Marcel Petitpas is the CEO and Founder of Parakeeto, a company that provides agencies with the tools they need to stay profitable. Additionally, they offer consulting and training. Parakeeto has helped hundreds of agencies improve their profit margins and agency operations. When he’s not running Parakeeto, Marcel is the COO in Residence for Gold Front, an award-winning creative company in San Francisco.
If you’re an agency owner who suspects your company isn’t as profitable as it could be due to your agency operations, then you won’t want to miss this podcast.
- [1:30] Why agencies leave a lot of money on the table.
- [4:51] Balancing a client roster the right way.
- [7:26] Developing a pricing model.
- [10:49] Managing metrics.
- [17:01] The Profitability Flywheel.
- [24:22] Growth ceilings.
- [27:47] Marcel’s Causes
Why agencies leave a lot of money on the table
“What’s unique about a service business is that your revenue is actually a liability until it’s been earned. And the margin you make on that revenue is dependent on how much time it takes you.”
While he points to working with contractors and having a “more elastic workforce” as a positive trend for agency owners, he does say that it underscores this problem.
“Every hour it takes them, you feel that right away on your P&L. Yet it’s also true of salaried employees.”
Marcel opines that he doesn’t see enough agency owners thinking about this.
“There is an opportunity cost with how much time your employees invest in earning revenue on a project, and you are always incentivized as a service business to become more efficient at earning revenue.
What it means is, if the opportunity presents itself for you to take on another client or do work that earns you revenue, you can do it in the time you’ve saved. That means with the same amount of overhead, the same amount of payroll, you can earn more revenue. And that means more money in your pocket at the end of the day.”
You can’t just see revenue as profit. You need to look at it in the context of your entire business, agency operations costs, and other clients.
“Okay, this client’s paying us 10K a month, but what does it take to earn that revenue? When I ask [agencies] who their most profitable client is they always point to the one with the biggest retainer. When I ask them to show me the timesheets or to show me the P&L, we find out they’re working for pennies on the dollar for that client.”
Typically that “biggest client” feels entitled to bully agencies or to ask for extra things, and agencies don’t feel empowered to push back.
“Often they could be making a lot more money if they replaced that client with others and worked more efficiently.”
Balancing a client roster the right way
“We want to have the right amount of client concentration. Generally, what you want to see is less than 30% of your revenue coming from under three of your clients, right?
So if three of your clients are making up 30% of your revenue, that’s a bad sign. If one of your clients is making up 30% of your revenue, that’s also a pretty bad sign.
You want to make sure you’ve got some diversification.”
There are two reasons why diversification is really important in Marcel’s eyes.
“One, if somebody leaves, it doesn’t tank the business, right? And this of course becomes more important the more you have a salaried team. Because then your utilization tanks and you need to find additional work to fill that with, or you have to do layoffs which nobody wants to do.”
He says the second reason is so you can fire clients who are not profitable or that you don’t necessarily enjoy working with, “or that are making your life a living hell.”
How can you get a solid distributed client roster with the right balance of concentration?
“The backbone is having at least one relatively reliable method for generating new opportunities for new business.”
From Marcel’s perspective, this is the “first nut any new agency has to crack.”
These lead generation strategies could be Facebook, cold emails, or even “standing on the side of the road wearing a chicken suit.”
The key is to figure out the channel and know how it works.
“We need to generate this many demos or this many discovery calls so we can close the client. We need to send 200 emails in order to get that done based on having done this consistently.”
The key is to do that every week. In still it in the process of your agency operations, no matter how busy your agency gets with client work.
“That gives you the confidence to be like: we can fire this client, because we know we have control over replacing the client. And then, once you figure that out, it’s time to start looking at how do we make sure that we’re actually profitable and scalable?”
Developing a pricing model
Many agencies struggle with pricing models. Marcel encourages agencies to think about it a little differently than most: how the pricing compensates for the risk in the business.
“If you’re doing custom development for software products, that is an inherently very risky thing. I don’t think I’ve ever met a developer that could actually estimate everything they were going to build because it’s just the nature of software development. You get into it and you never know. So hourly is a pretty good model for software development firms or a fixed cost per week where you’re really settling rails down on how much scope creep can really exist and how much margin creep there can really be.”
Measure risk, Marcel says, by evaluating complexity and uncertainty around a project or service type.
“As you get to more predictable things you can be like, okay, we know it takes us exactly this much time. Then you can start moving to flat rates.”
He also talks about unlimited services, like Design Pickle’s.
Yet he cautions that when you really dig into these companies, “unlimited” is something of a misnomer.
“You start to ask for too much stuff and they’ll call you up and say…you are now on the $800 a month plan. You’re now on the $1200 a month plan. Because they measure that stuff.”
Marcel also encourages agencies to consider value-based pricing.
“A lot of people get caught up in pricing based on margin. I think being aware of your margin is very important. You should always come back and check a budget and a scope against your costs…but you can achieve substantial margin simply by looking at: what is the relative value of our service and how has it changed based on who is purchasing it?”
He brings up the idea of the “million-dollar logo.”
“Who would spend a million dollars on a logo?
Someone with a forty million dollar print budget might, because it’s relevant to that print budget to decrease the risk. And if for no other reason than that perceived risk are they willing to spend a million dollars on a logo regardless of whether or not it takes that firm any more time or energy to produce the work.”
Finally, he says, there needs to be a 50% to 70% gross margin on the service.
“If you can hit 50% to 70% gross margins on a consistent basis, then you should be able to cash flow the growth of your business, have decent overhead, take care of your people, and be a happy founder at the end of the day.”
Marcel says efficiency metrics are the most important.
“You want to understand how efficiently you’re earning your revenue, and there’s two simple ways to do that. The first is to do it in your accounting software and looking at your P&L, and the number for that is gross margin.”
He says that a lot of accountants won’t understand how to do this because they aren’t set up for service businesses – which means agencies might want to do a little digging to find accountants who are.
“Your gross margin is your adjusted gross income minus your direct labor cost. I define adjusted gross income as the money that belongs to you, as an agency, and is your responsibility to earn.”
He gave the example of a $10000 website project. Perhaps one spends $2000 on other things, such as tools, leaving an $8000 adjusted gross income. You’d then need to look at what you paid to contractors or salaried employees.
“The way you do that is you take their salary, plus their benefits and perks, and you divide that number by 2080. That’s the number of working hours in a 52-week year.
That assumes people are salaried 40 hours a week. That gives you their hourly cost. And then it’s however much time they spend on the project. So you add up your costs. Contractors, direct labor, employees, you subtract that.
So let’s say in this case you spend $4000 on direct labor. Our adjusted gross income was $8000. Your gross profit is 50%.”
He says it’s not always easy to do this because it relies on you knowing you’re doing your books properly and tagging stuff against projects, and the data that helps you understand where you’re at can lag by about a month.
“If you want to get a signal that’s slightly less accurate but simpler, it’s called your average billable rate. And all you do there is take your adjusted gross income, divided by the number of hours you worked, and get your average rate. You should have a sense of your target billable rate.”
He says the ultimate purpose of all these calculations is to figure out which kinds of work pay your agency the best, as well as what parts of the process need to be improved so the team can get more efficient.
He says the second metric is utilization.
“If you have a team that you have on salary, you want to measure how much of their time is spent doing stuff that earns you money. It doesn’t matter if you price on value, fixed prices, hourly prices. At the end of the day, the time your team spends working for clients is time you’re spending earning the revenue you’ve sold to them.”
He suggests measuring that on a per-person basis, as well as looking at the whole team.
“The benchmark for that on an annual basis is about 65%.” He says that if you can get to 65% you should have no problem as long as you’re not spending twice as much time on all your projects as you’re supposed to.
The Profitability Flywheel
The Profitability Flywheel is a framework Parakeeto uses to help clients.
It involves four steps:
- Measure assumptions
- Measure reality
- Qualitative feedback
- Process improvements
“When the client says, hey, I wanna hire you to do this thing and then you give them a price. That price is based on some level of assumption about how much it’s going to cost you and how much time it’s going to take.
So we wanna formalize the way we capture and structure those assumptions. How do we structure it? Is it by role? By task? By phase?”
“Map it and track it. So if you have assumptions about how much it’s going to cost you, get into your accounting tool with your bookkeeper and start to set it up so you can structure it in the same way.
If you’re making assumptions about how much time it’s going to take you? Get in your time tracking tool and structure that stuff in the same way.”
Marcel notes he almost never sees this happening correctly.
“The estimate says this many hours to design, this many to dev, and then you go into the time tracking tool and it’s like six hours on UI wireframing for the website templates, and 6 hours on copywriting for the landing page and this copy. And then you’re like okay that doesn’t match up to the estimate.
So if I wanna answer this question, I went from having 30 seconds to pull a report on my time tracking tool to spending an hour and a half parsing this data, cleaning it up, trying to reconcile it against the estimate, and then I’m confused.”
He says the key is to decrease the latency of question to answer in regards to the data, and that happens by mapping the structure from one tool to another.
“If your project management tool has time tracking integrated that’s usually where this problem arises because your project management philosophy is probably very different than your operations philosophy.”
“This is a fancy way to say: talk to your team.”
He says you pull the report, and then you sit down with your team.
“You say we thought it was going to take us this long to do this thing, but it actually took us this long. Why do we think that is? What opportunities do we have to do better next time?”
Or, in some cases, asking what opportunities they have to do more projects like that, when it takes less time than they thought. As well as: “Why were we so efficient at this?”
He says the point here is to capture insight from the team on what process improvements can be made, what processes they want to replicate, and to create a backlog of process improvements to develop and refine over time.
“We’re developing a relationship line between whatever inputs we take during discovery, like a client’s budget or how many web pages they need, and outputs like assumptions about cost and time. Eventually we get to a point where the client says I need a custom website with thirty web pages and immediately you can point to the graph and say: that’s going to cost you $60,000.”
“Collecting the data puts data points along that graph so that we have a trend line, and process improvements puts rails on that graph and closes it in towards the centerline.”
“So what happens? When we tell a client what the price is going to be we’re doing so with confidence and certainty that we’re going to have profit at the end of it.
When we tell the team: hey, we’re going to do a project over these three weeks we’re doing so with confidence that we’re not going to find out three days before the deadline that we’re not done, and then they’ve gotta work evenings and weekends to cover for that.”
These steps make it easier to manage cash flow, easier to resource plan, easier to hire…easier to do everything you need to do to grow your business.
Where do inefficiencies occur?
Marcel notes he almost always finds inefficiencies in client communication, client on-boarding, and handoffs in between teams within the organization.
Marcel says he sees some specific growth ceilings repeat from agency to agency.
“The first one is at right around 10 to 12 people, closing in on two million in revenue, and the problem is we have no visibility into how efficiently we’re earning revenue, because we’ve just been getting clients and doing the work, and now we’re busier than we’ve ever been but have no money in the bank account and not making payroll.
So usually at that stage, the first step is: let’s get some time tracking in place, let’s get some basic reporting in place that you can start to understand. Here are some of the projects that have been dumpster fires. Here are some of the clients that have been really good.”
The next ceiling he sees is when the staff has grown to 20 to 30 people.
“Where the founder now needs to install a full layer of middle management. They need the visibility to manage through a layer of people and completely detach themselves not just from the clients but the people who are interfacing with the clients.
At that stage, we need to create systems that are easy to use, easy to track, and that empowers the team to leverage this data to make their own decisions so we don’t have to be involved in making day-to-day decisions. The team is just able to look at the dashboard and say, you know, we’re 50% over budget on this project, and they know what to do.”
The final ceiling is when they’re at 30 to 100 people, a road that can be surprisingly quick.
“Then it becomes all about forecasting. When do we need to hire, who do we need to hire, how do we keep up with capacity.
The chances are when you’ve got to that stage you’ve figured out how to get clients and now you’re really pouring gas on the fire and have gotta figure out how to get enough team members onboarded at the right places and at the right time to scale with that growth without hiring people too far ahead of time or hiring them on too-short notice and dropping the ball for clients or having them churn out of the business because we threw them on the deep end.”
He says forward visibility becomes is being able to accurately predict:
“Hey, we’ve got four websites in our pipeline, and we know roughly what that’s going to take to get done. Then you can start to model those scenarios out, start to handle your hiring, your resourcing, and your training around that.”
What's your right now cause?
While Marcel didn’t point to a specific cause, he asks entrepreneurs to be mentors to each other.
“I wouldn’t be doing what I do today if there weren’t mentors and experienced entrepreneurs that took the time to just have coffee with me, give me some advice, hear me out, responded to my emails.
I think that anyone that’s listening to this podcast is going to be a person who has the ability to add tremendous value to the next generation of entrepreneurs that are coming into this unprecedented world doing innovative and amazing stuff, especially reaching out to people who don’t have the same advantages that somebody like myself had in making time for them.
We have the power to do that, and I know for sure that’s made the difference in my life and career.
Trust that answering that email, sitting down for coffee with that person, could be the difference between them moving forward with their business or not.
And we all know the impact of small business.”
Connect with Marcel Petitpas
Want some immediate free help?
Download the Agency Profitability Toolkit, a cheat sheet that has all the metrics Marcel talked about as well as a bunch of other ones to improve your agency operations, along with all the formulas for how to calculate them and the benchmarks to aim for.