In this article we’ll explore how to set hourly rates in your agency.
As anyone running a creative agency knows wages and staffing costs are the single biggest expense they’ll face. Typically wages represent ~60% of gross profit for many agencies in Australia which is higher than other professional services industries which tend to average between 40% and 50%.
Given that you are spending such a huge percentage of your revenue on wages you are going to want to ensure you’re getting a good return on your investment and to ensure you’re getting a good return you need to have appropriate charge rates for you and your team.
We find it most useful to talk about wages as a percentage of gross profit rather than total revenue. Why? Depending on the type of agency you run you may have significant production costs and other costs of sales that can break these handy rules of thumb (e.g. don’t spend more than X of your revenue on staff).
Speaking of ‘rules of thumb’, a handy one is the 60/20/20 rule which states that you should aim to spend (no more than) 60% of your gross profit on staffing, 20% on overheads, and that will leave you with 20% profit. Yes, overheads may go under and staffing over, that’s fine, just make sure it still leaves you with some profit!
Okay. That’s a lot of talk about how much you’re spending on wages. Now let’s look at how we can get a good return on that spend.
Setting hourly rates is one of the key levers you can pull when it comes to determining the revenues you’ll generate from a client. The traditional model is based off a multiple of the wages paid and revolves around a rule of three — one for you (being your staff member), one for the business (to cover other costs), and one for me (being the profits), however achieving this 3 times return on wage spend can be difficult to achieve for small businesses so they tend to go with lower rates (e.g. 2.5) to help make them more competitive when compared with the bigger agencies which tend to operate with bigger multiples.
Now that we’ve got our multiple (let’s use 3) we can start to calculate the hourly rates. First step is to apply the desired return to the cost per working hour and then we apply the target productivity rate (doing it the other way around delivers unrealistic targets, particularly for senior staff). This calculation is simple, just take the total salary cost and divide it by the number of working hours in a year. You’ll need to consider the actual number of available hours each year, so that means taking out annual leave, personal leave, public holidays, etc. This usually means 52 weeks less 4 weeks annual leave less 2 weeks personal leave less 2 weeks public holidays leaving us with 44 weeks a year for a full-time team member. If they are working 37.5 hours a week (7.5 hours a day) that gives us 1,650 hours a year before we then allow for non-chargeable time for things like training, administration work and getting a cup of tea!
Let’s take the above and apply it to a simple example:
We can take that basic charge rate, the available hours each year, and apply it to the desired productivity rate (%) we expect to get from the team member. Typically, junior staff are more ‘on the tools’ and have a higher productivity rate (e.g. 80-90%) than senior staff (e.g 40-60%).
To continue our example above to see what the team member’s billing capacity is:
We can then easily calculate the return on investment with this team member being $190,080 (the fees) divided by $80,000 (the cost) which gives us 2.4. Not a bad result! Remember that you’ll typically achieve higher returns on junior staff than you will on senior staff, so it pays to be strategic with your staffing structure.
You may charge clients based on a fixed fee basis, and that’s fine, but it’s still crucial to understand the underlying charge rates so you know if what you’re quoting (and recovering) is sufficient to help your agency turn a profit.
What next? Put together a spreadsheet with all your team listed along with their salary packages and work through the above calculations so you can see what the billings capacity of your team is and whether your overall financial model (i.e. revenue less costs) stacks up. Our experience is that most agencies have excess capacity but need to go through this process (and then subsequently tracking results closely) to find where it is. Understanding the capacity of your team, having a budget that reflects capacity, and then having the reporting to support it (e.g. budget vs actual P&L, job profitability, team productivity and recovery rates).
If you’d like to speak with someone about reviewing the capacity of your business, why not get in touch? We’d love to help.