The Two Main Reasons Your Firm May Not Be As Profitable As You'd Like
I don't think I need to spend much ink supporting the idea of making a profit. A hobby costs you money, a job delivers a fixed amount of money for a fixed amount of effort and seldom more, and a company should deliver profit after paying all expenses...and a fair amount to the principal.
This profit doesn't need to be justified if the market willingly pays it, but it's how risk is properly compensated, how you build a cash cushion so that you are free to make long-term decisions, and it's what's going to interest a buyer (some day). More on that hobby, job, company motif here.
The main point to consider is that some of you are running a company without enough profit, which means you have a job that has a whole lot of uncompensated financial risk.
It's pretty easy to fall into a comfortable little mental trap that sounds like this: "Yeah, maybe things could be worse, but we're busy and clients are paying us and that's pretty good. Besides, every time I try to increase our pricing, we get too much push back, so let's not rock the boat."
Measuring our success by activity or busyness is bad enough, but it's also not terribly effective to relax based on how much money you have in the bank, because:
- Money in the bank doesn't mean you're tapping all the opportunity in front of you. There could be more.
- Some of that money in the bank should be in your personal pocket, instead, if you are underpaying yourself, and so the presence of that money might lull you into a false sense of accomplishment.
If you want more about this in a bigger context, the recently revised "Financial Management of a Marketing Firm" covers it in depth.
So let's simplify this: what are the two primary reasons for generating less profit than you'd like?
#1: Subsidizing Client Relationships
This is nearly always the primary cause. In other words, you're busy, but clients aren't paying you for whatever time it requires to get the work done. But if we dig a little deeper into this, there are many sub-reasons:
- Maybe you have no pricing power or you don't know how to negotiate.
- Maybe your standards are impossibly high. So high that the client doesn't even notice the difference between "good enough" and "let me impress my peers."
- Maybe you find it challenging to call out scope creep.
Whatever the reasons, this is the primary issue in our industry and I'm kind of tired of it (for you). If you want to take this seriously, here are some suggestions that the very best firms employ, in this order:
- View timekeeping as a necessary (albeit temporary) tool to improve the next estimate. And then once you close the gap, drop timekeeping, too, which is otherwise unnecessary. The only value enduring value in timekeeping is to improve your estimating, and once that gets to where it needs to be, free people from a practice that people (rightly) hate with a passion.
- Ensure that one of the healthy tensions you hold at the firm is the one between account managers, who want to please clients, and project managers, who want to make realistic promises. (We take a very scientific approach to this in our TBR.)
- Establish a positioning that makes it difficult for clients to find cheaper substitutes for your firm, and spin up sufficient opportunity so that you can say "no" to underpriced opportunity and still have enough to stay (profitably) busy.
#2 Unrealistic Comp Structure
This one is tougher to fix and in fact has no quick fixes. It's not usually right to assume that your people are overpaid (though that might be true), but rather that your firm isn't making enough to justify what you are paying them. In other words, this is a reflection on you and not them.
I've never measured it scientifically, but it seems like one-fourth of you just throw up your arms and declare surrender. "You have no idea how expensive great people are. Our firm is in XYZ, and things are just different here. Even our cheapest people are demanding XYZ, right out of school."
It's all a bit vapid, because most firms manage this swimmingly. These are the ones who:
- Don't overpay to cover up lousy culture so people will stay.
- Don't view a marketing plan for people as important as a marketing plan for clients, and frankly, great people are harder to find than great clients.
- Hold on to this strange idea that staff turnover should be avoided at all costs by continuing to increase someone's pay without passing those costs along to clients, meaning that you're going to keep paying people more and more and not get a matching ROI out of it.
You can afford to pay 45% of your fee base on unburdened comp, including a normalized amount to yourself. "Unburdened" means before taxes, benefits, and bonuses. That's like gravity: hate it all you want, but don't pretend there aren't consequences for violating it.
#3: Other
Every once in a while, we'll come across some other, more minor, reasons for lack of profitability, like high legal/accounting fees, spending too much on insurance, or spending too much on a facility (which almost universally disappeared in 2020 and forward), but none of these amount to enough of an impact to displace either of the top two reasons above.
You're a creative person, and I love how you think for clients. It's a blast to see a principal apply that same creative penchant to running their firm as the primary creative challenge in their work life!
