As it turns out, many of the younger generation haven’t read my columns on agency profitability analysis as updated for current thinking. Accordingly, I plan on bringing topics such as “value pricing” and understanding what’s necessary to make an adequate profit to this column.
The benchmark profitability in the industry is — or was — 20 percent. Problem is, many of the smaller agencies — and even some of the larger ones — don’t hit this mark. If your agency is earning less than 20 percent pretax this, in my view, is not an adequate profit margin to sustain growth.
If an agency has larger clients, it may have to deal with a procurement department. These departments are going into the agency’s accounting records with a fine-tooth comb before an agreement can be signed. The problem is that many of these procurement departments are asserting that adequate profitability for the PR agency is 15 percent. After taxes, there’s not enough profitability to make the money needed to cover costs and invest in the agency.
So, what is an adequate profit? The correct answer is as much as you can earn! However, putting this aside, 25 percent or more should be the goal. So, how does an agency achieve this? In my view, the answer comes down to implanting a value pricing strategy! (I will discuss this in a future column.)
So, where do you start?
There are many surveys that you can read to help you in this area. One that I like is the Gould+Partners “PR Agency Industry 2017 billing Rates & Utilization Report.” If you haven’t read this, call Rick Gould at 212/896-1909 and ask for a copy. The report is based on 2016 results and dated July 5, 2017. The 2018 report is currently in process.
You can compare the billing rates in the report to what you’re currently using. Are the rates you’re using adequate, regardless of all the reports and surveys you may have read? The answer is: “maybe!”
One of the smartest PR industry consultants that ever lived was Al Croft. He was one of the best advisors and generous with his time and advice. Al and I have written many columns together and I was a contributor to his book. For a PR professional that never studied accounting, he surely knew what needs to be done to be successful.
Setting hourly rates
To establish a billing rate, three factors must be considered: annual salary costs, plus overhead percentage, plus profit percentage desired. The total is then divided by the expected annual billable hours per person to arrive at an hourly rate that’s required to achieve the desired profit percentage. An individual’s annual salary costs include both his or her salary and benefits, either actual or a percentage share.
To determine your overhead percentage, divide your total overhead costs, including non-chargeable staff salaries (administrative personnel) by your direct labor costs. This overhead percentage figure — generally plus or minus 100 percent — is added to salary costs for an individual or group of employees. To set an hourly rate that will hit 25 percent, add a 33.3 percent factor to the sum of salary and overhead costs. To achieve a 20 percent profit, add a 25 percent profit factor; for a 15 percent factor, add a 20 percent profit factor.
Here’s an example based on a salary cost of $100,000 and an overhead factor of 80 percent: $100,000 salary cost plus $80,000 overhead factor equal $180,000. Apply a profit factor of 33.3 percent to arrive at a total of $240,000. Divide this, as an example, by 1,500 billable hours to arrive at a target billing rate of $160.
You can establish rates for a group of employees by title or salary increments ($5,000 as an example).
You may find that the system results in hourly rates that are too low competitively for junior staff and too high for senior people. You can now adjust these rates by raising junior people rates and lowering senior people rates competitively while maintaining the same projected profit. You may find that to earn a 25 percent your rates are not competitive (too high) based on other agencies of your size or the procurement department tells you that you are not competitive. Why is this? Assuming your salary cost are in line (they usually are) compared to the competition, your overhead is not in line with your competitors. For example, an overhead factor of 115 percent of labor may not give you competitive rates. This would be a good time to perform an in-depth review of your overhead structure.
Information needed to prosper
Step two is to understand what ratio analysis brings to the table. At a minimum, a PR agency needs five basic pieces of financial information to manage the firm: cash flow, individual staff productivity, overall staff productivity, individual client profitability and overall agency profitability.
Next month I’ll focus on ratio analysis. If you are thinking you can open a financial statement analysis text and use this information, you are partially correct. To understand your agency, you need to apply industry-specific ratio analysis. Next month I will go over some of the specific ratios that you need to review to be successful.
Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.