As a marketing agency profitability consultant, I see it time and again. An agency’s chief says they’ve never been busier but don’t have the cash flow to show for it.
It’s common to see agencies hit this growth ceiling, having figured out how to get clients but struggling with cash flow and profitability.
In this post, I’ll walk you through the most telling agency metrics I’ve used to lead clients to improved profitability, show their progress, and hone their strategy.
For each agency metric, you’ll see what it is, why it’s important, how to measure it, and a benchmark to aim for.
The five essential agency metrics
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5 agency metrics that will boost your profitability
There are dozens of ways to measure a marketing agency’s operational and financial efficiency. The five agency metrics listed here are best at surfacing the biggest bottlenecks and leak points.
1. Utilization rate
If you have an internal team that delivers work to clients, utilization rate will be the first and most foundational metric to start paying attention to in terms of profitability.
What is utilization rate?
Employees who interface with clients can split their working hours into billable and non-billable hours. Billable hours are those spent on client projects or directly working with clients, while non-billable hours are those spent not directly on the client, such as with internal projects and meetings.
Utilization is defined as the percent of your employees’ billable total time. To increase your agency’s profitability, you need to make sure your team has enough work to do for clients to keep a threshold of billable hours.
Why is utilization rate important?
Understanding your utilization rate helps you avoid situations where you’re paying a salary to the team but not earning any revenue in return. If the team isn’t busy, optimizing for profitability is not much point because the time recouped from increased efficiency can’t be transferred to other revenue-earning opportunities.
Suppose you primarily lean on contractors or outsourced partners to do work for clients. In that case, you may not need to worry about utilization as much since you’re not paying those contractors when the agency isn’t busy. Your contribution or gross margins may be lower, but if you haven’t figured out how to predictably acquire clients, keeping your workforce more elastic might be a good idea until you’ve sorted out your funnel and acquisition channels.
How do you calculate utilization rate?
Use the following formula to calculate utilization rate:
Gross capacity / Billable hours = Utilization rate
- Gross capacity: The total number of available billable hours (most employees are 40 hours per week for 52 hours per year less time off, or 2080 hours maximum).
- Billable hours: The amount of time spent doing work for clients (regardless of whether you’re billing hourly or not).
Utilization benchmarks
On a week-to-week basis, you generally want your “pure” producers (designers, developers, copywriters, etc.) to be utilized between 75% and 90%.
On an annual basis, you should aim to have your production team hit a utilization rate of between 65% and 80%.
With utilization above 65%, you should achieve healthy margins as a business, so long as you’re earning your revenue efficiently (more on that next).
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2. Gross margin
There are two primary ways digital marketing agencies track how efficiently they earn revenue: gross margin and average billable rate. I’ll break down the pros and cons of each to help you determine which metric is best for measuring and improving your agency’s profitability.
Let’s start with gross margin as the first of two metrics you can use to help track your revenue-earning efficiency.
What is gross margin?
Gross margin is a tried-and-true method for determining production profitability. Simply put, it means calculating the profit margin on a per-client or per-project basis by subtracting time and material costs from whatever the client has paid you.
This method is generally more accurate but can be more expensive and time-consuming to calculate since it usually happens in an accounting tool. And without an aggressive bookkeeping schedule, this may be something you can only ever look at retroactively.
Who should use gross margin?
I recommend the gross margin metric to mature agencies with a bookkeeper who updates biweekly or weekly and agencies that work with many contractors.
Why is gross margin important?
Being able to hit gross margins in this range consistently means your delivery systems are efficient enough to scale profitably, allowing you to cash-flow your agency’s growth.
How do you calculate gross margin?
Use the following formula to calculate gross margin:
Adjusted gross income – (COGS/Labor costs) = Gross margin
Gross margin / Adjusted gross income = Gross margin %
- Adjusted gross income (AGI): The amount of revenue left over for the agency to earn after pass-through expenses are paid (ad spend, print budgets, equipment rentals, etc.).
- COGS and labor costs: The costs associated with the people you’ve brought on to work on this project, be they internal team members or external contractors.
To calculate your employee cost per hour for internal team members, you’ll need to take their salary + benefits and divide it by their gross capacity. For most employees, this comes to 2080 hours per year (40 hours x 52 weeks).
Gross margin benchmarks
To run a highly profitable, scalable agency, you’ll want to aim for a 50-70% gross margin per client or per project.
That should set you up to hit a margin of 40-60% agency-wide at the end of the year, leaving you enough room to carry normal overhead levels and accommodate slow times without compromising net profitability.
One way to increase efficiency and improve gross margin is using AI marketing tools for agencies.
3. Average billable rate (ABR)
Average billable rate is often a much simpler, more accessible way to get an idea of your revenue-earning efficiency and benchmark different clients or projects against each other.
What is ABR?
ABR helps us understand the average rate we’re earning per hour based on the amount of time it actually takes us to earn our revenue. This method is generally a bit less accurate, but it is much faster and easier to calculate and doesn’t require a bookkeeper or accountant to figure out.
Who should use ABR?
I generally recommend using the ABR metric method for smaller agencies that may just be getting started with tracking metrics and for agencies that tend to work with fewer contractors and keep most of their labor in-house.
Why is ABR important?
For the same reasons mentioned about gross margin, if you hit ABR goals, you can grow profitably. ABR is a gut check for both the profitability of a client and the efficiency with which you can deliver the service.
How do you calculate ABR?
You can use the following formula to calculate average billable rate:
Adjusted gross income / Hours worked = ABR
- Adjusted gross income (AGI): The amount of revenue left over for the agency to earn after pass-through expenses are paid (ad spend, print budgets, equipment rentals, etc.).
- Hours worked: The total time your team spent completing the work for your client.
ABR benchmarks
The target for the average billable rate is the same as the gross margin. When we look at our average cost per hour for production labor, we want to be in the 50-70% margin range.
Usually, that means aiming for around 2.5x your average employee cost per hour or whatever contractor rates you’re paying the team.
For example, if the cost per hour to pay someone to do the work for us is $50, we’d want to target an average billable rate of $125 (which is 2.5 x $50 and equates to a gross margin of 60%).
4. Scoping accuracy
The riskiest part of any service business is that many of its critical functions rely on assumptions made every day when scoping work.
What is scoping accuracy?
The information we use to determine how much to charge for work, when to hire employees, how to resource a plan, and how to assign team members all comes down to what we believe is required to complete the deliverables we’ve promised our clients—aka the scope of the work.
Why is scoping accuracy important?
Without feedback about how accurate those assumptions are, building out the systems required to scale our agency and our team’s profitably is difficult. That’s why installing a feedback loop is essential to help us understand whether the assumptions behind our pricing are accurate.
How do you calculate scoping accuracy?
Scoping accuracy can be easily calculated by the following formula:
Estimated time and cost / Actual time & cost = Scoping accuracy (%)
- Estimated time and cost: The amount of time or money we estimated it would take to complete the work.
- Actual time and cost: The amount of time or money we spend to complete the work.
Usually, this will be divided into “buckets” like design, development, and project management. To learn more and avoid common agency mistakes in this area, check out my guide on choosing the correct structure for your estimates and actuals.
Scoping accuracy benchmarks
An acceptable margin of error is under 20% of the anticipated budget, with going over being more of a concern.
However, at scale, we should consistently aim to keep our margin of error under 10%. This should become achievable over time as we collect more data and install more processes to close the gaps between our assumptions and reality, thereby creating our own agency profitability flywheel.
5. Overhead percent
Once you’ve gotten a grip on utilization, earning efficiency, and scoping accuracy, you should already be head and shoulders above the competition. Your agency will feel more stable, you won’t be worried about cash flow, and planning for growth won’t feel so obscure.
The last piece of the puzzle for really dialing in your agency’s profitability is paying attention to your overhead spending—making sure it’s balanced relative to your income.
What is overhead percent?
Overhead costs are expenses that support your agency but are not directly tied to creating a specific product or service. They are the ongoing and necessary expenses of running your business that do not generate revenue. The three main overhead spending categories we’ll discuss in this post are administrative, facilities, and sales & marketing.
Overhead percent is the amount you’ve spent on overhead expenses as a percentage of your adjusted gross income.
Why is overhead percent important?
Landing in the acceptable ranges for each area should allow you to meet your agency’s needs relative to its size while maintaining healthy profit margins.
Keep in mind that through periods of aggressive growth, you may find yourself spending out ahead of scale. For example, you may sign a lease on an office much larger than what is necessary for your current team, anticipating having to make a lot of hires in the coming months.
There’s nothing wrong with this, so long as you’re making these investments consciously and with a plan to level your expenses back into a healthy relative range eventually.
How do you calculate overhead percent?
The percentages of overhead spending for each of the different areas below may shift depending on your accountant’s guidance on where to place expenditures that fall into “grey areas.”
Use the following formula to calculate overhead percent:
Overhead spending / Adjusted gross income = Overhead %
- Overhead spend: Any expense related to admin, facilities, or sales and marketing (further defined below).
- Adjusted gross income (AGI): The amount of revenue left over for the agency to earn after any pass-through expenses are paid (ad spend, print budgets, equipment rentals, etc.)
Overhead percent benchmarks
The general rule of thumb is that total overhead spending should be about 20-30% of your adjusted gross income (AGI). Within overhead, there are three primary categories to pay attention to:
- Administrative expenses: Administrative expenses include accounting, legal fees, a receptionist, part or all of the director’s or owner’s salary, and more. The target for administrative expenses should be 8-12%.
- Facilities expenses: These include any costs related to providing the team with a proper working environment, such as a building (rent), parking, and utilities. The target for facilities expenses should be 4-6%.
- Sales and Marketing expenses: Sales and marketing expenses include costs related to bringing in new business, like marketing spend, sales software, and the sales and marketing team’s salary. The target for sales and marketing expenses should be 8-14%.
These agency metrics will have a big impact on your profitability
If there’s one thing I’d urge you to take away from this post, it’s that it doesn’t take much to start measuring the simple numbers that will make a big impact on your profitability. What I’ve learned from working with hundreds of agencies over the last few years is that most of them don’t do this stuff well (if at all)—so even doing just part of it can help you set your agency apart from your competitors, and position you to outlast or outgrow them in the long term.
The peace of mind that comes with having good cash flow, efficient systems, simple yet clear-cut numbers, and visibility into your progress can make running your agency much easier and more enjoyable for you and your team. Allow us to show you how we can help make your agency more profitable and improve the outcomes you deliver to your clients.
About the author
Marcel Petitpas is the CEO & Co-Founder of Parakeeto; a consultancy turned software company that helps service businesses increase profitability and close more deals. He’s also the fractional COO at Gold Front, an award-winning creative agency working with top silicon valley brands like Uber, Slack, Google, Keap, and more. When he’s not helping agencies run more profitably, you’ll find him cycling, renovating his home with his fiance, Cearagh, or watching The Office on an endless loop.
