Wreck the Curve

The biggest ad agencies enjoy profit margins of around 10%. There two ways to increase the profitability of your firm:

  1. Increase utilization. This one’s obvious, the more you you and your employees are able to do work that is billable to a client, the more revenue you start with, making profitability more achievable. But utilization has its limits; the typical advice for operations is to optimize utilization rates at about 70%. Too low, and you are not covering expenses. Too high, and you lose resiliency, important tasks that may not be billable – like marketing, sales, professional development – don’t get done and your capabilities suffer.
  2. Profitable projects. It’s possible to run at 100% utilization and still have an unprofitable firm, if your projects are not run profitably. This frequently happens when projects are not estimated correctly, and you expend underpaid hours to complete work. Some clients may not have the budget you need to do the work profitably.

Example:Tom’s firm has a goal of achieving 40% gross margins. He has a client who wants a website, but has a very limited budget. Tom typically bills at $125/hr, and the project is going to take 100 hours. The estimate should be be $12,500, but the client can’t pay more than $8,000. For Tom to meet that budget, he would have to do the work at cost.

If Tom’s average employee costs $39/hourly (including benefits) and he achieves 70% utilization, then the employee actually costs around $56/hr. As a result, the project will take 100 hours, but Tom’s firm will achieve 30% margin.

A freelancer may cost about $75-$95/hourly. Assuming the project takes 100 hours, the cost to Tom will be between $7,500 and $9,500. Not much left over for profit at best, and losing money at worse. Tom will achieve between 6.25% and -19% margin.

By working with Covalent, Tom gets a fixed bid: $5,000 to complete the job. If Tom charges $8,000 he will achieve 37.5% margin.

By using Covalent, Tom takes a job that have little potential for profitability, and ends up with a happy client, and a healthy bank account.

EmployeesFreelancersPartner AgencyCovalent
Budget$250,000$250,000$250,000$250,000
Hourly Cost$56$95$63$50
Hours to complete Project2,0002,0002,0002,000
Hours accommodated by Budget2,0002,0002,0002,000
Utilization70%100%50%100%
Project Cost Basis$160,000$190,000$250,000$100,000
Gross Margin36%24%0%60%