Agency Forward

Unknown Speaker 0:00
Hey, everyone, today, I'm joined by Marcel. Pettipa. Marcel is the CEO of parakeeto and an expert in helping digital and creative agencies improve their profitability. He has worked with hundreds of agencies to help them get better at just managing their margins, setting accurate pricing, tracking project performance. If you have ever struggled to figure out where your profits are going or how to scale your agency without burning out. This episode is packed with insights that you won't want to miss. Marcel is one of my go to guys for agency profitability questions, and it should be yours too. In this episode, we discuss why net profit on a project basis is a flawed metric, the best way to track project profitability and set pricing. Why internal specialization is crucial for future success and more.

Unknown Speaker 0:51
Today's episode is brought to you by Zen pilot. There are lots of tools out there for agencies to manage projects, but any project issues aren't usually caused by the tool. They're from your own processes. Zen pilot helps agencies implement their project management tools while streamlining operations so your team can move from chaos to clarity. You can see for yourself at Zen pilot.com/forward,

Unknown Speaker 1:15
and now. Marcel pettapie,

Unknown Speaker 1:18
it's easier than ever to start an agency, but it's only getting harder to stand out and keep it alive. Join me as we explore the strategies agencies are using today to secure a better tomorrow. This is agency forward.

Unknown Speaker 1:37
What are the most common reasons that agencies struggle with profitability? It's a great question, and I'm gonna answer it at three levels. The first is, like the root cause issue, which is most agencies aren't actually measuring their profitability beyond just looking at their profit and loss statement and seeing that they have money coming in and not that much going out. But any measurement beyond that, most firms don't really have a whole lot of visibility into like well, why? Why is that happening? So to me, that's the root cause, because you can't manage what you can't measure. And then beyond that, there's really only three major reasons that we see agencies are not profitable. And you'd be surprised to know that, contrary to what you might read on the internet, it's almost never pricing, and it's almost never overhead. Actually, the most common reason that agencies are not that profitable is, number one, their utilization rate is not as high as it needs to be, or as high as they think it is, or and, or number two, their average billable rate is not as high as it should be. And when you hear the word average billable rate, you might think, Oh, that's a pricing problem. And actually, most of the time when we do our analysis, what they're pricing things at is appropriate, what they're setting their rate targets at is appropriate and high enough for them to be profitable. It's that they're often not actually earning the revenue as efficiently as they thought they were. So in other words, they're spending a lot more time to get things done, or the labor costs that they're incurring to get things done ends up being a lot higher than they assumed when they priced out the work. So those are at a tactical level, the two most common reasons that we see agencies struggle with profitability is they usually have a delivery margin problem. And that delivery margin problem as a function of utilization, average global rate and or average cost per hour. And that's really the golden triangle that we tend to focus on with the majority of the firms that we work with. Right? Do you think so, with the root cause being that they're probably just not measuring it? Do you find that that's for a specific reason? Are they intimidated by the numbers and everything they have to do in order to figure this stuff out? Do they just not know what they should be tracking so they ignore it?

Unknown Speaker 3:39
The first thing is, it's not something that you actually really need to be maniacally focused on until you reach a certain level of scale. And so it's one of those, you know, what got you here, won't get you there. Kind of traps that people fall into is they scale up to a million bucks in revenue a team of 10 people, then they start to feel this pain. But it's often not the first place that they look they're saying, like, Oh, we got here, and the financials that we had were fine, the office metrics that we had were fine. So they don't typically see that as being the issue, until maybe they get some help uncovering that that's a problem. So that's the first reason, is they're maybe just not focused on it as a problem. And then the second piece is there's three elements that you need in order to have a like a highly functioning profitability management system, and most firms only have one of those pieces. And so the three pieces are, you need data, right? So time tracking, finance, people, projects, you need information to be created on a regular basis in the business that you can then turn into insight. So that's usually not a problem. Most firms have the technology or the spreadsheets or the processes to create raw data. It's very inexpensive. It's very straightforward. There's tons of SaaS tools and project management tools for that. The issue is, most firms have all this data, but they're not getting insight. So why is that? Well, there's two other components that need to be in place in order for that data to turn into insight, the first, or I should say, the second component, so you have your data.

Unknown Speaker 5:00
Then you need a framework. This is where the first place that people start to get tripped up. So the framework speaks to what are the metrics that you should be tracking, right? So out of the 1000s of metrics that you could be tracking, which ones do you actually need to focus on, and why and how do you get that down to a small number of metrics so that it's easy to understand you're not tracking a bazillion things, and you can actually get inside make decisions once you know what metrics you need to track. Then the next question is, well, how exactly do you calculate them? And that is a whole other can of worms, right? Like, we could agree Chris that like, oh, measuring utilization, for example, is really important. But then when you double click on that metric, it's like, okay, well, what is someone's capacity? Exactly. What does it include? What does it not include? Is it all over time? Is it just time spent on client work? What about holidays? What about vacation time? What about sick time? What about internal meetings? What about the company off site? And the same thing is true about the other side of that equation, which is the billable hour. What is the billable hour? Is it all the time we spend working for our client? Is it just the time that we build to them? Does working on the company website count? Does it not what about all the other internal stuff that we work on, and who's included in that? Is it just the delivery team? Is it the whole team? So there's a lot of questions, and every metric has all of these kinds of questions, and the answer to those questions is really meaningful because it speaks to the third piece of the framework. So you have the metrics. What metrics are we tracking? You have the formulas. How are we actually calculating these things, which ties into number three, which is, what are the relationships between the metrics? So when one metric goes up or down, we know how that impacts all the other metrics that we track, but we also, most importantly, understand how it impacts the business, right? What does it mean when this metric goes up or down, what are all the reasons that it could be going up or down, and what does it say about the business? And unless we understand those relationships, then we're not going to get insight. We're not going to understand how to take action based on what the numbers are telling us. So the framework is the first place that people get tripped up, and it's actually a really hard problem to solve, but an important one, and we see this all the time. People pouring tons of time and energy and money into building scorecards and tracking things and getting KPIs in place, and then they're still taking the wrong action. They're still getting false negatives, false positives kind of spinning their wheels, and it ends up being a huge waste of time and energy for them. So that's the first big component. I'll pause there before I talk about the last component, which is the least, the least exciting for everyone listening? Sure, so

Unknown Speaker 7:25
I can't remember who said it, but I've heard it somewhere. But it's this idea that you can't improve what you don't measure, right, but you also can't measure what you don't define, right? And I think, to your point, a lot of a lot of people, a lot of agencies, skip the definitions point even when working with clients, right? Hey, we're gonna bring in this many MQLs. Okay, well, let's define what an MQL is, so that we're on the same page here. But yeah, when you're looking at your finances like those definitions can be, they can greatly change from one agency to another, and so being able to understand what those look like. Is massive. It's super important. And to your point, like you asked 10 agencies how they measure a metric, they'll probably give you 10 different answers. And it's not to say that one is right or wrong, but you have to consider what your answers are and then how it impacts all the other metrics that you're measuring, so that that whole system makes sense. And so the good news is, the framework is free. You can just go get it. We've just published it at no cost. You it's in a thing called our agency profitability toolkit. It has videos, it has templates, it walks you all the way through. So if you want to just like, adopt a framework that we know works because we've used it with hundreds of agencies, then you can just go and solve that problem. So then you hopefully will have two of the most important components, you'll have the data, and then you'll have the framework, so you'll have defined all the metrics that you're tracking, how to calculate them, what they mean, how they impact the business, all that stuff. But then there's a third piece, and this is the piece that everybody wants to pretend isn't important, but it absolutely is, and that piece is the process. Here's why the process is important. Chris, I can't tell you how many times I've spoken to agency owners or operations managers that are like, I just want to automate all of this and have a real time dashboard to measure all these things. You ever heard that before? Chris, yes, all the time. Yeah. And you know what? I want that too. We all want that. Unfortunately, it's not possible, and there's going to be some people listening that are going to be really upset with me saying this, but I wouldn't be saying it if I didn't know that it was true. I spent six years working with hundreds of agencies looking at this problem set, and this is, I think, the biggest fallacy in our industry, is that this could be automated, and that that's even the right approach to trying to manage this data. But the reality is, under process, you need to do three things. Number one, you need to have a data hygiene process. And the reason this is important is because the even if you look at like an all in one agency management platform, and there's some excellent ones out there, I think they're amazing for helping streamline a workflow and keeping all.

Unknown Speaker 10:00
Of the workflows that need to happen inside of one place and getting a lot of efficiency around creating that raw data. But when they talk about automating your reporting, the critical assumption that's being made there is that you're going to have perfect data inputs and that you're never going to have mistakes in those data inputs, and secondly, that those data inputs are never going to change in terms of their structure. And what I know to be true is that has never happened, ever. And the harder you try to control the inputs and get your team to put everything in perfectly, the lower your compliance becomes. So even if you can accomplish the things that end up in the system being perfect, what you end up with is only, like 30 or 40% of the data that you need being in the system. So you're still shit out of luck at the day. So this fallacy of we're going to be able to get clean inputs is just fundamentally not aligned to reality. So we need to build a system that assumes we're going to have mistakes in the data, assumes the client's name is going to be spelled differently in three different places, assumes that there's going to be seven different permutations of the word design that end up in our tag list for tasks inside the project management tool that assume that the way we structure a project and our time tracking tool is different than the way it's structured in the pm tool is different than the way it's structured on the estimate is different than the way the invoicing schedule is laid out in QuickBooks. This stuff just happens and it changes over time. So we need to assume that that's going to be the case and have a process for making sure we pull data from the source and run it through a hygiene process so we can fix these things, just in the same way that we have a bookkeeper that looks at every single transaction when we run our financial processes each month. That is also true about ops data, and it's true about every if you go up market to enterprise, you won't see an enterprise company that doesn't have a proper data management process in place that includes this kind of stuff in their data pipeline. So process, step one is hygiene. Step two is change management, right? So you need to have a process to make sure that every time you want to switch time tracking tools or start selling a new product or service or change the name of a function in your business from, let's say client success to customer success, that when you or change the way that stuff is set up inside of your project management tool and how your Pm team is organizing tasks and workflows, you need to have a process for looking at those changes and folding them into the reporting system so they don't break everything, so they don't create these big swaths of data that are now no longer congruent with one another. So like, hey, we can't track this trend over time, because as of three months ago, it's different than it was before, and those data sets don't match up. So we need to be able to, again, assume that that's going to happen, design our system around assuming that it's going to happen, and fixing it. So process, we have hygiene, we have change management, and the last is cadences, right? Right? So real time is a nice concept, but for a lot of these profitability management metrics, it's not actually feasible. So like utilization, for example, you could measure utilization in real time, and the result of that would be you would have a measure of utilization always available to you, but it would literally never be accurate, right, right? Because the problem with that is, if you're going to measure utilization in real time, that assumes that people will track their time in real time. But we know that that doesn't happen. Some people track it weekly, some people track it daily. Very few people are logging it on a regular basis, and you need to have a model of capacity that is in line with when that time tracking data is there. So just like in financial processes, for a metric like utilization, you probably want to determine, well, what is the cadence of the conversation that we have around this metric and the decisions that get made around it? Therefore, how often do we need to measure it? And therefore, how often do we need to close timesheet submissions? Review those, make sure they're complete, run them through hygiene, run them through change management, reconcile all of that and then measure the metric. And I know that that sounds like a lot of work, and it is, and it sucks, and I wish that it was different, but ignoring that piece is the reason we run into so many firms that they have the first two pieces, they get the data, they get the framework, and they throw lots of time and energy at trying to report on this stuff, but it still ends up falling short, and they spend their entire meeting wondering why the data looks off, why this doesn't make any sense. You know, tracing this back to data issues, and they're not actually getting the value, because they stop short of really being deliberate and saying, we're going to take this process seriously and we're going to account for these things that are actually going to be challenges in running this system. So, data, framework, process, those are the three keys. And most people that we speak to are missing the framework and the process, right? So one of the things that I'm doing with my clients that are, I've got a couple that are sub 500k

Unknown Speaker 14:39
in revenue, and for them, we're not we're doing everything manually, right, like you will go plug these numbers in all the time, primarily so that you get used to seeing these numbers and knowing where to find them, and you start getting well acquainted with them. And then we'll start looking at other systems that we can be using to bring other people in to help with stuff, and like a bookkeeper, things like that.

Unknown Speaker 14:58
But I guess question for you.

Unknown Speaker 15:00
What, at what point do you think the collection of data and stuff should become a bigger priority, as far as, like, time tracking utilization? If I have like, five team members and we're not making that right, we're making 500k

Unknown Speaker 15:15
I guess in my head, it's not the biggest focus. Like getting, making sure we're nailing our offer, and then we have, we're setting up whatever good process for delivering value to the client, so that we can start scaling that up would be a bigger priority. But that doesn't mean we can't start tracking some of these numbers early to make sure that we have, like, the foundation, I guess, set for later. What do you recommend? Yeah, I would agree with that. Like, I think that in terms of priority, sub a million dollars in revenue, you're still trying to find product market fit, you know, basically as an agency. So it's, you know, what do you what is the problem that you solve? What's the offer that you make to people to have that problem, and do they respond to it? Can you get paid for it? Can you deliver it? So that's all kind of first principle stuff. But if you're going to scale from, you know, 500k to a million, or a million plus, there also is some other stuff that needs to be true about that. So are we planning to have good margins when we sell something in the first place? So the good news about that is you don't need any data collection to do that math. You just need assumptions about how much time does it take us to do this, and what is the cost of that time versus how much do we sell it for, and what's the margin? Is that theoretically helping us get set up for success. So you should understand your model at that point in time, and like, do the fundamental assumptions about our business make sense? Because, of course, if they don't, then you have a problem. And then if you're finding that you have issues with cash flow with profitability that are actually creating resource constraints so you can't invest in your growth, then you would want to double click on, okay, which of these assumptions that we're making are not aligned to reality, and that would help you prioritize, like, Should we be paying attention to utilization? Should we be paying attention to project profitability and just do kind of the minimum effective dose of tracking that would get you there? And what I'll say on this is, if you can get ahead of time tracking early, even if that data set is not perfectly structured, there's often a lot that you can do to clean it up after the fact, if it exists and you've been on top of having your team track that stuff. So that's something I would encourage people to kind of take on early. It's Is it the most important thing compared to the stuff that you've surfaced? No, but it'll be so useful, and you'll be able to much more quickly address the challenges that you'll run into if any of the assumptions you've made about your business end up being incorrect. And in my experience as an entrepreneur, there are a lot of things that I've made assumptions about that ended up being incorrect, including with regards to my business model, right? Yeah. I mean, even with managing my own time, I can spend a week thinking I committed a lot of time to one thing only, to look back and realize that one project took a majority of my focus. And fortunately, it's like I have all the time in the world. But when you got a team around you, and you have to start figuring out, how do I price this stuff and make sure that we are utilizing everyone appropriately, it becomes a bigger

Unknown Speaker 18:03
issue.

Unknown Speaker 18:04
A lot of agencies talk about the importance of net profit, and I think they're using it looking at every every possible like variation of this, including individual projects. And I know you're a believer that that's not the way to go? Yeah,

Unknown Speaker 18:22
what's a What's the case there? So I think we can all agree that the bottom line is the objective, right? So let's be clear about that. The goal of the business is to have a strong bottom line. But I think that the mistake, the trap that people fall into is this is one of many, what I call precision traps. And it's, it's the fundamental belief that this tends to be pinned to is the more precise something is, the more accurate that it will be. And in my experience, those two things are not even correlated, but in a lot of cases, they're actually in conflict with one another. So this is a perfect example of that, of saying, Oh, well, if I try to infer the net profit that a project contributes to my business, that's a more precise measurement. It's more detailed. It's more specific. There's a lot more things being included in that. Therefore it's going to be more accurate. The problem is that's actually less accurate, because the concept of net profit on a project is fundamentally flawed, like it just, if you actually think about it, doesn't make any sense. It'd be like a bakery saying this muffin, when I sell this muffin to a client, like, how much net profit does that create for the business? It's like, well,

Unknown Speaker 19:31
it depends. How many muffins Did you bake this week, versus how many loaves of bread Did you bake this week, and how much overhead did you have? How like, there's so many variables that are, you know, how many people came in, right? Are you gonna Are you gonna change the amount of net profit that a muffin contributes to your bottom line based on if you had 200 customers walk in the door, versus you had 500 because a cruise ship came in and you had a bunch of extra foot traffic, and so the same thing kind of happens when you think about this for an agency, like, should the profitability of a project be in for.

Unknown Speaker 20:00
Influence by how busy the business was. No, definitely not. Should it be influenced by how much overhead you had at a given moment in time and or how many projects that overhead was being split across, where you could end up in two situations where it's like, depending on how you're modeling this, we had 50 little projects, therefore our overhead on each project was lower versus we had, you know, 25 larger projects like these things should not influence the profitability of a project, because then when you look at over time, you go, Oh, six months ago, our projects were more profitable than they are today. But then you figure out, Oh no, it's not actually the case that they're more or less profitable. It's just that we were less busy. That's just like, not an accurate insight into the question we're trying to answer, which is, is this project profitable? So the important thing to understand here is, is the project creating enough what I would call direct profit. We call it direct delivery margin. You could think about this as contribution margin to support all the other expenses in the business and give us a chance at being profitable. On the bottom line, assuming that these other things go right. And so that is the measure of profitability that we tend to focus on, is just the direct profit of that project, which is, how much did we get paid after we strip out pass through expenses and money that doesn't belong to us, and then what was the cost of the direct labor that went into that thing? And generally speaking, if that margin is 70% or higher, then we know that we're going to have 10 to 20% of that margin go to, you know, inefficiency or indirect delivery expenses. So utilization gaps, some of the overhead management, some of like the shared delivery expenses that we incur. So hopefully we land at 50, 60% delivery margin on the profit and loss statement, another 20 to 30% of that will go to overhead. So if we're hitting a consistent 70% margin on our direct work, then we should be in a position to land at, let's call it 20 to 30% net profit or more. And then the variable there will be well, did was our utilization as high as it needed to be, were we efficient with our overhead spending relative to our budgets? Those are separate problems, separate conversations, than was the individual project or client performant in and of itself. And so I think that there's just more nuance that needs to go into this. And it's not always true that more precise measurements are more accurate. In some cases they're less accurate, and they often are much more expensive, much more complicated, and, you know, much more time consuming to measure, which, especially as a small firm, but also as a big firm, right? The more this scales, sets you up for failure, because you end up with this thing that takes so much time to measure because there's so many variables that are constantly changing that you end up never actually having it be accurate at any given moment, even if it is theoretically a better way to measure something right well, and even just looking for, say, smaller agencies that need to get bills paid as projects are coming in, if you're you're overhead, You're gonna put what you said, uh, contributing your contribution margin, yeah. So like, that might be higher for your initial projects, because you need to take cash that came in as profit from these in order to pay some bills. But then towards the end of the month, your projects are looking more profitable because you're you don't have as much overhead to to manage at the time. So like, yeah, I can see how that. And it just like,

Unknown Speaker 23:24
like, a really good illustration of why this idea of net profit on a project is so asinine, is like, okay, let's say we're factoring our overhead and our utilization into our cost basis to measure the profitability of project. And we're going into a month, Chris and we just lost like, three big clients, so our team's not going to be busy, and now all of our overhead is kind of like getting all loaded into this and that we have a prospect that we're speaking to and they're ready to work with us. Are we really going to charge them way more money

Unknown Speaker 23:54
just because now we're less busy, right? Because, like, that's how that model would work. That model would tell us we need to charge this client enough money to cover all the expenses of the business. That's the opposite of what we would actually do in that situation. We would probably discount that project to get the work because we need it so badly, and that's probably the right thing to do in that moment. So this way of thinking, if we're trying to, like, base every project in terms of a concept of net profit, it's actually, like, in complete conflict with the reality of how we would be thinking in that scenario. So to me, that is like the first fundamental red flag of why this maybe isn't the right path to go down. And then there's all the other reasons that it's just harder and more expensive and more complicated and it doesn't actually get us any upside. Yeah, so if we are looking at project profitability and stuff. How do you recommend tracking that just over time? Yeah, the first place that I would start is actually just looking at average billable rate and slicing clients and projects that way. Average billable rate is a really simple metric, and it just allows you to understand across everything you sell, no matter how you bill for it, how efficiently do you earn revenue?

Unknown Speaker 25:00
And start to see patterns in different parts of the business. So the formula for this is you take the agency gross income for the segment that you're measuring. So agency gross income is how much did you get paid after you strip out pass through expenses. So this could be ad spend. It could be a white label partner. Could be materials, travel costs, right? So direct expenses that flow through you onto another vendor to get the work done. So what's left over is agency gross income, and you divide that by the number of hours that you spent directly working on that thing, regardless of if you were billing the client for those hours or not. It's like all the time that went into getting that work done. We counted. So you could look at this for a client, a project, a group of clients, a group of projects, a time period doesn't matter, as long as you have those two inputs, what was the money that we collected? How much time do we spend against it? And that'll start to give you some really interesting insight of like, oh, on average, when we do website projects for every hour that we spend, the business earns $200 per hour, whereas when we do SEO projects for every hour that we spend, we only end up at 120 that's interesting, right? So you can start to have really good conversations around that.

Unknown Speaker 26:05
The next step up from that would be thinking about direct delivery margin. So there you would try to track the average cost per hour on each of those things, and then the formula would be average billable rate minus average cost per hour divided by average billable rate. So let's just do an example, if I had a project where I made $150

Unknown Speaker 26:24
for every hour that I spent, and I had a $50 average cost per hour on that work, then I would have had a 67%

Unknown Speaker 26:33
delivery margin, direct delivery margin on that work. So that kind of gives you a quick proxy on like, Okay, how much profit is this really contributing to our bottom line and or really how much profit is this contributing at, like a gross level, and is that high enough to account for what we're going to spend on indirect delivery expenses, overhead and still put us in position to have a profit? And both of these are probably good cases for why you should start tracking time as soon as you can, because even at a 500k

Unknown Speaker 27:02
agency, right? That's those numbers being able to figure out what your ABR is. The only way that you could not measure profitability at a unit level, or, sorry, the only way that you could measure profitability at a unit level without tracking time is if you were allocating people fully to projects. But for most firms, it's just possible, right? So otherwise, yeah, you just need to have an understanding of where time is going. And time sheets is one way to do it, but a resource plan is another reasonably accurate way to do it. So if maybe you're not allocating people fully to projects, but people only work on two, maybe three things at a time, you could use the resource plan as a source of truth, especially if they're not working on multiple clients within a day, or they're they're spending like large blocks of time per client. In scenarios like that, you could still centralize time tracking and use a resource plan and just make sure that a project manager is there to say, hey, you were supposed to, Chris, spend a half day on this client and then a half day on this other client, is that what happened? And you go, Oh no, there was a fire. I spent the whole day on that client. Great. I update the resource plan. If there's big projects that kind of rounding can still lead you in a directionally accurate place without forcing everyone to fill out timesheets. So there's different ways to think about it, but you're right. We can't really understand how profitable things are and what's driving profitability unless we have a sense of where time is going, because time is our largest cost in this business. It's what we sell, whether we like it or not, and so it behooves us to have an understanding of where that cost is flowing, right? I guess. What are some of the other misconceptions that agencies might have around profitability management,

Unknown Speaker 28:39
that raising prices is like the only way to do it. And really, I think we've been made to believe that a couple of things, we can't be profitable if we sell hours and time. And that's obviously not true. It's just math. It's not my opinion. It's like mathematically, that's not true, you can be profitable selling time. And in fact, look at all the largest consulting firms on the planet. Look at the entire accounting industry. Look at the entire legal industry. Lots of people making lots of money, scaling being profitable, selling time, materials, billable hours, right? So that's a big misconception. There's also a misconception that you can't be profitable if you sell commoditized services to small businesses. I'm not going to tell you that that's easier. It's definitely not. It's very hard. But again, mathematically, it's not true. If you're a good operator, you can still make that work, and the pricing increases are the only way to improve your profitability if you have a billing model that's not tied to time. So if you sell flat retainers, project based pricing, value pricing decreasing the amount of time it takes you to earn your revenue has the exact same impact on average billable rate as raising your price. So we've seen clients do this. They have increased their average billable rate by 20, 3040, 50% without ever changing their price, just by getting more efficient at delivering the work. And in turn, if.

Unknown Speaker 30:00
Had the same impact as if they had raised their price by 20, 3040, 50% so there are other levers, not just on average bubble rate, but on profitability that have nothing to do with increasing prices. And we, you'd be surprised at how little we have to give clients that advice of like, Hey, you really need to raise your price. It happens, but not that often, and

Unknown Speaker 30:19
that's where I think I see it happen the most, where everyone it's like the immediate solution is raise my rates. Right? If I want to make more money, I can raise my rates. I can sell at a higher volume, or I can get more efficient. The thing that everybody goes through right away. So the easiest piece, if I just put a higher price tag on my website, now it's like, I can sell for more. But the actual easier thing might be figuring out some efficiencies within your team so that your ABR gets better. Well in the thing is,

Unknown Speaker 30:49
let me, let me just also back up. Like, if you can raise your price, now you should do it. Oh, yeah, do it Sure, definitely 100% right? Like, absolutely, if you can raise your price, then you should do it.

Unknown Speaker 31:00
But in a lot of cases, that's a temporary band aid to a larger underlying problem. So like, if your problem is utilization, increasing your price will help mask that for a while, but that's still a problem or an opportunity, however you want to frame it, and it's not going away just because you raised your price. In fact, it might actually get a little bit worse if you raise your price, right for being real, um. The other thing to note is that if you do recurring work, this might not fix all the indigestion. We've seen this a lot of times where we have a firm. In fact, I could tell you one specific example, two founders, they had tripled their business in 18 months, and they were talking to me, they were like, dude, I'm making less money than I was when the business was a third of the size. How is that possible? We have more revenue, more clients. We're busier than we've ever been. I'm making less money. What the hell is going on? They pretty much only sold retainers, and they're like, we're raising our prices. All the new clients coming in, they're coming in at higher prices. What the hell is going on? Well, we did an average billable rate analysis on all of their clients, and what we found was that they had a bunch of clients that started with them years ago. They were actually paying that client. Several of these clients, they're paying them money each work each month to work with them. The amount of labor costs that they were incurring to deliver the services was higher than what they were being paid. And so all these new clients coming in were literally paying the bill to subsidize the old clients that were there. And what we encourage them to do was, hey, next time you go and you sell a new client, rather than throwing that client on top of the pile and then hiring more people and it's just this game of, you know, kind of a dog chasing its tail, go to your worst client and renegotiate their contract if they leave no problem, that capacity is now replaced with higher quality revenue. So we're getting rid of indigestion. If they say, yes, great, you now have two higher quality clients. Go to the next one and keep doing that until you get rid of all the indigestion and they

Unknown Speaker 32:51
they could increase their profitability by 500% and grow their business 50 or 60% year over year, without actually changing the number of clients that they had, without hiring their staff without increasing their overhead, like if all they did was fix the indigestion, then that would have had a dramatic impact on their profitability. And so in their case, it wasn't a function of raising their price. If that's all they did, it wouldn't have actually fixed the problem. It was a question of recognizing that there was actually all of this drag inside the business, and just by maintaining the price where it was, but making sure they cycled out all those poor fit clients, that was actually the more important thing for them. So don't be, don't be too obsessed

Unknown Speaker 33:31
with this idea of like, raising your price will fix everything, especially where we have your recurring work. It might not actually again fix the problem. It might just mask in the short term, right? No, that's a great example, and a good another good reason why you should look at these numbers, right? Because being able to just see the data gives you this context on your business that you wouldn't have otherwise.

Unknown Speaker 33:53
And then, yeah, I mean, that's expanding accounts is something that we, I'm talking with all my clients about. We're looking at specific clients every

Unknown Speaker 34:02
every week, like we're going into their client accounts, we just pick one. Like, how can we actually make this a more effective engagement?

Unknown Speaker 34:10
This is, like, the perfect reason to do things like that, and so

Unknown Speaker 34:18
let's actually talk pricing models briefly, because I am interested in how, how the different pricing models might actually influence some of our billable rates and things like that, is, are there? Obviously we want to have the most effective kind of pricing model without over complicating things, so that it's still easy for the client to understand but also easy for us to be able to process on the back end. How are we actually like billing for this and stuff? Yeah. Are there any trends you've seen? Any recommendations you have for setting these up? Yes, we have one framework that we focus on in particular. This the pricing model quadrant. And this is really just a mental.

Unknown Speaker 35:00
Model for thinking through like, what is going to be the most effective pricing model in an engagement to do two things. Number one, maximize our chances of having good, strong, consistent margins. And part two, which I think is actually very important, to be able to work with the client in a way that is effective in getting them the outcome that they need. And this is something I see all the time with firms that do actually fairly complex or unpredictable work, because of all of the media in this industry that tells them that they should basically like, just quit if they're selling time and materials, billing. They try to force everything that they do into flat rates, value pricing, flat retainers, even if the work itself is very unpredictable and variable. And the problem with that is the idea of a fixed rate contract is that it's generally tied to the deliverables. So anytime that those deliverables change, the contract is now in the way of you adapting to that change, right? But if we know at the start but the client's needs are going to change. They're going to evolve, especially as we work on this and we learn things like, it's likely going to be fluid. Why would we set up a contract that literally gets in the way of us doing that thing, which we need to do to make the client successful? Like, it just doesn't make any sense. And then every time that that happens, you're either you have a choice to make. Do we go back through the contract negotiation and, you know, go through the sow and all the deliverables, and do the best practice of managing the scope, or do we just eat it and we continue to eat it until eventually we're on the wrong side of the equation, which should be the whole reason that we go to flat rate pricing, which is we know that we can come in and be efficient and come under what we would have

Unknown Speaker 36:41
come under the amount of time that theoretically we would have gotten paid for if we done this hourly. But if that doesn't happen, it's worse. We're going to make less money than if we just charged by the hour. So with all that in mind, the quadrant speaks to two things, how much value is there in the engagement? So imagine you're drawing a quadrant. The vertical axis is value. So on the top you have high value. On the bottom you have low value. And then on the horizontal axis, you're thinking about risk. How much risk is there in the engagement? So on the right hand side, you have low risk. On the left hand side, you have high risk. So value is the perceived value by the client, largely driven by your positioning. So how many other options do they have to solve this problem other than you? If you sell graphic design, they have a lot of options. If you sell enterprise B to B, system visualization through graphic design, probably have far fewer options, right? So specialization is important, and then relative value? Are you fixing this problem for a billion dollar company or for a startup down the street that has no money. Same problem, same solution can mean very different things to those two companies. So you got to understand the value that the client sees in this service and your positioning of it. The other thing that we have to think about, and everybody kind of inherently does this, but no one's really talking about it out loud, is how predictable is this thing? Right? Have you done it 1000 times before you have a clear process? The deliverables are very clear. They're unlikely to change. That's a low risk engagement. So you can generally take more risk on assuming you can price that risk into a flat rate or a value based price. Whereas there are certain things that are just not that predictable, we don't know what the client's needs are. They're going to evolve over time. We have to use an iterative process to get this done. There's a lot of unknown, unknowns, if you're trying to build, I don't know, an enterprise software system for a huge company that is solving a problem that they've never solved before. It's very unlikely that we're going to be able to actually predict how much time that's going to take, right? So how do we handle that? And the answer is, if you have low value, low risk work, or, sorry, low value, high risk work. So we're talking bottom left hand corner of the quadrant. We sell time. It makes a lot of sense, right? We can create the perception of value by having generally a lower hourly rate, and we can generally do that because it's low value work. So typically, what that means is you don't need very experienced or very expensive labor to get that work done. So it's generally going to be more commoditized stuff. So again, if you can make sure that you spend less than 30% of whatever that hourly rate is to get the work done on the labor, and as long as you get paid for most of your hours, then you should be fine.

Unknown Speaker 39:12
If we go to the high value, high risk side of things, that's typically where we do abstracted time materials. So instead of selling hours, we're usually selling larger buckets of time, so days, weeks, bi weekly sprints, months and then, instead of selling individuals, we're generally abstracting to larger swats of a team. So for example, if you wanted me to build you a SaaS app, like an enterprise SaaS software, I might say Chris, my cross functional SaaS development team is $20,000 a sprint, and this project is going to take anywhere from 50 to 65 sprints based on the backlog that you've given us. And then every time something changes, because so many things are going to change. In fact, probably half the stakeholders that are responsible for this project are going to change in the 18 months it takes us to do this right. Every time they ask for something new, they.

Unknown Speaker 40:00
Answer is not yes, but let us go change the scope of work. It's Yes. And do you want this before or after? The other things that are in the backlog because we're getting paid for sprints. We get paid $20,000 every two weeks. Our job is to prioritize and build the things that are most important and keep our velocity high. And in firms that are doing this kind of work, those typically end up being much longer engagements. But again, as long as they're making that 70% plus margin on that two week sprint and the labor that goes into it, they're good. So they're selling time, and that time based billing model handles uncertainty and handles fluidity much better. So that's kind of the left hand side of the quadrant. We could talk about the right hand side, the low risk stuff in a moment, but I'll pause there. Yeah, I mean, this is this master class level, uh, instruction here. I don't know that I've ever heard these, uh, presented this way, and so I'm sure there's a lot of agency owners listening right now that are getting some value from this. Hope so. And I'll try to get, I'm sure you have graphics for this. I'll get some we've put in the show notes as well to, uh, help with the visualization. Also should have brought it up earlier. We'll get the any of the courses and stuff. We'll be in the show notes, as well as the the parakeeto foundations course. We'll have a link to that

Unknown Speaker 41:12
in there, so you guys can actually get some more hands on value from from all of us. Yes, absolutely. And I have a video that goes through this. I draw it, I talk through it all. So happy to include that in the show notes. And yeah, we can talk about the course and the toolkit later on as well.

Unknown Speaker 41:27
So yeah, to the right side, back to the model. So on the left hand side we had the high risk stuff. And so we covered that, low value, high risk. It's generally time materials, high value, high risk, generally abstracted time materials. And then when we go to the other side of the quadrant, we have the low risk stuff. So Low risk, low value. This is typically where we're doing flat or value, sorry, flat or productized pricing. So giving an example of this, Chris, if you came to me and you said, Marcel, I want you to build me a website. And I said, No problem, Chris, it'll be $500 an hour. You might tell me to go pound sand. You might think $500 an hour. I don't even pay my lawyer that much. I'm not paying you $500 an hour to build me a website. But if I said, instead, Chris, no problem. Happy to build you a website. It'll be up in two weeks, proven to convert blazing fast, you know, all up and running, and it'll cost you $5,000

Unknown Speaker 42:22
you might say that sounds like a sweet deal, dude. And if I can get that website done in 10 hours, I still make my 500 bucks an hour, and you get a high amount of value. And I could do that because maybe I know that I have a process. I've done it a million times. I've built, you know, websites for people like you. I have a template, I have a process. I know exactly what it's going to take. And so I can take on the risk because there is low risk, and I can price that risk into the project, and I can still end up making more money because I'm being efficient, right? So the key idea here is I can price in the risk because I know what the risk is, and I can set a flat rate that creates the perception of value for you and creates the opportunity for upside for me. So that's the bottom right hand side. And then when we move up to higher value stuff, this is typically where we get into value based pricing, which everyone's very excited about. And I love value based pricing, but in this context, right? So the only difference, typically, between flat rate or productized pricing and value based pricing is, instead of saying, I'm going to charge you $5,000 for a website we're anchoring, in that case, the fees to the deliverables, I'm trying to abstract away from deliverables and focus more on outcomes. So in that scenario, you might come to me and you say, Marcel, can you build me a website? And I would say, Well, Chris, maybe tell me about your business. Tell me about your current website. How much traffic do you get? How many clients do you get through that website today? What's the conversion rate of your website? What is a client worth to you? Oh, very interesting. How much do you think a new website would increase that conversion rate? What kind of impact do you think that would have on your business? Oh, fascinating. You think a new website would make you a million dollars next year if you had a better website. And you think that I'm the right person to build you that website. You that website. You think I could get you that outcome? Okay, awesome. Well, do you think it'd be fair to invest 10% of that upside to get the outcome? So now I'm I'm anchoring the price to $100,000 for that same website, as opposed to five, but it's because I know the outcome that you're gearing towards. So again, I'm taking on a lot of risk as the person doing the service, but I could create a lot more space for risk in that engagement by anchoring to value. And there's a progression to that, which is actually anchoring to outcomes on a performance basis. Very few agencies get here, but in that example, the most extreme example of this would be to say, Okay, there's a base fee of $5,000 to build a website, but I want 10% of every additional client that you close relative to last year on this website.

Unknown Speaker 44:46
Now, of course, there's so many questions that come with that you and I now need to define what that means. We need to be able to measure it. We need transparency. So like that, stuff is non trivial, and I now need to not only de risk the processes.

Unknown Speaker 45:00
Take me to get you that outcome. So the risk fits into the price. I also need to de risk, like my ability to predictably know I can deliver the outcome. And very few firms get to that level of maturity. So performance based pricing, it's a good way to get your first few clients if you're just starting out. But very often you have to pivot away from that and build true maturity before you can go back to it and build a business on it, because you actually know reliably how to identify people that you can predictably get the outcome for. And do it with the margins that are going to allow you to scale. So that is the right hand side of the quadrant. Low value, low risk. You have flat pricing, high value, high risk. You have value based or performance based pricing? Yeah, I think on the performance based pricing, I've seen more ad agencies using it because I think it's easier for them to have the predictions.

Unknown Speaker 45:54
But actually also just talked with Patrick kisney for an episode where we were talking value based pricing came up because we were talking about his concept of the value chain. Of the value chain based on where, where the agency kind of falls into working with the client, right? If you're down as like an implementer, it's really hard to do value based pricing because you're the one pushing the buttons. You're probably more in the hourly bucket.

Unknown Speaker 46:15
And so for anyone who wants to learn more about that, you go find that episode.

Unknown Speaker 46:21
But a great point, yeah, this was, yeah, yeah. That was awesome. I'll say one last thing on the quadrant, which is that this is not an event. It's a process, right, identifying where the things you sell fall on this, because the context is going to change for most agencies over time. Things are going to move up and to the right in the sense that they're gonna have more proof that they know what they're doing. They're gonna have more experience doing that thing, therefore, they'll be able to predict how long it's gonna take them. They'll have a better process. They'll have more templates. They'll have guard rails on this stuff. So something that starts in the low value, high risk quadrant over time, it's normal for you to move up the value chain, and also it's normal for things to move down the risk chain as well as they mature. So understand that evaluating where things fall is something you probably want to check in on every let's call it six months a year, to really make sure that you're aligning your pricing models to the reality of what those services are like inside of your business.

Unknown Speaker 47:21
Awesome. Well, so I guess at risk of you just repeating yourself, I guess my last question for this is, what is that? One thing that you would recommend every agency start today in order to maximize their profitability.

Unknown Speaker 47:35
I think the first thing that I would encourage you to do is make sure that you're setting yourself up for a healthy delivery margin when you sell something

Unknown Speaker 47:44
that's number one. If that's all you did, it would probably solve a lot of your problems. And if you're finding that the price you would need to charge is too high, right? Because let me just take another quick side tangent,

Unknown Speaker 47:58
there's some truth to that. Most people, their blocker to raising their prices is psychological, and most people can stand to do it. That's true that there's also some truth to the fact that there are limits that much you can charge for stuff. Like, there's no amount of DMT I can do in the Peruvian jungle that's gonna make a pizza shop down the street pay me a million dollars for a logo. Like, it's just not happening. That's not a mindset thing. That's just the reality of business. So you might find that as you evaluate your pricing, you're like, I can't sell to my customer for this amount of money. So then I would encourage you to look at the efficiency side and say, Is there a way that you can get this done with less cost, so that you can end up with healthy margins and build a business on that? And if you can't, then there's probably a deeper reevaluation of your business strategy that needs to happen, unfortunately, but for most agencies, that's not really, that's not a problem. So if that's the only thing that you did, I think you'd get very far. And then the second thing, if you want to do two things, if you're a superstar, studious person, I would go and evaluate your delivery margin and figure out what that is and if it's healthy. And if not, then I would dig into why that is. And if you want to learn more about how to do that, this is where I would again, would, again, plug the toolkit. It'll teach you, kind of walk you through how to think about that stuff.

Unknown Speaker 49:07
Awesome. All right, this might be the episode that has our longest show note

Unknown Speaker 49:13
to accompany it. So that's good. We're gonna have a lot of assets for everybody.

Unknown Speaker 49:18
My wrap up questions here,

Unknown Speaker 49:21
what is one book that you would recommend every agency owner read? One book that I would recommend every agency owner read? It's a

Unknown Speaker 49:31
good question, because there's a lot of really good ones

Unknown Speaker 49:35
that I've read are on this topic,

Unknown Speaker 49:38
and I have not written mine yet, which, when I do, I'll recommend it.

Unknown Speaker 49:44
I'm gonna give you, yeah, I'm gonna give you two. Actually, the boutique by Greg Alexander is a great book. It's a lot of great first principles and kind of walks you through. It's like a little bit of everything.

Unknown Speaker 49:59
And.

Unknown Speaker 50:00
And another one that I read recently that I think is like, really, really good from a positioning perspective, is anyone, not everyone? By Corey Quinn, our mutual friend, so highly recommend that one. I think those are two really, really solid books. And

Unknown Speaker 50:14
you know, on the finance side, you asked me for one, I'm giving you three. One of the books that really informed a lot of the ideas that parakeeto is built on. That gives you a kind of a really good start. And the toolkit will give you a lot of this too, in video form. But this was one of the first books that I read when I got into this industry. It was really influential to me. Is digital dollars and cents by Jodi grunden, who built some at CPA, which was kind of one of the first real thought leaders in this idea of management accounting for agencies, so connecting the dots between the P and L and operations with the simple metrics and so that one's great. It's timeless. So definitely recommend checking that one out as well. Awesome,

Unknown Speaker 50:54
man. Yeah. If anyone wants to go back and listen to Corey Quinn's episode as well, feel free we dive into some of the stuff from his book there. But yeah, these book requests, like, when I ask this is purely so that I have more books, so that I get to read and so

Unknown Speaker 51:11
last question, I guess for you, is, where can people find you learn more?

Unknown Speaker 51:16
Well, you can connect with me on LinkedIn. I recommend that very active there. Send me a DM. I'm happy to chat with you. Of course, you want to learn more about parakeeto, and what we do, you can head to parakeeto.com and if you do parakeet.com forward slash toolkit, you get access to a bunch of free stuff to help you improve your profitability. So those would be my, my two places to go. And again, we will have a lot of that free stuff listed out in the show notes for

Unknown Speaker 51:41
everybody to enjoy, but yeah, all right. Marcel, thank you for joining. Thank you for having me. Chris, always great to hang out with you. Man, yeah, this is a very insightful episode.

Unknown Speaker 51:54
That's the show everyone. You can leave a rating and review, or you can do something that benefits. You click the link in the show notes to subscribe to agency forward on sub stack, you'll get weekly content resources and links from around the internet to help you drive your agency forward. You.

Transcribed by https://otter.ai