The good news is that you don't need an MBA and you needn't have taken an accounting class to get the basics of your cost structure and an associated billable rate.
Let's roll through a simple set of steps to understand your overall strategy, which will dictate the underlying cost structure and associated blended rate of your services.
And though I typically write for the digital marketing agency ecosystem, these steps really apply to any services business. You can—and should—double-check these steps with your friends who are consultants, lawyers, accountants, etc.
Cost Structure: Important for a New Firm or Any Dynamic Operational Change
Depending on how long your business has been operating, many of the concepts in this article may be well understood, but it never hurts to start with the basics.
Even if your digital marketing agency is well established, should you be launching a new service, or opening an office in a new city, or taking on a new large client that will entail expanding your resources, you will want to roll right back to these basics for a sanity-check on doing smart business.
What's the objective of understanding your business's standard billing rate? The objective of this exercise is simply this: When your firm puts together a bid for a client, you and your team should be able to quickly check whether that bid equals profitable business.
Therefore, in the Keep It Simple spirit, my recommendation is to come up with a single blended hourly rate for your business. This way, everyone knows what is good business for your firm, assuming you can accurately estimate the number of hours involved.
Bigger firms may bill out different clients and different personnel at different rates, but for most small firms a single blended rate is a good starting point.
Step 1. Business Strategy: Specialized or General Services
Conceptually, your business should be able to charge higher rates for specialized services compared with general online services. The flip side is that...
- Significantly fewer clients need certain specialty digital marketing services relative to an array of services, so you will likely have more costs in attaining clients (i.e., more unbillable time spent in business development).
- When you need to hire additional employees, the more experienced employee who has the expertise to provide the specialized service will cost more than the generalist marketer you can bill out for a range of services and campaigns.
Let's look at both cases:
- Most firms we work with are asked by their clients to execute different digital marketing campaigns across channels (email newsletter, search engine marketing, social promotion to a custom landing page, website performance analysis, etc). If this example rings true for your firm, you will want to be aware that the higher your blended hourly rate (relative to your local market), the less likely your clients are to want your services in a broad set of general marketing activities. Instead, your firm is perceived to charge a "premium rate" for a narrower set of more specialized services
- Assuming some baseline rate per hour for a 6-10 year veteran, let's say you can charge a standard rate 50-100% higher for a specialty in just one high-impact service, such as email database marketing or SEO.
Decide which strategy of the two above you want to pursue, because you will need to know that in order to benchmark rates and market expectations in Step 2.
Step 2. Market Analysis: Which Rate Will Your Target Market Bear for Services?
Your local market conditions matter mainly because they reflect what the general client will regard as "in the ballpark"—or not. For instance, an SEOmoz survey on specialized SEO services indicated that rates in the US are concentrated in the $101-$150 per-hour range, whereas in the UK they are slightly lower, in the $76-$100 range.
Compared with that specialty services strategy, a rate for general digital marketing services would be more in the $60-100 per hour range. In any event, you must know which strategy you are pursuing to have a general idea of what the market will bear for that strategy.
If your business is relatively new—say, you launched within the past 2-3 years and have a roster of 15-20 clients—I recommend having "market prices" for your region (in either strategy) that don't feel "too premium" to a prospect. The point of this exercise is to verify that market prices actually provide good business for you.
Step 3. Financial Objectives: At What Rate Should the Partner Bill Out?
In your digital marketing agency, the only partner may be you. Or perhaps there are two or three key principals. A good place to start on your internal cost structure is to determine two financial objectives for the partners for at least the current year and the following year:
- What is the minimum income each of the partners needs to live on for the current year and the following year?
- What is the desired (but reasonable) income for each of the partners during the year?
If your firm has two or more partners, I highly recommend that you have the hard conversations early so that everyone has the same expectations regarding No. 1 and No. 2 above. It's simpler to manage the business and manage internal expectations if that's the case. It also becomes much more difficult to develop consistent rates otherwise.
However, perhaps there is a senior and junior partner based on experience (i.e., one can bill out a lot more in the marketplace), contacts (one can bring in a lot more business than the other), areas of expertise, etc. Those two folks can (and should) bill at different rates.
Step 4. Billable Hours: How Much of the Partner's Time Is Billable?
Start with the services billing rule of the mythical number of billable hours in a year: 40 hours per week * 50 weeks = 2,000 hours. I say "mythical" because anyone who has been a consultant for long knows a minimum of 30% of his/her time gets sucked into non-billable time, primarily business development activities as well as other administrative activities and overhead.
Starting from a baseline of 70% of a partner's time at your firm is billable (best-case scenario), you can figure that percentage degrades if your agency is growing. Why? Because you are likely hiring some junior employees or contractors to fulfill client services needs. In that scenario, recruiting, training, and management activities start to significantly affect a partner's billable hours.
Going back to Step 3, my general thumb rule is that a partner should set an hourly rate so that...
- She can meet her bare minimum financial goals if only 25% of her available hours are actually billed in a year: 500 hours * $YY/hr = minimum financial income goal.
- She can achieve her desired (but reasonable) income if 50% of her available hours are actually billed in a year: 1,000 * YY/hr = desired financial income goal.
Step 5. Billable Hours: Determining Employee Bill Rates
In a digital marketing agency or any services firm, the first 8-10 employees must all be billable. You might pay an accounting firm or part-time accounting clerk for standard accounting, billings and collections, accounts payable, etc.—or you may do that yourself. But, otherwise, everyone needs to be billable.
Assume that each of your employees is billable 70% of the time, or 1,400 hours in a year. If you aren't confident they can be 70% billable, I advise not hiring them or bringing on a part-timer until you are confident of getting him over the 70% billable bar. Assume that you need to bill employees out at 2x what you pay them at a bare minimum, and your baseline internal rate (list price) for your staff should be 3x what you pay them.
So if you have a $20/hour entry-level digital marketer—you know, that communications major right out of the local university—your list price should be to bill them at $60 per hour, and your bare minimum billable rate for them, even after protracted negotiations with a client, should be $40 per hour (2x their cost should NOT be the norm for their billable rate).
That way, even if you bill them out at only 70% of billable hours at 2x what you pay them, they are still contributing something back to the business from their billable time.
Step 6. Simple Math for an Overall Blended Rate for Your Business
We have developed the partners' billable rates from Steps 3 and 4, and we have an idea of billable rates of employees from Step 5. Now, simply average them out to get a baseline rate for your business.
For a small agency, I have generally observed a ratio of 2-4 junior employees per partner. So a one-owner/partner agency may often have 3-6 total employees early on, and a two-partner agency may have 8-10 total employees.
If you want to get fancy, you can do a weighted average based on the partners' billable time vs. the junior employees' billable time, but I think that is splitting hairs and will give you a lower baseline rate. You will have enough pressure to reduce rates due to many factors in business development, so start with a healthy blended rate that is good for your business.
Bring It Full Circle for a Blended Billable Rate Reality-Check
Now let's go all the way back to Step 2 and see whether your blended rate developed in Steps 3-6 seems reasonable given your specialist/generalist strategy from Step 1 and your associated local market conditions from Step 2. If not, you have to adjust somewhere.
What should you "adjust" in your baseline rate? Note that the most common answer I hear is, "Well, I need to adjust my rates down." I would urge exactly the opposite—strive to defend your rates. You are better off spending time developing a strategy and associated tactics of how to defend a blended rate that may be a little above market but works for you and your business.
An Aside on Defending Your Rates
Besides obvious reasons based on the exercise above, I also urge you defend your rate because once you start at some standard billable rate with a client, it is very hard to increase that rate over time with that client.
Since each early client is gold to a new agency and you really want to expand services and billing for those clients, changing the expectation of that client later is VERY difficult (hard experience talking here). If that scenario occurs, you end up stuck with some unprofitable clients, which ultimately affects each partner's desired income (in Step 3, above).
This article isn't about defending your rates; rather, it is about developing a standard blended rate that works for your business. But you can do some simple things to defend your newly developed blended rate—specifically, things that increase the perception of your firm's value in the eyes of the new client:
- Do you have reference clients? Do you have some written quotes from them on your website or LinkedIn profile? You will need to be very scrappy and possibly discount your rates more than you want for a few of these early and referenceable clients, but don't make
- Do you have an up-to-date and professional website? Do you have not only your personal LinkedIn profile but also your firm's LinkedIn profile updated?
- Do you have some marketing collateral—maybe a one-pager on services your firm offers and a backgrounder on your own experience?
- Can you provide examples of deliverables—insightful reports or metrics your firm offers for various types of digital marketing services?
- Can you point to specific partnerships, standard processes, qualifications, or systems that establish your firm as having well-developed and consistent services compared to your competition?
You now should have a baseline to bid a project once you make an assumption on number of hours involved. The more clients you work with and the more digital marketing services you provide, the better you can dial in the assumptions above to develop a solid blended rate that helps you build a great business. Keep after it!