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Agencies struggle to estimate profitable projects

The agency ‘holy grail’ – profitably estimating projects

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Let’s face it, one of the biggest challenges agencies face is profitably estimating projects. Clients are demanding more work for less and the days of Time & Materials and ‘retainer’ projects are dwindling. A recent survey commissioned by Deltek & Campaign “Reflect, Recharge, Move On : Creative Agencies In 2021” highlighted this once again. Some of the findings were:

  • 61% [of agencies] are producing more work and offering extra services, but 36% are seeing lower profit margins.
  • Profitability is a focus for 58% of agencies, and efficiency for 52%

US research also suggests 73% of the advertising and marketing industry have experienced workplace burnout recently.

This may all sound bleak, but the fact of the matter is that agencies do still have several tools to ensure that they are profitably estimating projects, estimating effectively, and avoiding overwork.

Horses for courses

The first step in profitably estimating projects is that you need to be clear as to what the piece of work is which is being estimated. Maybe it seems obvious but an estimate for a fixed fee job needs to be different from a retainer vs time & material. The process also needs to be different if you are involved in a pitch or not. Your agency needs to have tools, templates, and processes to manage each type of job and client pitches.

A tool like WorkBook (designed & built by agency veterans for ad agencies) allows them to create templates for any type of job (including retainers). This allows agencies to effectively estimate each type of work.

Let’s go through each of the above in turn and then took at some other less used profitably estimating projects methods.

Fixed fee/price

These are now pretty much the norm when it comes to agencies and oftentimes are also the market price. The project is sold at a fixed fee and the agency must ‘eat’ any overwork. The keys to estimating fixed fee projects are:

  • Ensuring that the scope is clearly stated and agreed upon. This makes it easy to see what is in and out of scope. This must be agreed with the client in writing.
  • The agreement must communicate clearly the change order mechanism. The client must understand and accept it.
  • The scope does not just include deliverables but also timings, quality, etc.
  • The estimate is realistic. I may seem ridiculous to state this but if I had a buck for every time that an agency dropped the quote from a client by just reducing the hours and nothing else, I would be on my tropical island sipping a cocktail and not writing this blog. I totally understand that the agency may need to drop the price but if that is the case then what it needs to do is:
    1. Try and renegotiate the scope of work. If that fails
    2. Reduce the rate. I know it means that you may need to fight with finance etc but this is important.  It’s better to go into a project knowing that it will have a reduced margin than pretending that it’s fine and then losing money when delivered.
  • The estimate (unless brand new) is based on similar projects. If you have a project management system that has job profitability, then you should use it.

Retainers

Agencies love retainers and it is easy to see why. They are a guarantee of work from a client for a set period, typically a year, for a set fee per month. Forecasting is easier and it means that the agency does not start from zero each year.

Unfortunately, clients are moving away from these because of budget constraints and their perceived lack of value. They do exist and the best way that agencies can protect and maintain them is to manage them differently from a typical project.

The agency’s management system should allow tracking the progress of retainers easily, invoice appropriately, track profitability, and highlight work that is out of scope, so it’s billed and not missed. Far too many agencies write off billable work and expenses because they don’t have the tools and systems in place, which is a terrible shame.

Having a clear, real-time picture of the retainer’s profitability also helps when it comes to the renewal.

Time & Materials (T&M)

Traditionally, most professional services (or project-based) businesses sold their services on a “time and material” (T&M) basis. This was great because it meant that every hour worked was recharged to the client. All expenses were also recharged to the client. That way, assuming the business calculated its billing rates properly, the business made a profit.

As I stated in the introduction, T&M projects are becoming things of the past when it comes to agencies. The obvious disadvantage, from the client’s point of view, is that it bore most of the risk in terms of the fee vs. the delivery. It also made it difficult for the clients to allocate their budget as they were unsure of the spending on each piece of work.

Agencies should make sure that they have accurate billing rates. This allows them to estimate T&M or capped projects. If possible, and I know it’s a big ‘if’, the rate should be discounted vs fixed fee work in recognition that it’s a T&M job.

Once again, having the tool in place to be able to provide the agency with information to calculate the correct billing rates is invaluable.

Pitches

The agency pitching process is becoming increasingly common when it comes to profitably estimating projects, new work, and renewals. It’s unfortunate that this is the case, and it reflects the relative shift of ‘power’ between client and agency. It’s also rather bemusing that it’s happened to ad agencies and not other professional services businesses. Imagine asking several firms of accountants to pitch for an audit or lawyers to pitch for a case!

Most agency pitches involve a multitude of agencies vying for the same piece of work. Typically, this requires a major investment by each participant in terms of free work before one is selected. I saw a great Twitter thread last year from Stephanie Nadi Olson which encapsulates the frustrations that agencies face in the pitch process.

Since they are the norm, your agency must have a process to address them. This should include:

  • A mechanism for deciding which pitches to go for and which ones to pass.
  • Monitoring the cost of pitching work by client to ensure accurate client profitability.
  • Predefined tolerances for investments based on the value of the pitch.
  • Systems that allow your agency to provide several options based on several scenarios.
  • A system for evaluating the success rate and costs of pitches.

Value Added

This is a pricing strategy that attempts to capture the extra value that a particular client segment associates with a particular feature or benefit of the agency. This may not be that common for agencies but that does not mean that it should not be used. Many agencies work in niches or develop a very specific identity.

It works for them because requires that your service offering is different in some meaningful way from your competitors (i.e., differentiated) and that potential clients value that difference.

This methodology is based on two key concepts.

  • First, the value of a service is subjective and will likely vary for clients in different circumstances. Further, a given service may be perceived as more or less valuable depending on how it’s “framed” or explained.
  • Secondly, the cost of providing a service is only partially related to its perceived value. The client perceives additional value based on the specific skills that the agency has and/or the reputation it has developed.

The biggest issue with this is defining the price point for this type of work as it’s subjective but can be tested. In many cases, this avoids pitches as the agency’s specific skills and or reputation make it a preferred supplier.

Milestone Billing

Agencies don’t often use milestone billing because of the nature of the work, but digital agencies could use it.  For example, a client wants you to design and create a new website so the first milestone may be agreeing on a design and the home page. It also is used as a method to try and disrupt a pitch by quoting to a specific deliverable rather than everything.

Cost (Plus margin)

Other project-based businesses, like market research, commonly use this. However, advertising agencies don’t. I don’t believe that agencies should use this methodology however it’s very useful to know what the breakeven cost rates are, especially when times are tough.

It’s even better if you know the cost rates which cover staff costs. That should be the minimum that you charge for a piece of work.

For example, say your account directors have a standard billing rate of $200 per hour. If you know that the ‘fully loaded’ cost is $150, it tells you that this rate covers the cost base of the business (i.e. you should break even). Anything less than that is loss-making.

It may make sense to take work for less than this rate, but if you also know that the staff cost rate is $120 per hour, then you know that selling a job at less than that rate means that you will not cover the cost of employing the employee. In other words its not worth doing the work at all.

Summary

There is a lot to unpack in this article, but the key is that your agency has the right tools and processes in place to address a very competitive market for agencies. One size does not fit all.

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