One of the hardest things about owning an agency, or being a solo operator, is that a lot of us get into it without necessarily being an expert on how to run this type of service business. We tend to have nothing to benchmark ourselves against, because we don’t really know how other agencies are doing, and if we’re on the right track.

Drew McLellan is the head of the Agency Management Institute, an organization devoted specifically to bringing agency owners together to help them build better agencies. Through research, AMI has figured out the formula to a successful agency: What are the key financial benchmarks? What is the role of the agency owner?

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Drew shares with us:

Drew has only worked in agencies since college.

“I was at the perfect junction of ignorant and arrogant. I was young. I knew enough to be dangerous and I was young enough to be a risk-taker.”

In 1995, Drew became dissatisfied with the agency he was working with. He thought that he could run an agency differently than how he saw it being run. He wanted to run an agency with integrity and serve clients and employees well. But Drew couldn't find an agency that was organized around these values, so Drew decided to start his own with just enough credit to buy a computer.

Although he was comfortable and good at interacting with clients, he knew nothing about running a business. So he started researching and found Agency Management Roundtable (now Agency Management Institute). AMI lets agency owners get together, learn from each other, commiserate, and collaborate. This is where Drew learned all the business stuff required to run a successful agency.

10 years later, the founder of AMI approached Drew to take over the organization. Now, Drew spends about 75% of his time on AMI and 25% on his own agency. He can do this because he has learned how to run an efficient agency with 15 years and counting employee retention, so they are very efficient and don't need him around all the time.

How to get started as an agency owner:

Low overhead: Drew started by working out of a house rather than renting an office space.

Business Partner: Supported each other and kept each other accountable.

Scrappiness: Drew didn't spend a dime he didn't need to spend. “Duct tape and string and paperclips pretty much.”

Tenacity to weather the storm: Drew learned to compromise to make sure he had an income and to survive the ebbs and flows that comes with client work. He did whatever he had to do to make it stand on its own.

“Part of being an entrepreneur is deciding that you are not going to let it fail.”

The barriers to entry for entrepreneurs are now so low compared to 30-40 years ago. You can start a business with a computer and little investment and learn as you go. But what separates the successful from the failed attempts is learning how to run a business.

When Drew started, he thought that everything would take care of itself as long as he took care of his clients and employees. But it really comes down to metrics and financial equations in order to make payroll and get off the ramen noodle diet.

What Drew did not think about when he started:
Money management, cashflow, billing policies, rules of engagement with clients, how to set expectations with clients, what to pre-bill for or bill for after, what do do when the client has a cashflow issue, how to protect himself from copyright infringement, what does the contract look like...

“Oh shoot, there's another half of this running a business thing, which is the business part of it. I better learn that very soon or I'm going to be sued or screwed.”

That's where AMI came in and connected him to people who were much more experienced than he was and who were willing to help him out.

Measurements to determine if an agency is successful:

The standard way to measure agency success is Gross Billings, but that number is meaningless.

What really matters is:

Gross Billings – Cost of Goods Sold = Adjusted Gross Income

Cost of goods are the things that you are serving as a bank for your clients.

Adjusted Gross Income (AGI) is the money that an agency can spend on itself. AGI is spent on people (salaries, benefits, etc), overhead (rent, transportation, entertainment with clients, cell bills, professional development, legal fees, etc.), and the rest is profit.

A successful agency breaks down AGI according to:

• 55% spent on People (including you the owner's W2 income, not the dividends)
• 25% spent on Overhead
• 20% is the Target for Profit

The Over-staffing Problem: 70-75% of AGI is spent on people and the rest goes to overhead. So the agency has nothing left for profit.

It is no longer brag worthy to have a large number of employees. Since the recession, there has been a shift in agencies having full-time employees and paying for benefits, bill-able and non-billable time to agencies having contracts with freelancers and only having to pay for the billable work. Fixed costs of staffing has become variable costs. So now, agencies will add hours to contractors when they get bigger or more projects rather than hiring.

You need to have about $130,000-$150,000 AGI for every full-time equivalent, including owners. If your AGI is $600,000, then you should have a staff of 4, including yourself as the owner.

Why is over-staffing such a huge problem then?

Your heart gets in the way of what you know is financially right for the business. You don't want to let an employee go who you know well, you know their family, you know their personal stresses such as mortgages and paying for their child's education. So you rationalize that more work is coming. But in reality, you are taking money out of your own pocket, your kid's college fund, or your house fund.

When times get tough, many agency owners will sacrifice themselves for their team, paying everyone else without paying themselves. This is an indicator that the agency is not using its money effectively. The agency owner is already taking all the risk and if the agency goes under, they lose the house. Their employees can find another job.

When things are good, you build a pot of money that is later used to finance the bad decisions such as not downsizing. You need to get the money out of the business and invest it instead.

Basing your estimate as though everything will go perfectly the first time: But since when has a project gone perfectly according to plan? You need to plan for the worst case scenario. That lets you plan accordingly and maximize profits.

Growing irresponsibly: Growth is the most expensive business investment. Let's define growth:

“How do I increase my gross billings, how do I reduce my cost of goods so that my AGI gets healthier.”

Growth should depend on what your AGI goals are for the year. Every business should be able to double its AGI in a 3-5 year period of time. But you have to keep the AGI ratios to 55%, 25%, 20% as you grow!

The danger of growing too fast is that you add too many bodies and then the client work falls through. So you have to make the tough decision of who to let go, or worse, not pay yourself so you can keep everyone and slowly starve yourself.

Back in the day...
A client would sign an Agency of Record contract with the agency so everything the client wants done for marketing or whatever X is, would be done with you. The agency becomes and extension of the client's business. With the internet, things have become much more complicated in advertising (no longer making ads for print, TV, and radio, but now advertising requires in depth knowledge of SEO, different social media platforms, etc.) and most clients believe that a single agency doesn't have the expertise for all of these different areas if there are less than 300 people in the agency. Instead of signing on a single agency, clients now break up their needs and approach specialists, such as SEO shops, brand shops, PR shops, etc.

Now, Drew has found by looking at hundreds of agencies and their financial spreadsheets:

“The ones who are making the most money are the ones who have clearly defined what they are good at and what they don't do.”

Successful agencies don't try to do it all. They specialize. They then partner with other specialists to make sure the clients get all their needs are met.

“Most agencies suck at getting new businesses.”

They do the feast and famine business model. When times are good, they are so busy taking care of clients that the pipeline is empty.

Then something happens when a client leaves for some reason and the whole agency goes into panic mode. The agency scrambles to get any client possible and doesn't worry about whether the client is a good fit. They may not even know how to qualify a client.

If the agency gets a few clients again, then we are back into feast mode and everyone is fat and happy. All the efforts to get new clients dries up. Pretty soon, famine.

How to get out of the feast and famine cycle?

Understand who the best-fit client is for you.

“Who can we knock it out of the park for every single time?”

Look at your current clients and star the ones you love to work with. Ask yourself, who would you clone? Who respects your efforts and opinions? Who lets you do good work? Who pays you on time? Who refers you to other people?

Based on the clients you love, develop a list of 10 criteria to help you find future awesome clients, such as: has an internal marketing department of at least 3 people, has an annual agency spend of $50,000, etc. If a potential client doesn't score at least an 8 out of 10, then don't chase after them.

Make a list of 25 businesses that you would love to do work for. Put together a marketing program with online and offline touches and go after them. Reach out to them every 6 weeks with something: send an email, mail a book, send them articles that remind you of them, be active on their social channels, in short, get on their radar screen. To be considered as an option, you have to be on their radar screen.

“When you own the joint, you are responsible for going out and bringing home the food that feed all the babies.”

About 50% of the owner's time should be spent on some form of getting new business, either to get new prospects or working with current clients to grow revenue. About 70% of new revenue should come from existing clients. To do this, you have to build relationships with the CEOs and business owners of your current clients. And you have to do this every day! Like exercising :)

Your new business plan should have 4 layers:

Macro-level: Reach people who have no idea who you are or what you do. You do this by speaking at conferences, becoming a though leader, PR about your shop, SEO, etc.

Micro-level: Stay in touch with contacts by providing helpful and valuable information so you are top of mind when the time comes when they need your services or can refer you.

Nano-level: This is the list of 25 businesses that you are going to pursue directly “until they either hire you or they get a restraining order.”

Client retention: What are you doing to make sure your clients know that you love them, that you're always thinking about how to help them grow their businesses, always looking for new opportunities for them, and connecting them to people you know? You have to actively plan how you are going to maintain and grow these client relationships because it doesn't happen naturally.

One of the main reasons that agencies get fired is because the client doesn't feel valued and feels taken for granted. The competition is always hungrier and sending them emails and articles everyday.

In each level, you need to develop tactics to push the business plan forward. The tactics need to be put into a calendar to keep you on track. Someone has to be doing these things every single day.

When a client hires an agency, they are looking for people in the agency to have business conversations with, not about how your specific marketing strategy will work. They are interested in the business goals that they want to meet and how to get there.

The client cares about business goals because that is how the person representing the client will be evaluated for promotions and keeping their job. If the person that hires you on behalf of the client doesn't meet the goal of launching a product on time for X amount, then that person might be fired. They don't care about the optimal number of tweets and blog posts or how to change the code on your website to track analytics and improve SEO. They care about the big picture, the business stuff. If you make sure that this person is taken care of and looks good to their bosses, you have gained a strong advocate.

Most often, the best person to have these business conversations is the agency owner. In the process, you become an advocate for your client to be better at their job and get more funding for tactics in return. You become a trusted business partner, not a vendor.

You should try to have as many conversations with the client that you can because these generate new revenue for the client which means more revenue for you. But you have to check-in on a regular basis because goals change and obstacles pop up.

Resources Mentioned:

• Spreadsheet to Calculate Key Benchmarks for Your Agency's Financials (Mac) (PC)
• 5 Financial Mistakes that Every Agency Owner Makes
• AMI Research and Surveys

Find Drew Online:

•  agencymanagementinstitute.com