Benchmarks to Tell When an Agency’s Running Hot
It isn’t easy to tell when an agency’s running hot.
It’s especially difficult when revgen’s covering everything up.
We saw this in 2023. The revgen tide receded, and the bony wreckage of nasty agency metrics littered the sand. They were always there, but everything looked ok up top, so many agency leaders were reluctant to dive too deep under the surface.
A key part of my job is showing this stuff off.
If we address these early, there’s typically still time to fix it, but it’s important to be quick as optionality recedes with the revgen tide.
Before we address fragility, we need to measure it.
We need markers for running hot.
Here’s how I quickly assess the precariousness of an agency’s position:
Operations & Finance
Utilization
Everyone knows about utilization rates by now.
When they’re properly tracked, they’re the clearest marker of a fragile agency. When you’re pushing 90%+ on your production staff, a single event can cause a massive disruption.
There’s some nuance to this based on the style of shop you’re running. The Factory-Consultancy Spectrum has a ton of influence on this.
For factory-style agencies, you can get closer to the 90% end with fewer potential issues. For consultancy-style agencies, sustainability exists more toward the low end.
OpEx / Adjusted Revenue
Operating expenses / (Revenue – passthrough)
This is a sneaky one, mainly because of the somewhat random accounting standards across shops. If you’re properly costing out your direct labor costs to COGS, then OpEx/Rev is a useful metric. If not, don’t use it.
OpEx are essentially support expenses, so this ratio gives us an idea of the general level of support in an agency. Too much spend here (>35-40%) and you’re either in major growth mode or just burning margin. I’d consider an agency running hot when this metric dips below 20%.
Cash Reserves / Monthly OpEx
I love this one because it can give me a sense of how risky leadership is. If leadership is comfortable with the current level, and their cash reserve is 12x their OpEx, then I know they’re incredibly risk-averse. If they’re comfortable with it being <1x, then I know they’re happy living on the edge.
Because of that, it’s a tough metric to guide.
The fact that the “right” amount changes with business and economic outlooks takes it from tough to guide to nearly impossible.
During the summer of 2020, we saw shops increase this ratio to 12x and beyond. Once the PPP and EIDL cash hit, this grew even further until it receded back to normal-ish levels in 2021.
With that said, for a leadership team with an average level of risk aversion and an average outlook, a 2-4x multiple of cash to monthly OpEx is common.
Revgen
Sales & Marketing Investment / Adjusted Revenue
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7% is the average for this.
It’s not a good average, but that’s life.
A ton of shops are running this closer to 3%. There’s a huge overlap between them and the ones who say they’re worried about leadgen.
I don’t think that’s a coincidence.
A 7% investment at average revgen effectiveness has been good for 13% Y/Y growth over the last 9 years. Unfortunately, we all know how rough 2023 was and how middling 2024 seems to have been. That 7% probably didn’t net many shops a 14% growth rate this year.
If you want to grow faster than average, you either need to be more effective than average, or you need to invest a larger percent of revenue in revgen.
7% is running warm.
<5% is hot, and not in a good way.
For the average shop targeting a 20% Y/Y growth rate, I like to see their investment in revgen in the 11-14% range.
Lead Pipeline Activity
Most agencies don’t need a ton of leads.
The average agency only adds 11 new clients a year.
At a 20% close rate, they need to pitch 55 new clients a year.
Everyone’s math will be different from here on back, but the top of the funnel isn’t huge. It’ll be bigger for the pure-play factory-style shops, but even then, start with a few hundred clients a year and work back. It’s still not astronomical (unless their conversion rates are garbage).
This is why it’s possible for shops to successfully niche down and serve a market with only a few thousand participants.
It instantly sets off alarm bells when a leader tells me they’re churning through list after list, and their biggest issue is where to find the next one.
Sales Visibility
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Here’s some data from our 2024 State of Digital Services that didn’t make it into the final report
11% of agency teams don’t forecast sales at all.
While that’s a massive red flag, I’d argue that forecasting anything less than a few months is a problem.
Managing capacity in this business is tough, and mismanaging it can lead to an instant evaporation of margins. Poor revenue forecasts (or expectations if you don’t forecast) are the root of most capacity issues.
Try to get it reliably into the 4-6 month area. Longer if possible.
Client Concentration
Concentration risk can arise when too much revenue is derived from a single client.
Client dilution risk occurs when no single client makes up a moderate portion of revenue.
Too much revenue coming from a few sources can increase the risk to future cash flows.
Too little revenue can lead to operational and profitability issues as the system to profitably serve an enormous number of tiny clients becomes fragile. This is why factory-style shops need to be so absolutely dialed in.
Here are the quick guidelines I use for assessing the top three clients.
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Leadership
Partner Utilization
After 20 FTEs, anything over 0% is too much.
It’s a misuse of resources.
Partners, or high-level leaders if you’re big enough, have so many more important things to do than client work. They’re also typically the only people in the org. who can accomplish certain things. This is especially true around directing strategy and high-level revgen.
Alignment
I’m specifically looking at strategic an execution alignment here.
Are the leaders aligned on the strategy and tactics necessary, and do they prioritize things similarly?
This is really tough for an agency to suss out internally, and I see it come up a bunch during leader interviews.
While I do this through interviews, you can get most of the way there by simply asking leadership to write down the general strategy, why it is what it is, and the top 3 priorities for each functional group. If they know what’s up, they can do this in 5min on a call. Then, compare and contrast.
We went deeper on this in a past newsletter.
The Wrapup
Small operational cracks can become costly in an industry where margins can disappear quickly.
Finding those cracks early is key.
Use the markers above to assess your agency’s fragility, and you’ll be better equipped to course-correct before a revenue dip forces your hand.
