lot less stress. You owe it to yourself: When a business consistently makes a profit, the financial gods are saying, “This is working.”

Is your agency pricing for value?

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