Cracking the Agency Business Model So You Can Sleep at Night

Agencies are relatively easy to start and don't require an elaborate business plan before they get going. They often find their way in the market organically by responding to demand. While this is great for short-term survivability, it's not the best way to if it wants to position itself for long term growth. So how would our agency look if we were to start over all again? These are the traits I'd carefully weigh when starting a new agency from scratch.

Solve for Pain and ROI

The easiest product to sell is one that immediately alleviates or fixes a problem for the client. Remember that buyers often go out on a limb to engage with you. The easiest choice is not buying, so make it easy to rationalize this decision.

It gets even easier when you can clearly show the return on investment for a given service. Helping a customer reduce their costs by $40.000 a year makes a one time investment of $20.000 look cheap. They make their money back within the year. 

When it's hard to justify the importance of your service the business is more susceptible to a drop in demand during economic headwinds. Discretionary spending is always first to go. Offer a service that immediately reduces costs or increases revenue and clients would be crazy to say "no" to.

Factory vs. Consultancy

Is the agency a boutique player that requires an expert team or does it offer highly productized services? Promethean Research dubbed this the "Factory-Consultancy Continuum". This decision is fundamental in how an agency has to shape its workforce and how it will sell its services. Factory-style agencies require less human capital, have a highly standardized offering which can be mass-marketed more easily. Consultancy-style agencies will need to continuously update their offering to stay relevant. The sales cycle is often longer, with a higher Average Revenue Per Customer (ARPC)

Both ends of the spectrum allow for sound business models; trying to cater to both ends of the spectrum is where things get messy. While this can be managed across different business lines, the possibility of one line cannibalizing the other always exists. Both externally (selling the lower margin product instead of the high margin product) or internally (the lower margin business line using expensive resources from the high margin business line). Picking one end of the spectrum will make business much easier.

Dealing With the Global Talent Market

Agencies have always been at the forefront of the global talent market and COVID has helped normalize this further. Running a business in a global language (English, Mandarin/Chinese or Spanish) means you will have access to a global talent market and more easily attract the right workforce. This might also mean you will be facing more competition.

If you offer a highly commoditized product to a global market, based in an expensive locale the business model is not likely to be sustainable due to high labor costs, while being unable to demand a premium price. Services and customers that favor face-to-face interaction are a lot more viable in specific submarkets, depending on availability of talent and associated labor costs. Remember, agencies do not only compete with other agencies for their talent, but also with corporates.

Decide On the Founding Team

Many opinions exist on the right number of founders for a given business. The higher the number, the smaller the piece of the pie. While some are able to go at it alone, this option is only really viable for those with prior experience or individuals with unabating energy and optimism that allows them to grind.

Some business models skew heavily towards a single business function. For instance, a dropshipper only requires a single individual that understands marketing and sales. A highly standardized/productized service business might only need two. Someone to take the lead on selling, another to ensure great delivery. Professional service businesses that err more to the side of consultancy might require an additional equity partner to lead up product development to ensure the long term relevance of the business through product innovation.

» Read "Forging Business Relationships That Last"

Scale Past Key Man Risk Quickly

Agencies are highly dependent on their team. Building a business that lasts, requires eliminating all key man risk, meaning there should not be a single person within the organization that is required for smooth operation. This includes sales and marketing, delivery and operations. Each organization that wants to eliminate this risk, requires that all critical tasks can be performed by at least two team members.

Ideally all businesses–including agencies–achieve this stage as early as possible. Keep in mind this is not tied to a specific number in terms of headcount or revenue. It is highly dependent on the complexity of the business and number of the services offered. Offering a single, highly standardized service makes it relatively easy to remove key man risk, because you require fewer people to remove the bottle neck. A great side-effect is that scaling past this point requires formalization of SOPs, resulting in quality improvements due to improved consistency and increased transferability of tasks.

Getting to this stage early also helps settling on a cost and price structure that supports the required overhead of a lasting agency. There are huge costs involved once you start adding in additional structure to allow for this added scale.

Utilization and Backlog Dynamics

If a quick turnaround is a key feature of the agencies' service offering it needs to consider how this impacts the bottom line. In order to quickly respond to a change in demand you need to be able to either add capacity on demand (through overtime or freelancers/contractors) or have the financial cushion to have team members sit idle. 

Business models that require a high level of utilization may result in long wait times for clients when capacity is constrained. Clients are typically less inclined to wait if they can find the same service somewhere else, but they are generally fine waiting for capacity to open up for consultancy-style work. These types of agencies have often more trouble absorbing additional demand through hiring contractors, as the required training may outweighs the economic benefit. A solid backlog of work is beneficial to ensure a consistent level of utilization.

Different utilization rates for different business models might translate to the same revenue for a given period, depending on the effective billings rate. A business can generate $100 worth of revenue at a 80% utilization rate at $125, or at 50% utilization at $200. 

Understand the Funnel First

Getting a sale is easy, getting sales consistently is hard. Finding a strategy that works reliably through the lifecycle of the business should be the first priority of every new agency. Many start out based on personal networks and word-of-mouth, often to find out these tactics do not allow for growth past a certain stage, or require an outsized level of effort.

An ideal marketing and sales strategy makes it possible to deal with changing demand by either reducing marketing and sales effort as needed. Agencies that identify as a factory-style agency will find it easier to do this as these services are generally more suited to more scalable marketing methods. The shorter sales cycle also makes sure the effects are notable rather quickly.

The leadflow of consultancy-style work is typically harder to manage. These businesses need to regulate new business in the short-term through dynamic pricing or simply say "no", hoping clients are OK with a certain wait time.

Wrap up

Left unmanaged agencies end up in the messy middle. They are characterized by both consultancy-style and factory-style attributes, like a high utilization while offering a time-sensitive service that is very particular to each client. While this is not insurmountable in itself, it leaves little room for error in terms of execution. Don't make business more difficult than it needs to be; pick one end of the spectrum and stick to it.