This year, one of my smaller agency clients was forced to deal with a procurement department in the course of working with a multi-national client. Obviously, the role of this department was to determine what the proper billing rate should be for services to be rendered by the PR agency.
The agency had to deal with something as vaporous as an hourly billing rate with an individual whose professional experience encompassed buying products — at the lowest possible cost — that would be used to produce other physical products. That, coupled with the fact that control of the PR budgets rested with the client’s marketing department. Suffice to say, and the agency wasn’t prepared to deal with the level of sophistication required by this process, which is something that smaller agencies must work through when dealing with larger clients. A few years ago, Al Croft addressed this very issue.
Historically, the level of profitability achieved by a privately-owned PR agency had been a matter between agency management and the IRS. This has changed because of the procurement department.
The procurement process
The goal of the procurement department was to understand every facet of the agency’s billing rate. They were asked to supply previously confidential agency information, such as overhead percentages, salaries and the amount of profit the agency expected to generate on the account.
The trouble with this so-called cost-based system is a higher rate for value-added services that are lost in the process. The model used by the procurement department starts with direct labor costs (staff salaries), adds indirect costs (overhead) and then assigns the agency a “reasonable” profit for the account. The profit an agency earns should be based on how well the agency is managed and how well the clients are served, and not on the cost-dictated formula. However, agencies should nevertheless use this formula internally to determine what billing rates are needed to earn the desired profit. It’s also a management tool. If the calculated billing rates aren’t competitive with other agencies of similar size, a problem exists. For example, if overhead is 125 percent of direct labor, the calculated billing rates will probably not be completive with other agencies and agency profitability low.
What should an agency earn?
I guess the answer to this question is: as much as it can! The profits an agency earns should be based on how well the agency is managed and how well the clients are served, not on a cost-dictated formula.
A PR agency’s single-largest expense is the salaries and benefits of its staff. Most agencies consider how much staff time it must invest to deliver a certain value to the client and to help the client achieve its business and communication goals. If the agency isn’t well managed — a topic for another column — it may wind up investing a lot more time than predicted to deliver the expected value or may even deliver less than the promised value. If the agency is exceedingly well managed and its staff exceptionally skilled, it may even be possible to invest less staff time than previously imagined and yet produce even greater value than promised.
Do clients have the right to impose limits on agency profitability?
The answer to the above is a simple “no.” If a client doesn’t believe the value offered by the agency is sufficient to warrant the price — and thus, the profit earned by the agency — the client can simply decline to buy.
So, what should an agency do if asked to supply confidential data and accept the profit limits? Simply bite the bullet and acquiesce to the client's demands? Try to educate the client’s procurement department personnel on the realities of PR agency operations while providing as little privileged information as possible? Or, refuse to provide confidential information and accept profit limits and tell the client that the only way the price — and thus, agency profits — can be reduced is if the client accepts less value, requiring less investment of agency staff time?
With the space left this month, here are some things that are necessary if and when you want to sell your agency:
1. At least three years of financial statements.
2. At least three years of tax returns.
3. Accounts receivable aging.
4. Accounts payable aging.
5. Office lease(s).
6. Selected bank statements and year-end reports.
7. Revenue by client analysis.
8. Bio of owners and staff.
9. Census by person with title, compensation and hourly rate.
10. Retirement plan report.
11. Firm brochures, press release, etc.
12. Business and financial plans.
13. Profitability analysis by client.
14. Client lists with copies of significant contracts.
Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.