No doubt you’re already aware of the importance of your pricing in terms of agency success. I mean, obviously – it’s one of the first and most impactful levers when improving your profitability and cash flow! As such, this makes it one of the sexier topics across the realm of nerdy profitability metrics. Strap in, because the fee structure conversation is an exciting one.
Having the correct fee structure in place really props your agency up on a super solid foundation. You see, most agencies think they just need to sell more at the same price. What they don’t quite realize, however, is that they aren’t suffering from ‘starvation’ of client work… rather, they’re suffering from ‘indigestion’.
What’s agency indigestion, you say? Well, simply put, it’s not being able to output deliverables with a reasonable margin built-in.
How to Calculate Your Agency’s Fee
Generally speaking, your agency fee should leave you with a 60-70% Delivery Margin relative to your Delivery Costs. When calculating your agency’s fee, it’s important to factor in your margin target. If you aren’t already doing this, here is the formula you’re going to need:
Agency Fee Formula
Agency Fee = (Delivery Cost / (1- Margin Target )) + Pass-Through Costs
$5000 Delivery Cost / (1-70%) ) + 10,000 in Pass-Through Costs
$5000 / 30% = $26,667
OK, so you’re now set up with the required formula, but you’re unsure of what exactly needs to be included in some of these terms – like “Delivery Costs” and “Pass-Through Expenses”. If that’s the case, check out our terminology decoder below!
- Delivery Cost: this is all the costs associated with delivering the promised outcomes, or deliverables, to the client. Usually, this will mostly comprise of labor costs and freelancers. To learn more about calculating delivery costs, check out this blog post.
- Margin Target: the target margin you’d like to achieve on this particular subsection of work. We encourage agencies to aim for 10-20% higher than their target on the Profit and Loss statement, which should generally be around 50% or higher. Therefore, on a per-project basis, agencies should (ideally) be targeting 60-70% margins. This margin is relative to the amount of Agency Gross Income (AGI) they are receiving from work, alongside the delivery costs they’ll incur to get it done.
- Pass-Through Expenses: money that passes through you onto other vendors, which you are not responsible for earning with your internal time and resources. This can be defined as expenses for external vendors, such as white label partners, advertising spend, hard goods, print budgets, etc.
Interested in seeing how changes in your standard rate can influence profitability as a whole? Our Agency Model Generator spreadsheet helps you do just that, and is accessible for free in the Agency Profit Toolkit:
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There are two types of “Mark-Up” for agencies. The first refers to the margin you apply to your costs when pricing out projects. We encourage agencies to target a 60-70% + Margin on their “Delivery Costs” when pricing projects.
The second kind of “Mark-Up” is a “fee” applied to pass-through expenses – such as advertising spend, print budgets, hard goods, etc. Typically, this is meant to cover the internal costs associated with managing those pass-through expenses. Those markups typically range from 15-30%.
At the end of the day, what’s most important is that the Agency Gross Income of any given piece of work is high enough to create a 60-70% markup – relative to delivery costs. Agency Gross Income measures the money remaining after subtracting Pass Through Expenses, and would include any “markup” that has been applied to said pass-through expenses.
Remember… “Mark-Up” applied to Pass-Through Costs is simply a pricing mechanism. It’s important to quantify the amount of time, or cost, it is meant to cover and ensure a good margin is achieved with the markup that is being applied.
Agency fees range from $25 to $2500 per hour in terms of Average Billable Rates. That is the actual rates agencies end up charging for their services. What’s of the utmost importance, however, isn’t what other agencies charge – rather, if your margin is sufficient. The margin agencies achieve on their prices, and ensuring said margins are adequate to achieve a 50% delivery margin on the profit and loss statement, is key to propelling you towards the next level. That said, throughout our audits we’ve observed that – when it comes to most North American agencies – the average agency rate sits at around $150-$160/hr
At Parakeeto, we have insight into the financials of hundreds of agencies. Therefore, we can say with near certainty that a ‘good’ profit margin would be a Delivery Margin of 50% (or above) and EBITDA Margins of 15% (or above). Now, a great agency would be in the 25-35% EBITDA range…
For more information on EBITDA ratings, and how to prime yours to skyrocket, take a peek at this blog post.