At first, consulting seemed like a great business opportunity.
With operation costs low, your small team of a few consultants was firing on all cylinders.
Perhaps your numbers looked something like this:
|Payroll (for 4)||Rate|
|Payroll taxes||Hours Billed|
|Basic health insurance|
|Office Rent||Net Margins|
Not too shabby, this can work!
So you add a new team member, and then another.
Soon you have the bustling office of professionals you always dreamed of, but your margins are shrinking fast.
Your team has grown, but you find yourself working harder for less money.
This was supposed to be easy! What happened?!
The problem is that the profit of your business is directly tied to how productively people use their time.
If you pay an employee about $30 an hour, which they bill out as $80, your margins seem good – over 60%.
But if they work an unbilled hour, that cuts those margins in half. You’re paying $60 for an $80 profit. Your entire revenue depends on everyone staying productive, and managing that becomes increasingly difficult as you bring on more people.
Here’s three problems that are preventing you from fully capitalizing on your growing team’s productivity, and three solutions to create leverage and increase your margins.
Problem 1: You’re squandering valuable time
The majority of agencies achieve a billable ratio (hours billed vs. hours worked) of between 30-40%, even though digital agency experts say you should be striving for 60%. Bumping up this ratio is just a matter of increasing the efficiency of your work.
Using the same data as in the above example, here’s what that would mean:
|Unbilled hours||Revenue lost/person/day||Revenue lost/person/mo.||Gross margins|
|6 (40% billing ratio)||$653.10||$13,715.10||28.98%*|
|4 (60% billing ratio)||$435.40||$9,143.40||52.65%*|
|*for a 10 hour work day, with an $80 rate|
In this example, shifting to a more productive schedule would increase our margins by almost 25%.
But getting employees to fill most of their day with billed hours is easier said than done.
Every agency is plagued with meetings, calls, and other “necessary” interruptions that billable hours have to be squeezed around.
The Solution: Shift to a maker’s schedule
In order to achieve a higher billing ratio, your team needs to take a more ruthless approach to what tasks get on their calendars.
Paul Graham’s solution is to switch to “the maker’s schedule.” The principle behind this approach is that makers (people whose tasks take up an hour or several hours) can’t afford interruptions the way managers can.
The more time your projects take up, the more costly an interruption is.
Let’s say that, without billable hours, an employee’s schedule looks like this.
According to Gloria Mark of UC Irvine, it takes about 25 minutes to refocus on a task.
Factor in a half hour prep time and those 6.5 scheduled meeting hours have turned into almost 14 hours of that week! That’s almost two full work days.
But if you only allot one morning, or three hours of one afternoon per week for meetings, you’re freeing up the rest of your week for work that pays. As a result, you’ll be able to:
- Have more flexibility for when you have time to meet with a client
- Be able to bill full research hours, so that you don’t over-service
Having just one time slot for meetings will force your team to be ruthless about which meetings are worth those precious hours. Everything else can happen asynchronously through team updates that you send via a project management tool (hey, that’s us!).
Problem 2: You’re undervaluing your service
There’s a cap to how many billable hours just a few people can achieve. So the next logical step to grow your business is to hire more people.
The assumption is that, with more people, margins can be maintained and your revenue growth will scale linearly with the number of employees you hire.
But the unfortunate reality is that growth decelerates with each new hire. You’ll need to spend more to keep up the same revenue. This is due to:
- Managerial overhead: As your team grows, you won’t be able to manage and train your entire staff yourself. You’ll need people who make sure work is getting done, clients are taken care of, and employees are satisfied.
- Administrative overhead: When you have just a handful of clients, it’s easy to keep your records straight. But once you’re managing dozens of clients who get passed between employees, important details get lost. Some kind of office manager or administrative assistant will be necessary for staff to stay on top of things.
- Operation costs: You need a bigger office with higher rent, more hardware, and more software that your team needs to better communicate.
If you hire one manager and one administrator for every five people that you hire, your spend will grow without impact on billable hours. So your margins will suffer:
|5 consultants||10 consultants||15 consultants|
The Solution: Raise prices regularly
To make up for this blow to your margins, increase your hourly rate as your team grows.
The SaaS pricing experts at Price Intelligently advise young companies to raise their prices every 6 months. And while this advice works well for subscription software services, it applies even better to agencies.
Agencies, more so than software and other products, are able to use price elasticity to their advantage.
Economists define price elasticity as:
But consulting work is a value-driven product. If you increase prices, clients who see the value in your work won’t leave.
With inelastic pricing, your price has a direct correlation to demand. Raising prices will keep people from buying your product or service. In an agency, you can and should raise prices with relatively little change in demand. Even if you lost a client or two in the process, ultimately, you’ll significantly increase your profit.
So raise your prices every 6 months, and let your existing clients know in the form of a proposal. Explain an increase in quality, sales, demand, or turnaround time.
Problem 3: You’re worried about turnover
Agencies lose an average of 30 to 40% of talent a year. Consultants with a lot of industry experience are a hot commodity, so it’s all-too-easy for them to be swept up by bigger businesses with cushy benefits and high wages.
This can be crippling to a small agency where training new employees can take several months.
Using our same data sample, here’s how a two person turnover would impact our monthly margins:
New hires will cost you double – you’ll lose the billed hours they’re not capable of taking on, and you’ll lose money on the salary you have to pay them from day one.
Not to mention, training can absorb other employees’ valuable time, pushing your margins even lower.
But if you can keep employees happy, you’ll prevent turnover in the first place. You’ll then not only decrease the annual cost associated with onboarding, but you’ll get employees who are growing in efficiency and value.
The Solution: Profit-sharing
The problem with consultancy is that the founder’s goal isn’t necessarily aligned with the employees’ goals. Founders want high billing ratios, and employees want to do good work, get paid and go home.
But, if you can get them to have a vested interest in their work, you’ll be less likely to lose them.
You can achieve this by splitting profits with your employees.
Set a target billing ratio, and once your team hits it, share the profit.
This might seem like an expensive option, but it’ll save you a significant sum in the long run:
|Cost of one employee quitting:|
|Hours lost that month||140|
|Cost of sharing 20% profit w/ one employee:|
|20% profit share||$12,320|
The results are clear:
The cost of keeping happy employees around is much lower than losing them altogether.
Not to mention, studies have shown that happy employees are more productive and learn faster.
Conclusion – Don’t leave room for chance
As your team grows, your risk increases. There’s no way around it.
You’re putting your trust in more people to use their time wisely, and every additional team member has the capacity to single-handedly slash your profit margins.
Increasing your margins aren’t just a fancy way of saying, “go make more money.” It’s a way of increasing the buffer, so that you can mitigate the risk that comes with agency work.
And the extra bucks are a huge added bonus.
Looking for more productivity tips? Download the infographic below!