TL:DR:
For some agencies, AI is reversing the last few years of negative margin pressure caused by salary inflation.
Early indications show a 15-25% productivity boost for production-level employees. If this holds true for agency-wide gains, it could result in an 81% increase in net income for those shops that successfully implement it.
In addition, there’s also potential for improvements to revenue-generating activities.
AI’s impact
Last time, I asked, “How has AI impacted your shop,” and I got some fantastic responses.
One of the most shocking was:
I had the opportunity to dig a bit deeper with a few shops and found that they’re seeing productivity gains anywhere from 15-25% after implementing AI tools in their workflows.
They’re also relatively easy to implement.
In this newsletter, I want to dig into the margin math to help uncover just how impactful these kinds of changes can be.
Spoiler: it’s significant.
Do better than the benchmarks. Identify risks, ensure alignment, and evaluate implementation with a comprehensive review of your shop’s strategy and structure.
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Recent margin pressure
For three years now, agency profitability has been under immense pressure from record demand and talent scarcity. These forces, along with generally high inflation, have conspired to significantly increase salaries.
As we showed in our “New Agency Economics – Margins Are Shifting” newsletter a year ago, those forces weighed on average net margins and reduced them to an average of ~17%.
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What can change in just a year?
One of the most significant benefits of adopting generative AI is the potential for cost savings and increased efficiency. By automating repetitive tasks and streamlining workflows, AI tools can help save time and resources in areas like content creation, graphic design, and web development. This frees up teams to focus on higher-value tasks, leading to improved profitability and significantly more options.
If we look back at those early indicators of 15-25% productivity improvements and we assume utilization rates remain the same (aka there’s plenty of work coming in to keep the production teams steady). We can map those productivity improvements almost directly to cost savings. When we apply them to the standard digital agency’s cost structure (mostly salaries), we get an entirely new margin profile.
This is what an income statement looks like with a 20% productivity improvement to production-level (COGS) employees. Since the majority of COGS are employee-related expenses, we modified 95% of the COGS line with a 20% productivity improvement.
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That’s a 62% improvement in net income over the industry average baseline margin profile.
When we extend this to the OpEx line, things get even more interesting.
Here we’re keeping half the amount fixed and only adjusting 50% of the OpEx costs by the 20% improvement since you have more non-employee costs here.
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This raises net margin by another 12% over the production-level improvement for a total improvement of 81%.
Now, that OpEx improvement might be a bit optimistic since we’re seeing mostly quality improvements there vs. productivity improvements, but there’s potential for both.
What about the top line?
Everything we just reviewed focused on cost reduction and margin expansion, but we’re also seeing advances in sales and marketing.
While I didn’t get any hard numbers on productivity increases for sales, it’s easy to imagine a sales development rep increasing their output significantly with AI tools. A large portion of their job includes content creation (email drafting and research) that can be almost completely automated.
The improvements to marketing aren’t just in how much content they can produce but also in the quality. Like devs, they’re able to spend more time on tricky parts like hyper-targeting campaigns and conversion rate optimization. This lets them generate more leads that are converting at even higher rates.
Even if this results in a slight increase in lead volume, close rates, or upsells, it’s worth looking into. On the other hand, if it results in a broad-based uplift to the entire marketing and sales process, it instantly enters “must do immediately” territory.
Let’s talk tactics
So, what exactly are shops doing to achieve these gains?
Content marketing is the obvious one.
Agencies selling any kind of content generation are using AI to increase their output. The owners I spoke with are still instituting significant checks and balances here, and I’d expect this to continue for some time.
We’ve seen some attempts at image generation and branding but nothing too concrete yet. The models either need additional tuning to individual brands/styles or aren’t capable enough yet.
Code creation and debugging
That quote about replacing Stack Overflow with ChatGPT sounded crazy when I first read it, but it seems less far-fetched after a quick conversation. They’re using ChatGPT for everything from initial code creation to reviews to comment generation.
This is changing the role of devs at their shop.
It’s freeing them up to spend time on the more challenging (and value-adding) problems vs. the tedium of the job. It’s also putting some upward pressure on more senior devs.
Sales and marketing
Outreach is about to explode.
Just about every shop that responded was using AI tools in sales. Some are using it on the persona and lead research end, while others are having it draft email outreach campaigns. There have been some pretty garbage attempts at using AI for personalization, but I’d expect these to get better and more natural quickly.
I’ve seen shops using ChatGPT to build buyer personas and even design entire marketing campaigns.
With all that said, no one trusts AI completely. Each agency has an experienced “handler” checking the content generated for errors.
Back-office tedium
Ops professionals are using AI to fine-tune employee onboarding materials, knowledgebases, presentations, and more. Instead of productivity gains, I’m seeing shops opt for higher-quality output in this area.
New-new agency economics
After all that, it looks like margins will be shifting again. Luckily, they’re expanding instead of contracting this time. Even if all AI progress stopped today, the current productivity gains can’t be ignored.
Those that implement AI assistance early stand to gain a significant advantage. Almost doubling their net margins today, and if we look a bit further down the road, there’s even more upside potential.
It’s not without its risks, though. It requires a handler since it can just be flat-out wrong. The potential for the penalization of AI-generated content by search engines is huge. Finally, the long-term value of “everyone can make 10x more content and flood the internet with trash!!!” is questionable at best.
Even with those risks, measured use of this tech seems to provide more benefits than not.
As always, I love to get feedback from readers. Feel free to reach out if you have any questions or would like to share your experiences. Quotes are always kept anonymous unless you give explicit permission otherwise.
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If you’re looking for executive-level talent (VP / Director level or above), or you’re an executive-level talent looking for a new adventure, reach out, and I’ll help share your info with others who might be a match.
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