How to Improve Your Agency’s Profitability with Marcel Petitpas

All right, hello and welcome to the 7 Figure Agency Podcast. We're interviewing highly successful digital marketing agency owners and strategists from across the country. Today I'm super excited because we're joined by Marcel, and I don't want to butcher your name, Marcel, but from Plaquido. He is a, you know, really one of the foremost leaders in how to maximize and optimize profitability in a digital marketing agency, uh, and I was connected to Marcel via Dan Martell, one of my coaches and mentors, and he said, "Hey, look, you really need to have Marcel on your podcast." And so Marcel, so glad to do this and thanks for being here today.

I appreciate you having me, Josh. It's a pleasure to finally connect with you. I feel like we've been ships passing in the night all these years, so great to finally be here.

Absolutely. So I guess let's start off, tell us a little bit about, like, you know, your background, how you got into this world of agency and agency profitability.

Yeah. Um, so as you mentioned, uh, this all kind of happened through connections, um, that I made through Dan Martell. So I lived in the same city as Dan for a while and my first ever business was actually an agency. We were doing virtual tours for real estate agents before you could do it with your iPhone, when you had to take a camera, take, you know, 27 different pictures from a hotspot, turn it into a 3D image. So that was the service offering that I was in and we had horrible margins. Because you might recall back in 2015, '16, '17, it was a total buyer's market in real estate. Houses were sitting on the market for 2, 3 years at a time. So real estate agents really weren't pouring a lot of money into their listings. And here I was doing this service that took 20, 30, sometimes 40 hours to do, and they were willing to pay me like a few hundred bucks to do it. Right. So that was when I became familiar with this challenge of, you know, the, how important the unit economics in a service business are, but also how challenging it can be to answer these simple questions that you're asking yourself every day when you run a business like that, which is like, are we making money on any of the work that we do? Which clients are unprofitable? Should we be hiring people? If so, when and how much can we afford to pay them? And right, these, these things are challenging. So I became familiar with that. Then I kind of switched to being interested in software. That's how I met Dan. And then one day Dan connected me to a guy named Jared who I started the company with. And Jared had already been working on this problem internally at his agency, which was much bigger than any that I had ever run. And he just said, look man, I spend like 2 days a week in spreadsheets trying to figure this stuff out. There has to be a better way to do it. And so I said, yeah, totally resonate with that. We started speaking to other agency owners. Everybody had the same challenge and we decided to really pursue this. Um, and that was back in 2018. So we've been at it for almost 7 full years now. Um, just solely focused on this problem and, uh, we've, we've come a long way in terms of figuring out how to solve it.

So good, man. So you had the experience in the agency world, you kind of pivoted to like, let's solve the big problem of, of profitability and margins. What are you finding are like the biggest challenges agency face when it comes to maintaining profitability in their agencies?

I think, um, there's two main challenges. The first is that I don't think a lot of agency owners actually fundamentally understand the business model that they're in. And I think that's a result of so many people ending up in this space as a byproduct of being really good at the creative discipline that is at the corner, like that is the cornerstone of their service offering and not really having a business background and You hear this story over and over again, right? Which is like, I was really great at building websites or I was really good at SEO. And next thing you know, I have a team and I have an office and I have all of these expenses and oh shit, I have a business. How do I run that? Right? And this is probably where a lot of people start to look for mentorship and coaching from people like yourself. And so I think that's part one is they don't really understand the business model. So they don't feel like they have mastery over why does my business make money or not make money? What are all the different ways in which I can affect and influence that? And then the second part of that is assuming that you do understand that business model, then there's a question of how do you measure it? And if all you're getting is a P&L from your accountant once a month, 3, 3 weeks after the month is done, and it basically only tells you that there's money coming in, there's money going out, and there's not that much leftover, that's not that helpful in answering the question of, well, why is this happening? Right? Is it that we don't charge enough? Is it that we spend too much time in doing our client work? Is it that we pay our people too much relative to what we charge? Is it that our overhead is too high? Is it that our team's not busy enough and not utilized enough? Is it all of those things? And if it is, how do I think through prioritizing that? That is a much harder problem to start to unpack and measure your way through. Um, and part of that is because we don't really have a lot of tools or frameworks for small agencies to help us facilitate that. And that's really the problem that we've tried to take on at Periquito.

So good. I think it's 100% true. If I look at the agencies we work with, typically in the best case scenario, they've got a bookkeeper that's updating the financials in QuickBooks or Xero or one of these platforms. Best case, they're looking at that P&L once a month. And so they're making reactive decisions after the, you know, in the rearview as opposed to being proactive. Would love to hear some of the insights or some of the resources you guys have developed to be more proactive on the financial planning and profitability planning side of the equation.

Yeah. Well, so we get into, this is such a big topic, but I'll start by talking about sequencing, right? Because sequencing is important. And I think a lot of people get this wrong where they start struggling with profitability. And so the first thing that they jump to is I'm gonna start tracking everything, right? They, they see this as a metrics problem. And so they get really aggressive about tracking, time tracking, project management. They get really aggressive about maybe making the complexity of their financial statements much bigger and start breaking things down into a billion different accounts, which will actually often slow that process down. So now you went from getting it 2 weeks after the month is done to 3 or 4, because it's way more complicated. It takes your bookkeeper more time. But what's interesting about this is if you think about insight, the way I look at this is insight is a byproduct of having two things. And I'm a visual person, so for those of you that are watching this, I'll share my iPad screen. I'll share a little something. Yeah, and I'm sure you've got the, the power to make that bigger. Yeah, okay. So if we think about insight, I think about the formula for insight as being a combination of two things. One is actuals, right? So we measure actuals and actuals would be things like finance, time tracking. My handwriting is terrible, by the way.

Beautiful. No, this is great.

So these are measures of what has actually happened. And this is great because we get to look back and say what has occurred in the business, but these are retroactive. But here's the interesting thing, right? And I think this is what a lot of people don't realize is if you get a reading from this, so let's say for example, you get some time tracking data back and you realize, let's say we're measuring a metric like utilization, for example, and you get a measure of utilization and it's like our utilization percentage was 48% last month. Well, what do you do with that information, Josh? Is that good? Is that bad? And the problem is we can't answer that question because we're missing half of the equation, which is the plan, right? We can't put actuals into context unless we know what we were planning for in the first place. And I think this is really important because there are so many firms that we've worked with that are planning to fail and they have no idea. And so there's no amount of this that's going to fix that problem. The problem of our— their business is designed in such a way that it can't meet their profitability targets. It can't meet the cash flow targets that they have. Like it can't actually get them to where they want to go, but they keep failing and they think that it's an execution problem, but it's actually just a planning problem. And so all things being equal, when we start working with a firm and they don't really have any insight, right? They're trying to get to this. We start in terms of prioritization with the plan and then we go to the actuals. And there's two reasons for that. Number one, The plan is often much faster to clarify because it doesn't require net new information. It's just a question of structuring assumptions about the business in a way that become more clear. And then the second reason we do it is because we don't actually know how to structure the actuals until we have a structure for the plan, because the whole point of the actuals is to contrast against the plan to understand where things are not going the way that we thought so we can get more focused and take the right actions at the right time. So. Just as a starting point in terms of sequencing at the very highest level, this is how we would think about working through that kind of problem space.

Love it. I think that's so true. Like, just trying to look at your financials, revenue, profitability, gross margin, in the absence of having initially thought like, what does that need to look like? What are our expectations that we're benchmarking against? It's just information, right? And I think that's why a lot of agencies, Don't even bother looking at it because it's like, you know, I don't know how to make any intelligent decisions or insights from this information.

And of course, what tends to happen in that situation is you'll start to look at industry benchmarks to try and tell you if your metrics are good or bad. And, you know, there is some value to that. But the issue is, let's say you get this industry benchmark of like, oh, our delivery margin or gross margin should be above 50% on our P&L. Okay, well, that's a pretty legit benchmark. Right. I would say that's probably a good way to look at it. And the higher you can get that number, the better. But then if you're not accomplishing that, then the question is, well, why? And if the answer is, well, your business is designed such that if everything went perfectly, your team was completely busy, took all of their time off, all of your projects were perfectly on budget, you would max out at a 45% gross margin.

Hmm.

Well, that's very different than your business could theoretically be at 60%, but you're ending up at 45. Right? One is an execution problem, one is just a fundamental business design planning problem, and those are very different in terms of how we react to them. So being able to differentiate between those things is critically important as a first step. I love that.

So you've got to get the plan in place so that your, your actual data can make sense and have something to compare against. What's the next big kind of thought process or big component?

Yeah, so we'll talk about the plan. The plan, we break it down into two steps. The first is the model. So this is literally about building a model of your business, and the model has 3 components. Essentially, the main one is what we call a payroll grid, and that's just like a fancy technical term for a list of all of your people with some basic information about how much they get paid, how many hours a week you expect them to work, how much time off they get, where you expect their time to go. And that gives us a really solid understanding of, okay, we buy this many hours from our team. And if we just wanted to go through like some simple math to articulate an example, let's say we had a team of 10 people and those 10 people each had 2,080 hours of capacity. So we have 20,080 hours of capacity, right? So that's one important thing to understand. And then we would say, okay, well, if we look at the breakdown of all of the time that those people have available and where it's gonna get spent, we're gonna be able to spend, uh, 12,000. Of those hours on client work. Like, that's the max that we could do with our team. So this would be what we call our delivery capacity. And then if we do the math on that, that gives us a maximum utilization. So like, unless people worked overtime or we kind of blew through those targets, if we just divide 12,000 by 20,800, that gives us a utilization of 57.7%. So that's the theoretically the max that we could achieve, 57.7%. And then you might say, okay, when I sell something to a client, let's say I sell a $10,000 a month deliverable. So imagine it's a really simple agency. We have one product, it's $10,000 a month, and we expect that product to take us 100 hours to deliver. Then I'm expecting to earn an average billable rate of $100 per hour. In other words, for every hour of effort my team spends, On average, we'll earn $100, right? So then that tells us, okay, the maximum agency gross income that we can earn is $12,000 multiplied by 100. If anybody's good at math around here, they already know what the answer to that is, right? So we can make $1.2 million with this agency. And then if we understand how much payroll we're gonna have, we can get an understanding of, okay, what will our gross margin be? If we have an understanding of what we expect to spend on overhead or what we spend historically, we can start to get an understanding of what our net profit will look like. So there's some really simple math. That we can do working between 3 important sets of information. Number 1, our team, which gives us kind of our capacity and utilization information. Number 2, our pricing, which kind of gives us an understanding of what are we expecting to earn per hour of effort based on our pricing model, regardless of if it's flat rates, if it's project-based fees, if it's value-based, right? All of those things, we can always reduce it down to this number. And then if we have financial targets and budgets, we can really work towards net profit and gross margin and get an understanding of, okay, like what is the best possible outcome? So now we have a container to place our targets into or our actuals into. So step 1, this is what we would call building a model of the agency.

Love it.

So from there, then it's about forecasting. So we take this a step further, we go to forecasting. So that's when we start to break this down, you know, into more granular levels. So month by month, week by week, how much capacity do we have available? How many hours do we actually have planned for delivery work? What is our utilization expected to be based on the things that we've sold? What are we expecting our ABR to be? So then it's a question of like, are we actually on track to accomplish these things so we're not surprised when we get the results, right? And then the last piece is measuring actuals. And this is where we can get into the specific metrics, but there's two camps. There's financials and then there's what we call non-financials, or we call these ops metrics. And I can break down exactly what those are. And this is what really gives you the feedback loop of saying, okay, are we accomplishing, you know, these targets that we're aiming for or not? And where are the outliers? And we can really manage the business mostly off of these non-financials, which can be much more timely. And much more specific than our financials, which just kind of act as like these big monolithic touchpoints along the way.

I love it. And this is much different than, you know, usually when we think profitability, it's just about, you know, the P&L and looking at how much do we spend, how do we reduce the costs. This is really drilling down based on a plan. Like, how do you pull that data? How do you access that information? How do you, like, how does that process work? In, in your world?

So yeah, it's a great question. I'll, and we'll talk a little bit about what the metrics actually look like here in a moment, but at a high level, this is where people start to get tripped up, right? Mm-hmm. The common fallacy here is that this should be a linear process. And I think this is informed by like the old way of thinking about this. So the way that most people think about this, I call it the siloed agency. Hmm. And so they think about in terms of, okay, we have sales, right? So sales goes out and sells stuff. Then we have delivery. So delivery does the stuff that we sold, right? They do the work. And then at the end of this process, we have finance. Finance counts up all the beans. And then at the end of that, we get both profit and profit insight, right? So this is the old way of thinking about this, and this made a lot of sense at a time when agencies just billed everything by the hour, right? Remember 10, 20 years ago when that was the case, Josh? And you've been fighting, you've been fighting against that paradigm shift for quite some time and helping encourage people to take on these more modern ways of billing, abstracting time and money. These more nuanced ways of staffing their agency, right? It's not just about having a bunch of full-time hires. Now you have a mix of full-time people, contractors, outsource partners, white label partners, right? So there's a lot more complexity to this. And the reality is that this is not how it works anymore. And so what we have to do instead is kind of take this more integrated approach where we look at it more like this. Let me see if I can grab some stickers. They're over here. I gotta remember how to use this thing. There we go. We wanna take a more integrated approach where we're thinking about these things as being interconnected because they are. We have sales, we have finance, and we have delivery. And if we can get these things working together, and my model that I just shared earlier is a good example of how these things are inherently interconnected. This is where we get good profit management. Now the trick is, In order to do this, we have to be able to accept the fact that, you know, the problem with this idea is that there's just gonna be like clean data flowing through to finance. But the reality is that that's not gonna happen, especially time tracking or project data. It's gonna be really messy. So the way that we solve for that is we take a modern approach to managing this information, and that is using a framework called ETL. And this stands for extract, transform, and load. So I'm gonna burst some bubbles here, Josh. I apologize.

I love it. This is awesome.

How many times have you heard someone say to you— I'm assuming you've heard this a lot. I hear it a lot. I just want a dashboard that measures all of my KPIs in real time. Oh yeah. Everybody wants that. Oh, absolutely. Everybody wants that. And don't get me wrong, I want that too. It would be awesome if that was possible, but the critical assumption behind that is that the data that you're pulling out of your time tracking and project management tool is going to be clean. It's gonna be consistently structured. Everyone's gonna have followed the naming conventions perfectly. So if it just gets zapped straight into your report, then the report is actually trustworthy and accurate. The other thing that it assumes is that compound metrics will be able to be measured in real time. So I'll give you an example of this, a utilization rate. Well, there's two components to utilization. One is your capacity and the other is how much time has been tracked. Well, in order to measure that in real time, your team would have to track their time in real time. Yeah. So I've never seen any of those things happen before. Yeah. I've never seen clean data. I've never seen it be consistent. I've never seen perfect adherence to naming conventions. I've never seen things not change and I've never seen that kind of compliance on time tracking. So that whole idea is just like fundamentally not feasible. So instead, what we wanna do is extract things from our tools for things like time tracking, finance, PM. We wanna load it into an environment where we can then transform the data. So if there's 7 different variations of the client's name across all the different tools that we use, we can normalize that to one client name. You know, if there's time missing, we can catch that. If a person left their timer running and logged a 99-hour time entry over the weekend, we can catch that. Like, we can stitch together data sets. So we used to use this project management tool, but then we switched 6 months ago to this new one. Let's normalize those two sets of data so we can report across both those time periods. These are all the kinds of things that are gonna happen, so we want to account for those here. And then we load that into reports. So there is a process that needs to occur around here. And I think that people understanding that you gotta embrace this middle part and there's a human that needs to be accountable for managing this leads to much better outcomes on reporting and gets you a system that is gonna work long-term even as these things are imperfect or changing or not clean, because that's kind of inherently a part of the process. So In terms of the high-level process, this is a big idea, but I think it's an important one, and it's, it's a big part of the reason that we do things the way we do at Paraquito.

Makes a lot of sense. Definitely different than, than what I've seen before, and I think, you know, like, lends itself to potentially having a big, big impact on, on agency's ability to manage their profitability. So we've got the plan, we've got a way to gather the data and normalize the data, transform the data. Um, where we go from here in terms of actually, you know, pulling logical, logical insights.

Well, what I'd love to do, I think would be really insightful, is share the metrics that people should be paying attention to, in my opinion, the, the financial and the non-financial metrics. And as part of that, we can talk about the specific targets and then how you might use those to really massively improve your profitability. So, um, I'll go back to sharing my screen. I'll share a couple of things. I want to start with the core kind of financial insight that we should be able to draw from whatever financials we're getting. And the unfortunate reality is very few people can see these things. I mean, we, we do several audits a month. We've probably done 150 audits over the last couple of years, and I could count on one hand the number of firms that they could actually see all three of the things that I'm about to describe here accurately when they got financials from their accounting team. So I'm going to start here because almost everyone listening hopefully has a bookkeeper doing their bookkeeping at least once a year so that the IRS doesn't come down on them. And so hopefully this will help you get a little bit more value out of that exercise that you're already spending time and money on. And these are the things that we want to be able to see. So the first is something we call AGI, and this stands for agency gross income. So what is agency gross income? And why is it different from revenue? Well, it's different because this represents revenue, which is all the money that a client might give you minus what we call pass-through expenses. Hmm. Okay. And this is really important, especially if you do, for example, digital. So let's say we have a client. Let me give you an example of this. We have a client that pays us, uh, $10,000 a month for Facebook ads. But we spend $8,000 a month on Facebook ads. So is that a $10,000 a month client, Josh, or is that a $2,000? $2K, definitely $2K, right? It's a $2,000 a month client. This is a real important distinction, especially if you have a lot of material expenses. And so other things that this could take the form of, you sell SEO, this could be the backlinks that you buy from a third-party vendor. This could be the content you buy from a third-party vendor. If you do website design development, but you never do the development in-house, this could be the dev shop. That you hire as a third party to do this for you. If you're doing a lot of travel as part of this, this could be the travel expenses or hard costs, right? So there's lots of different examples of pass-through, but the important thing is we gotta be able to isolate those things. So we know what our actual revenue is that we need to earn with our time. And we know how to actually size up our spending decisions against the true size of our business. Because if we don't do this, you end up with this dangerous situation where you think that You know, let's say we have 100 of these clients, right? You think you are a much bigger agency than you actually are and you might start spending like a big agency when you're actually a small agency. And I've seen this play out, Josh, like we did an audit the other day, a client that had significant amounts of pass-through. They thought they were a $6 million agency. They were closer to a $1 million agency, but they were spending like a $6 million agency and then wondering why there was no profit.

Where's all the money, right?

Yeah. So that's step one is can you isolate your AGI, which is really about can you isolate your pass-through expenses? Now, most firms that we see, pass-through expenses are being isolated using cost of goods sold on their P&L.

Yeah. So I was thinking, is that, how's that different than a cost of goods sold?

Yeah. Well, it's, you'd, this is why we use different language. So you're going to notice I'm going to use some different terms that accountants would not use because if that's a semantic discussion, right? To me, like, the use of COGS on the P&L, that's fine. There's a lot of different ways to isolate this. What's misleading about that is if you use COGS to isolate pass-through expenses, then agency gross income is being represented by gross profit on the P&L. Now, to me, that's a little bit problematic because it's, it's at best misleading because it's not actually your gross profit, it's your Agency gross income, it's your real. So this is where we get into, like, if you were looking at GAAP accounting or tax accounting, then COGS might be the right thing to call that. I don't really care. What's important to me is we are isolating pass-through expenses so we know what our actual revenue is. So makes a lot of sense. The TL;DR is, if that's what's going on, your P&L, it's not a problem as long as you know that that's what's going on, right? Uh, thank you, Fraser. Hope you're enjoying this. Comments flying in from YouTube. Okay. So part 1, what's your AGI? Part 2, what does it cost you to earn that money? Right? Because Josh, you and I know this is the rub with the service-based business. You got to spend money to make money. And how much you spend comes down to how much time your team spends to get this thing done. That is what determines your cost. And so unlike a product company, we really got to pay attention to this because it's not static. It's variable, especially if we're innovating on our service offering all the time, right? This is not gonna be like this thing that is necessarily fixed unless, you know, we have this slightly different business model where we're outsourcing a lot of those things, which may be a viable path. But the TL;DR here is we gotta understand what it costs us to earn our revenue, and that is our delivery costs. And the objective here is to keep our delivery costs to under 50% of our agency gross income. On the profit and loss statement. Okay. So when we look at our P&L at the end of the month or at the end of the year, we should see that what we spent on delivery is less than 50% of what we got paid. And the way that we calculate this is we look at the payroll and the shared delivery expenses allocated to delivery. And so for most of the agencies listening to this, there's gonna be some people on your team that are 100% allocated. All of their payroll is gonna go to delivery. This is like your designers, your copywriters, your project managers, et cetera. You're gonna have some people on the team that are split, like maybe you as the owner, you spend like 50% of your time doing client work, the other 50% doing sales and marketing administration. So you might split your payroll 50/50. So we wanna allocate payroll in terms of what people's jobs are. And then our shared delivery expenses, those are gonna be things like the software that our team has to like bring to the job every day. So if you do website design, it's like Figma, Adobe Creative Cloud. If you do SEO, this could be like your SEMrush or your Search Atlas. Subscription. Shouts out to Monique, search out. Yeah. Right. So these are the things that we want to consider. And the goal here is to have a delivery margin of above 50%. And again, you might be thinking like, hey, isn't that just gross margin? And the answer is probably that's what it should be, but I don't wanna argue with your accountant about this. So I'm using different language so we don't have to have some semantic discussions about what this is or isn't. So that's like part one of this. And the reason we want to have that is so that we can spend anywhere from 20 to 30% now on overhead of our agency gross income, and ideally end up with a profit of 20% or more on agency gross income. Of course, if we can do better than that, that's great. Now the pop quiz that I have for you, Josh, is we've done hundreds of audits, we've measured these numbers for a lot of different firms. What percentage do you think have an overhead problem? So their overhead's too high, that's why they're not profitable, versus have a delivery margin problem? There's an unbalance here.

I would think the, the lion's share is on the delivery and, uh, cost of delivery.

That is absolutely right. That is absolutely right. I could count on one hand out of hundreds of agencies, the ones that actually had an overhead problem. Almost everybody suffers from indigestion. They just think it's starvation because it feels the same and it looks the same on their profit and loss statement. Right. So the next set of numbers I wanna talk through are really the 3 ways that we can improve this. And to the degree that we can improve delivery margin, we give ourselves optionality as owners because we can then choose to spend more on overhead. If we want to grow faster or buy back our time and work 20 hours a week or whatever we want to do, or we can let that flow through to profit, or we can kind of do a bit of both. We have options to the degree that we have really strong delivery margins. This is the foundation for profitability. This isn't healthy, everything else is hard. If this is healthy, everything else gets easier. Yeah, no doubt. Awesome. All right. So we're following so far. If you're watching this live, if you have questions, leave a comment. I can see them. This is a very fancy tech platform that we're using here.

Uh, Joshua Nelson says, let's go. Uh, great stuff. Powerful insights. Yeah. Keep going, man. I know we've got limited time, so this is amazing.

All right. So let's dive into the 3 levers to improve delivery margin. And we'll revisit here the formula for this. So if we agree that delivery margin is 99% of people's problems and we fix this, we fix everything else, then we have agency gross income. Minus delivery expenses over agency gross income. So as an example, if I had a firm that did a million bucks, we spent $400K to earn that revenue, then we would have a 60% delivery margin, which is great. I'd be very happy with this. Okay. So how do we improve this? Well, there's really only 3 vectors. And what I'm gonna describe here are 3 operational KPIs. So these are the non-financial KPIs that you can use to really get a grip on what's happening in your agency in between your financial reporting cadences. And then you'll be able to predict what your finances look like ahead of time because you'll know how these metrics are performing. And my favorite thing about these 3 metrics is you can use them to measure any horizontal or vertical slice of the business. What I mean by that is horizontal Any time period, a day, a week, a month, a quarter, a year, whatever. And vertical, you could look at a client, a project, a group of clients, a group of projects, a service line, a product type, a department, right? Any slice of the business for which you can get the two inputs to each metric, which are very simple. Okay. So with that in mind, average cost per hour, the first metric, average cost per hour. Is a proxy for delivery expenses. So essentially what this is helping us understand is what is the average cost of an hour of labor in any segment of the business on a certain type of project, certain type of client. And to the degree that we can lower that number, we should over time spend less to earn the same amount of revenue. And as we grow, we should see our delivery expenses grow slower than our revenue. So a practical example of this would be I have a service offering, I have a really expensive senior strategist doing 40 hours of work on that thing. And then I figure out that like half of the stuff that they're doing, I could have a junior person do and they cost one-third of what that senior person costs. So if we're using freelancers and contractors, well, our delivery expenses will very quickly decrease because we'll just start hiring less expensive contractors to do more of the work on those projects. And if we don't, then either we'll reorganize our team, or when we get to the place where it's time to hire that next employee, rather than hiring a really expensive senior person, we might be able to instead hire a junior person but increase our revenue by the same amount as we otherwise would. So this is where we start to see this difference in how quickly these two metrics are scaling. So high level, that's average cost per hour. That's kind of the first vector that we can improve this across. I'm gonna pause there. Any questions on this, Josh? No, I just keep going, man.

I wanna, I wanna see the whole, uh, the whole model drawn out.

This is beautiful. All right, well, on that note, I started with my least favorite metric, so I'll move to the more exciting metrics. The second one is average billable rate, ABR, and this is a proxy for agency gross income. So how much revenue we can earn with our team. Now when I say Average billable rate, a lot of people, they immediately think, well, I don't bill by the hour, so I'm gonna stop listening. That would be a mistake. Cuz the thing I love most about average billable rate is it doesn't care about your billing model and it normalizes all billing models so you can actually compare them apples to apples. So even if you have one thing that you sell as a productized service over here, and then you have like a percent of ad spend thing over here and you have a value-based pricing over there, this will normalize all of them apples to apples because all it cares about is How much AGI did we earn and how many delivery hours did we spend to get it done? And delivery hours, you notice I'm not using the word billable hour. I don't care if you build the client for the time. I just care about how long it took you to get it done. That's it. Point blank. I don't care how it got billed. How many hours did you spend to finish the promise that was made? And what did you earn after pass-through expenses? And so you think about what this looks like in practice. You could use this to compare all kinds of things and really get clear on like, where do we make the most money for the time that we spend? And the other thing that's interesting about this is oftentimes I see increasing profitability being framed as like a one-trick solution, which is raise your prices. And don't get me wrong, that is effective. If you can do it, I encourage people to do it. But the other thing that's just as impactful is figuring out how to do things with less time. It has the same impact on this formula. You could double your average billable rate by just spending half as much time to get the same thing done. Right. So yeah, that's a powerful idea. And it's illustrated by, I'll give you an example of a report that you might run where here we're comparing 3 projects. And so without this information over to the right-hand side, if I asked clients, hey, who's your most profitable client? They'd almost always say the website build. Because the revenue number is the biggest. But when you actually look at how efficiently we earn revenue across these things, you notice the funnel build, even though the revenue is the lowest, it's really efficient for earning revenue. And so it's like this report could drive a really interesting conversation of, hey, can we do more of these? Is there something we do here differently than we do on our other services that we can learn from? Is there something about our website builds that is off, that's getting in our way, that's making us inefficient? So I really love this metric. I find it to be really, really insightful. And the TL;DR here is if you could double how much money your team made per hour of effort, you could double how much money your agency makes without changing anything else. Powerful, right? It sounds too simple to be true, but it's not my opinion. It's just math. Hmm. So that's metric number 2, ABR. Metric number 3, the last one, utilization. And anybody that's worked in a big agency before, they probably get hives when I say this word, right? Because misused, it's a really, really hurtful metric. It can really backfire if you especially start to try to like hold your team accountable to utilization targets. But this really should be a metric that you as a management team use to hold yourselves accountable to a really important question, which is how much of the time that we buy from our team is actually getting used to earn revenue or earn this average billable rate? And so it's measured by how many delivery hours are spent over the total capacity that we buy from our team before stripping out time off and holidays and things like that, because we wanna see time off and holidays lower our utilization because that is a cost. That's a cost that we need to be able to see reflected in this metric. And so essentially the goal here with utilization is to try and get as much of the time that you buy from your team as is reasonable. Spent on earning client work. And this is essentially the golden triangle where using these 3 numbers, you can improve your delivery margin. And if you'd like, if we have time, I'd love to walk you through an actual example of what that math looks like. That would be beautiful.

And just for context, a lot of the 7 Figure Agency members and listeners, we've encouraged to build a program which is like $2,500 to $3,000 a month, and it includes a suite of things. We're gonna build a website, we're gonna do the ongoing SEO, we're gonna manage the ads campaign, we mapped in advance, like how much does that cost to build and then how much does it cost monthly to deliver? Um, so just like the context of that, if you can frame the example for that type of scenario.

Yeah, well, okay, let's, let's, um, let's talk about this at the agency level and then we can double-click on what does this actually look like at a per-service, per-client level, because it's a little bit different, but I think a really important conversation to have as well. Is that cool? Yes, absolutely. All right, so we're going to start at the agency level and we're going to walk through an example of an agency that starts in one place and then starts to tweak these numbers and see the impact that it has on their profitability. So in this example, we have a pretty big agency. They've got, uh, 100,000 hours of capacity. So just for context, this is a team of roughly 50 people, right? Give or take. They spend $3 million a year on delivery costs. So that's the payroll and the shared delivery expenses that are specific to delivery. And then they spend another $1.5 million on overhead. So that's the payroll and the expenses that are specific to overhead, which would be sales and marketing, administration, maybe some facilities if they have an office, right? So this is their situation. Okay. Yep. So in scenario number 1, they have a 50% utilization and $100 average billable rate across all of the different things that they sell. So in this scenario, how much revenue can this agency earn? Well, we take their 100,000 hours. We multiply that by 50%. So that's how many get spent doing client work. And then we earned an average of $100 per hour. So that's 50,000 hours multiplied by $100 per hour, which ends up giving us a $5 million agency. Well, that's exciting. $5 million, right? That's pretty cool. Then the question is, well, what do we have to spend to earn this $5 million? And the answer is $3 million. That's what we have to spend on the team that actually does all the work and gets the promises delivered. So that leaves us with a $2 million delivery margin, which is 40%. Right. So not bad. We said we wanted this to be at 50, we're at 40. Okay. So we're not quite there, but still not bad. And then the question is, well, what do we have to spend to run the business? And the answer is $1.5 million, right? We got to get the clients. We got to do our taxes. We got to pay for all the different software tools we use to run the business, do payroll, all those things. So that leaves us with a net profit here of $500 grand. Which is roughly 10%. Okay. So that's honestly pretty average when you adjust for founder salaries actually being in market. There's not a lot of firms that are doing a whole lot better than this consistently, but I don't know about you, Josh, if I built a $5 million agency and I was only walking away with 10% of the upside, I would not be satisfied with that personally. I don't know about you. Nope. Right. So. Being the type A kind of people that we are, we're going to make some optimizations to this firm. So the first thing that we're going to do is we look at our model and we say, hey, you know what? Our utilization is low. We could be at a much higher utilization rate. And we've kind of been getting out ahead of our skis in terms of hiring. I think there's some resource planning stuff that we could dial in. I think there's some team composition stuff that we could reorganize. So we make all those adjustments and we go from a 50 to a 60% utilization. So now this firm, rather than spending 50,000 hours on client work, We get to 60,000 hours. We don't do anything about our average billable rate. That stays exactly the same. But now the same company can earn $6 million with that same team, same expenses, which means we can get to a $3 million delivery margin, which is 50%. But look what happens to our profit, $1.5 million, which is 25%. Hmm. So there's a compounding effect here because remember our overhead hasn't changed. Okay. But we're not done yet, are we, Josh? We want a little bit more than this. So the next thing we do is we get our average billable rate up and maybe we make a couple pricing tweaks, right? We productize some services. We work with Josh. We learn how to price based on value. We learn how to, you know, really charge more for what we do, get some better positioning. But the other side of this is we also get much more efficient because we templatize our process. We really dial in and get more efficient. We get some good technology, some automations in place. We maybe install some AI and we're able to go from $100 to $125 per hour of effort. Now this firm can do $7.5 million with this same team, which means we have a $4.5 million delivery margin, which is 60%. And look what happens to our profit. We are now at $3 million, which is a 50 Sorry, a 40% profit margin. Okay. And we have not even talked about lowering the cost of our team, our average cost per hour. We have not talked about cutting overhead at all. All we did was play with these two simple levers and we were able to dramatically increase the profitability of this business.

So good.

That's what's up. And we haven't even talked about valuation yet. How much more valuable is this business? Right. Versus this business significantly. Right, right. Hundreds and hundreds of percentage points. This is the difference between going and getting another job at the agency that bought you and retiring forever with generational wealth. Yeah, man. Right. So that's, that's the power of these simple building blocks in terms of utilization, ABR, average cost per hour, for just how powerful simple tweaks and paying attention to these what that can do to your business's profitability. So the next thing that I wanna dive into is the example that you talked about earlier, which is pricing at an individual project level. So here's the big idea with that is it always comes back to delivery margin. So let's go through the specific example that you gave. You said you, you help your clients develop an initial service offering. So walk me through the economics of that. What does it cost first and foremost?

So let's say you figure out a $750 a month cost to deliver, and that would include building out the website, writing the content, doing ongoing SEO, putting the tracking in place, you know, the entire program, right? And you would map this out on a spreadsheet and figure out it's different. Some people do it in-house, some people use white labels, some people, you know, have a virtual team. But let's just say you map it to $750 a month cost.

Totally. Yep. And then what are you charging for that thing? Or is the question, how much do we have to charge?

Yeah, let's just say you charge, you charge $3,000, but like you could say, how much, how much should you charge based on a $750 hard cost?

So let's look at the, um, minimum price formula. Okay, so this will answer the question of how much do I need to charge. And here's the fun thing about this, is this also works for any pricing model. So whether you're doing a flat fee, a value-based price, or you're even just pricing hours, this works for all of those different things. So the first thing we got to figure out is the delivery cost. Then we want to divide that by 1 minus our margin target, and then we want to add on whatever pass-through expenses we're going to incur, and that will get us to our minimum price. So in this example, uh, we would do the following math. So we would take our $750 That's our delivery cost, right? We would then divide that by 1 minus our margin target. Now here's the question is on a per project basis, what should the margin target be? Well, we know we wanna end up at 50% on the profit and loss statement. So we generally wanna add 20% to the per project level so that we can account for all the unutilized time that we're gonna experience, right? We're gonna also give ourselves a little bit of room to make some mistakes cuz let's be honest, things don't always go perfectly 100% of the time, do they? No. So my general, um, target here is we want a 70% plus margin when we sell something. So in this case, we, let's say we want to have a 75% margin. So we would go 1 minus 75%, or we would divide this by 0.25. So for this simple service offering, our minimum price is $750 divided by 0.25, which is $3,000 a month. Imagine that your pricing was exactly spot on. Right. So that's a really solid baseline. And then let's, let's imagine that on top of this, you were going to run $1,000 a month worth of ads and you would just add that on plus $1,000 for pass-through expenses. So that gets us to a total of $4,000 per month. So, so powerful, man.

The way you explain this is really next level. I have not seen it broken down in this way before. I think a lot of agencies will do this same program and try and sell it for $1,500 a month. And then they'll scale to 10, 20, 30 clients and they're like, where's the money? There's no profit in this. Like, is because the price, you know, you're putting too much in the program for the price that you're charging.

100%, right? And that 50% margin, it might seem like it's great, but it's really not enough. And there's two nuances that I wanna speak to while we're on this subject. One that we see all the time, and I'm sure you see this with the early agencies where the founder is still doing a lot of the work. Mm-hmm. They don't account for their own costs in this, right? Right. So really important thing is when you're getting to this $750, right? How we typically do that in practice, I'll just add a page here to break this down. So how we typically do this is the first thing we wanna write down is what are the roles? Mm. So think about this in terms of the hats that we wear, right? So one role might be you're a designer. Another might be that you're a project manager. Another might be that you're a strategist. Account manager, right? AM copywriter, right? So if let's say early days, you're like doing all of this stuff yourself. So what you want to basically figure out is what is the average cost per hour that you would incur if someone else was doing this work? And then you wanna estimate how many hours. So let's say this is $20, this is $30, like I'm just random numbers. Then you would think about how many hours and you multiply that. And this is how we're kind of getting to our cost per hour. And if you're doing all of this work still, you want to try to account for that so that your costs are based on what it would hire to hire someone else, what it would cost you to hire someone else so that when you get to that place where you're maxed out and you need to hire people, you don't have two problems. Mm-hmm. Problem number one, I can't afford to hire anyone. So now I have to raise my prices, change. Like that's a whole mess that you don't wanna end up dealing with because the second part of that problem, which is hiring people, training them, retaining them, having them, you know, like that's hard enough already, right? So let's not make it more hard, right? Right. By running into this brick wall and realizing not only can I not afford to hire people and I'm crazy busy, but now I also have to like figure that whole thing out. So this is how we arrive at our kind of delivery costs is that simple math. It doesn't have to be super scientific. And I encourage everyone to track their time in this way as well, so that once you've done 10 website projects on your own and you get to that point where you need to start hiring other people, you can start to understand where you can buy back your time and get the most value from that. And generally you're indexing towards the thing that has the lowest cost to replace combined with a really high share of your time that you can buy back. Mm-hmm. Right. So that's a big idea. And then the other big idea that people often don't consider is, especially in the early days when they're passing a lot of things through them onto third-party vendors, is they, they just think of markup as being pure profit. And they don't consider again, the time that they spend earning that money. Mm-hmm. So to give you an example of that, Let's say I had a project where I'm charging, uh, $20 grand. So this is the revenue. My pass-through here is, let's call it $15 grand. So I'm, let's say it's a website project, but I'm like outsourcing all of it. So this would give me an agency gross income of $5,000. And so a lot of people would think like, oh, you know, this is like $5,000 of pure profit. But what they don't account for is the fact that like, okay, but you're actually gonna end up spending like 20 hours getting on calls with the vendor, reviewing stuff, doing, you know, managing the client, doing some strategy, right? Like there's probably actually gonna be time that goes into managing this. And so this is important because let's say those hours cost you on average $30. You have a delivery cost here of 20 multiplied by 30, which is $600. So you still have a good delivery margin on this, but in a world where this actually takes you like 60 hours of time, your delivery margin is not good. And so I think a lot of people, when they, when they feel like they're passing a lot of the work through to a third party, they start to forget that they still have some internal time that they're spending, or they, they don't really pay attention to it. And then again, they run into unit economic issues because even though it's a small amount of time, it's still important to make sure that like this math still works. So two nuances on pricing that I think not enough people pay attention to but are important.

So, so good, man. So many great insights and takeaways here. I think typically when we talk profitability, it's just revenue minus expenses, looking at the P&L. Have you checked, you know, have you, have you checked your expenses? Um, lots of, lots of great insights and takeaways here. I wish we could go longer, but I know you've got a hard stop. Marcel, if people want to learn more about like you, your platform, how you guys work, what's the best place to learn more? And if you could talk high level about what that looks like, uh, yeah, you help agencies with this.

So I'll start with free stuff. Uh, if you head to parakeeto.com/toolkit, And, uh, I'll just bring a QR code up on the screen. If you wanna go much deeper on the stuff that we talked about today and get some free templates, tools, spreadsheets to help you do a lot of this math for yourself. Uh, it even right now includes free access to a beta, a software that we built for you to do all the modeling that I talked about earlier. So you could actually build your own model. You can get all that for free at perky.com/toolkit. So I would encourage everyone to start there. Um, also follow me on LinkedIn. I'm very active on LinkedIn and, uh, love nerding out about agency profitability there. And then in terms of how Periquito works with firms, um, there's a lot of different ways that that can look, but the ultimate version of this is we essentially step in and take care of all of this for you. So we start with an assessment, we build a model of your business, we tell you exactly why you're not as profitable as you want to be, what your max profit is, what the metrics are that you need to optimize to get there. We then install a forecasting system so you always know if you're on track or not. And then we actually measure all the financial and non-financial KPIs that I showed you and meet with you and coach you on them and start to show you all the different clients and projects and team members, how they're utilized, how they're performing. So you can really kind of get to the specifics and make progress towards improving your profitability. So in a, in a perfect world, that's how we work with clients at a high level and take care of all the onboarding and then actually work with you on an ongoing basis to make sure your data is clean. You understand what it's telling you. And you know actually what to do about it. So good.

Is there an ideal size agency that's a good fit? Like what, what's like, what size does an agency need to be to make this make financial sense typically?

Yeah. So for like the top end full service engagement with us, you generally have to be over a million in revenue, but we do have ways of helping much smaller firms that are, you know, a few hundred grand, let's call it $400,000 to $700,000 in revenue, um, get some of these basics in place. So you don't necessarily have to be all the way there to get some value from what we're doing. Um, so hopefully that helps everyone that's listening get an understanding of where we can be helpful. And if you're not at that level, I encourage you to start with the toolkit, and it should have everything you need to really get through the stage of growth that you're in now. Um, and there's also a course in there that's a fairly low cost that helps you go a lot deeper.

So good. So it's on the screen, but it's pearketo.com/toolkit, and then you can connect with Marcel on on LinkedIn. It's kind of his go-to platform, go-to place. Amazing stuff. Like, I'm really impressed. I love the way that you've broken this down. You're a master with drawing models. I love that. And just great insights and takeaways. I know our community is gonna love this and wanna, you know, connect with you further. Thanks for offering that toolkit as a resource. Anything you wanna say as we wrap up today? I know we've got a hard stop in like 30 seconds. Yeah.

Um, I'll just say that I know this can be pretty overwhelming. And for a lot of you, it's not the reason you got into business, right? You got into business because you love what you do. You love your craft. You're good at it. And so if there's two things that you take away from this, it's gross margin and gross margin or delivery margin and delivery margin. So just go try to understand what that looks like for you today and make sure that when you sell things, you're setting yourself up for really solid delivery margins. And as long as you do those, things, everything else should get a lot easier. So if there's nothing else, that's the one directive I would give you. So good.

Marcel, thanks for taking the time today. Thanks for sharing these amazing insights with us, and I look forward to talking with you more in the future.

Thank you for having me, Joshua Nelson. It was a pleasure.

If you've got follow-up questions, we will be watching the chat whether you're watching this live or on the replay. Uh, drop your questions. If it's for Marcel specifically, I'll make sure he sees it, and we'll see everybody next time.