Where Agency Profits Come From
By Tim Williams
Consider the deceptively simply question, “Where do profits come from?” When you pose this question to a group of agency professionals, the answers will typically include such things as clients, hours worked, and even efficiency. But the real answer to this question is that profits come from risk.
Just being in business – paying salaries, rent and the light bill – is a risk. Sure, innovating is a risk. But so is coming to work and doing things the same way every day. The fact is every day in business is a risk of some kind, so why not choose your risk instead of letting it be chosen for you?
Risk as a positive concept
The word “risk” doesn’t always have to be negative. Risk is actually an economic positive. If you eliminated risk, you would eliminate profits. The point is to be conscious of the type of risk you’re taking, and to choose the kind of risk that has the most potential of paying dividends – in other words, profits.
The biggest profit drain in your firm is not risk, but the cost of not taking a risk. Of course, the cost of lost opportunity is never tracked or measured, and certainly never shows up on an income statement. Investing in new agency disciplines that will take the agency successfully into the future is certainly a risk, but it’s the type of risk that produces future profits. Likewise, changing the agency’s pricing and compensation approach is a risk, but it has the potential to be an “economic positive” that will spur profits.
Agencies and risk avoidance
Most agency principals will go to great lengths to avoid what they see as risk. While it’s basic human nature to avoid risk and uncertainty, the forms of risk-avoidance at agencies are primarily:
Sticking to traditional organizational structures
Using industrial-age efficiency metrics and cost accounting methods
Tracking efficiency instead of effectiveness
Focusing on activities and costs rather than results and value
Legacy performance measurement and reward systems
Cost-plus pricing
Ultimately, the worst offender on this list is the last one – cost-plus pricing – because it so directly affects the firm’s ability to invest in its future. It also affects the agency’s ability and willingness to invest in its clients.
A survey by agency consultant Avi Dan reports that “The vast majority of clients feel that agencies are struggling to change their business model. Clients simply do not see traditional agencies as adjusting well in an era of rapid technological changes.” In other words, agencies are not investing in their own R&D.
The power of belief
In business, as in life, we are guided not by what we think, but what we believe. And as long as agencies believe they’re selling FTEs instead of IC (intellectual capital), they will continue to undervalue – and underprice – their services.
Do you buy this argument? If so, change the way you price your services. As the wise Stephen Covey used to teach, “To know and not to do is really not to know.”
80% of the world’s wealth is in the form of intellectual capital, not oil or land. The richest companies in the world are those with very few physical assets (like Microsoft and Google) but tremendous non-tangible assets in the form of IC. The purpose of an agency is to create wealth for its clients, and wealth is created primarily through intellectual capital. Everything an agency does is – or should be — the means to that end.
