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The landscape for digital agencies has shifted. Over the last twenty years, there\u2019s been a downward pressure on profit margins. People want to get paid more, clients want to pay less, and (thank goodness) the 80-hour work week is a thing of the past.\u00a0\u00a0<\/p>\n
To protect margins, marketing agencies develop complex billing and staffing models: full-time employees and freelancers working together on the same projects. On top of all this, there are more service offerings and departments than ever.\u00a0\u00a0<\/p>\n
So, how do you get insights into the health of your gross margin? How do you know what to do if it\u2019s not where you want it to be?\u00a0\u00a0<\/p>\n
You need to understand your agency\u2019s financials and related industry benchmarks and determine ways to shift these key metrics<\/a> if they aren\u2019t in an ideal position. Working with agency clients, we have uncovered trends in creative agency profitability and determined how agency owners can move the needle on their gross profit margin\u2013without getting lost in the weeds.\u00a0\u00a0<\/p>\n Your gross profit margin uncovers how much profit your agency is able to keep compared to the costs of your services. The higher your gross profit margin, the \u201chealthier\u201d your agency\u2019s profitability.\u00a0\u00a0<\/p>\n To calculate your agency\u2019s gross profit margin, you just need a simple formula:\u00a0\u00a0<\/p>\n Gross Profit Margin = <\/strong>(Total Revenue \u2013 Cost of Services Sold (or COGS)) \/ Revenue x 100.\u00a0\u00a0<\/p>\n If you notice that your digital marketing agency\u2019s gross margin isn\u2019t ideal, it\u2019s time to look at three specific non-financial metrics (what we refer to as Creative Agency KPIs<\/a>):\u00a0<\/p>\n Adjusting business strategies to influence these three metrics quickly shifts your gross profit margin. To influence these metrics, you need to reassess your agency\u2019s time tracking procedures. This will help you diagnose areas of concern and potential opportunity. You may need to re-evaluate your pricing strategy, prevent scope creep, use a more effective project management<\/a> tool, cut \u201cfat\u201d, optimize your utilization rate \u2013 or all of the above.\u00a0\u00a0<\/p>\n Time tracking has a bad reputation. It\u2019s true, if you do it for the wrong reasons, it can be a black hole of busy work. However, if we agree that gross margin is important, and you want to know what\u2019s happening at a more granular level, there\u2019s no way around it.\u00a0\u00a0<\/p>\n Time tracking is a useful tool to determine where your team\u2019s time is going, and therefore, where inefficiencies could be happening. These inefficiencies drastically impact your average billable rate, utilization rate, and average cost per hour, so addressing them is of the utmost importance. A few inefficiencies to look for include:\u00a0<\/p>\n That\u2019s where we can start to surface the insights that drive the profitability of the business forward.\u00a0\u00a0<\/p>\n Imagine you have a small inefficiency in your most popular offering, costing you a few hours per week per client. When you multiply that one inefficiency by 150 clients for 52 weeks out of the year, it\u2019s a huge impact on your average billable rate\u2013so you know it\u2019s worth your while to invest time in finding a solution.\u00a0\u00a0<\/p>\n The danger of tracking is creating a system so complex that no one uses it. So, identify why<\/em> you\u2019re tracking. If you set up your systems with a clear picture of what you need your team to tell you on a regular basis, then you know where to look for insights.\u00a0\u00a0<\/p>\n Your utilization rate measures what portion of your employee\u2019s working hours are spent on billable work. The basic formula to calculate utilization rate is total billable hours\/total working hours.\u00a0\u00a0<\/p>\n Once you determine how many working hours are spent on client work on average, you can determine whether there is room to make more of these hours billable. Making nonbillable hours more efficient cuts down on time spent on these activities. Then, more time can be spent on client work that can move the needle on profitability. Look into optimizing time spent on time tracking, training events, continuing education, team meetings, etc.\u00a0<\/p>\n Creative agency owners frequently worry about pricing services too high. Unconsciously, owners assume every person on this earth is looking for the cheapest option. However, effective pricing strategies are based on value provided. There is an opportunity cost to pursuing the cheapest option in many circumstances and agency services are no exception. That\u2019s why your clients are willing to pay your prices!\u00a0<\/p>\n It also likely comes as no surprise to you that pricing your services too low causes profitability issues and puts you at risk of struggling to break even or even losing money on client services. So, it\u2019s best to price according to the value provided\u2014for both your profitability and to honor the time you and your team commit to agency work.\u00a0\u00a0<\/p>\n There are specific metrics that help you determine if you are pricing too low. While we can\u2019t cover all of them in this one blog post, we can cover one of the most important: closing ratio (or the percentage of sales opportunities that are successfully converted to closed deals).\u00a0\u00a0<\/p>\n Your closing ratio should be between 25-35%. If you are closing less than 25% of deals, your pricing is too high. If your closing ratio is above 35%, your pricing is too low and likely doesn\u2019t match the value that your service provides.\u00a0<\/p>\n Once your pricing model is adjusted in the correct direction, you will see closing ratios improve and profit margins increase.\u00a0<\/p>\n As marketing evolves and new technologies come into play, scope creep has become a frequent problem for creative agencies. Agency clients want more than they initially requested, but they don\u2019t necessarily know how much these services increase time spent on deliverables by their agency team. While your agency should charge more for these added lines, you may feel like you\u2019d be jeopardizing client relationships. So, your team does the work without modifying the contract to match the additional work and time spent. \u00a0 Setting expectations prevents surprise and frustration on the client side and will ensure your agency gets paid for all work performed.\u00a0\u00a0<\/p>\n There are so many project management tools out there. It\u2019s easy to sign up for 20 different tools that promise to simplify some part of your project management process, but if your software and team don\u2019t speak the same language, more ends up being less.\u00a0\u00a0<\/p>\n We hear it on sales calls all the time, \u201cMy tools are the problem.\u201d But the tools are never the problem. Spoiler alert: It\u2019s how the tools are being used.\u00a0\u00a0<\/p>\n The best tool is the one your team uses. (We\u2019re having a great experience with ClickUp<\/a>, an \u201ceverything\u201d project management tool with time tracking included.) An effective project management tool fits into your team\u2019s workflow. If your team pushes back on using the tool, it doesn\u2019t matter how precise the data is; it\u2019s not going to be accurate.\u00a0\u00a0<\/p>\n Whether you choose an all-in-one, or a bunch of specialized tools, what\u2019s important is making sure that you understand: \u201cWhat is the core data schema that you need to measure for your business?\u201d If you understand that the core outcome needs to produce data that looks a certain way, then you can align your project management tools with your needs.\u00a0\u00a0<\/p>\n Keep in mind these two questions when choosing a tool:\u00a0<\/p>\n Collecting the data is the first step. The second step is reporting\u2013and that\u2019s where you need to control for human error. The bigger the team, the more mistakes they\u2019re going to make. Sometimes you\u2019re going to forget your timer is running and you\u2019re going to log a 99-hour entry. Sometimes there\u2019s going to be an apostrophe in the client\u2019s name in the project management tool but not in the finance tool.\u00a0\u00a0<\/p>\n You don\u2019t want incorrect data going straight into a report, which is why you need a middle layer between collection and reporting\u2013a process that\u2019s deliberate for extracting, cleaning, transforming and formatting the data, and then doing something with it.\u00a0\u00a0<\/p>\n Insights gained from project management tools inform how our team is spending their time and what client relationships are positively (or negatively) impacting profitability. So, prioritize correct implementation of the software from the onset.\u00a0<\/p>\n What we call \u201ccutting business fat\u201d is actually a broad phrase to describe cutting any unnecessary expenses within your business. Cutting fat is not only a great practice in efficiency, but it also significantly impacts the financial health of your business. According to industry data gathered by SoDA in their Q1 2025 Sales Pipeline and Outlook report, 56% of agencies stated reduced spending is the reason for 15%+ net margins in 2024.\u00a0\u00a0<\/p>\n Take a look at all of your expenses, including operating expenses and overhead costs. Identify any expenses that are affecting your bottom line but not leading to any business benefit. A few examples include unused software and subscriptions, more office space than necessary, etc.\u00a0\u00a0<\/p>\n Unused expenses can quickly drive up project costs, affecting your average cost per hour. By cutting anything unnecessary, you directly influence profitability.\u00a0\u00a0<\/p>\n Understanding what makes a profitable agency is great insurance in a crisis, but the long-term benefit is that it helps you make day-to-day decisions that profoundly impact your agency.\u00a0<\/p>\n If you\u2019d like more guidance on increasing profitability and financial performance within your agency, learn more about our virtual CFO services for agencies<\/a> or sign up for a free consultation with one of our CFOs<\/a>.\u00a0<\/p>\n Our firm provides this information for general educational guidance only and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Podcasts posted by Anders CPAs + Advisors are not intended to be used and cannot be used by any individual or business, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. Please note that some content may be generated using artificial intelligence and is intended for educational and informational purposes only. In no way does listening, reading, emailing or interacting on social media with our content establish a professional relationship.<\/p>\nBut First\u2013Calculate Your Agency Profit Margin\u00a0\u00a0<\/strong>\u00a0<\/h2>\n
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Track Time\u2013but Stay Out of the Weeds\u00a0<\/strong>\u00a0<\/h2>\n
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Optimize Your Team\u2019s Utilization Rate<\/strong>\u00a0<\/h2>\n
Prevent Scope Creep<\/strong>\u00a0<\/h2>\n
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However, scope creep drastically impacts average billable rates, utilization rates, and average cost per hour. Rather than bypassing this conversation with clients, expectations should be set from the onset of the client relationship<\/a>. Create proposals and SOWs<\/a> that clearly outline contracted work and fill clients in on how you will charge\/document additional work that is requested later on in the relationship.\u00a0\u00a0<\/p>\nPick the Right Project Management Tool<\/strong>\u00a0<\/h2>\n
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Cut Business Fat<\/strong>\u00a0<\/h2>\n