A Complete Guide to Calculating Agency Margins (+Free Calculator)

A Complete Guide to Agency Margins

QUICK SUMMARY:

Understanding an agency's profit margin sheds light on the effectiveness of profit generation from revenue, accounting for service delivery costs to clients. Agencies primarily focus on two types: gross profit margin and net profit margin. Calculating these margins is challenging yet vital to grasp the actual profits an agency retains. This article guides on accurately calculating profit margins, evaluating their adequacy, and adjusting pricing strategies to ensure a profitable agency.

Running an agency often means wearing far too many hats, juggling clients across verticals, and dealing with a perennial talent shortage. The last thing you want in the mix is dealing with low profit margins due to pricing issues, inefficient processes, and high expenses.

The question now is: how exactly do you calculate profit margins? And if your margins are too low, what can you do to increase them? What’s a healthy profit margin in the digital marketing industry?

As a digital marketing agency, understanding and maximizing your profit margin is crucial for long-term success. In this article, we will explore the key factors that influence profit margins in the digital marketing industry and provide strategies to optimize your agency’s profitability.

What Are Profit Margins?

Profit margins are a crucial financial metric that digital marketing agencies use to assess the profitability of their operations. They provide insights into how effectively an agency is generating profits from its revenue by considering the costs associated with delivering services to clients, including the importance of accurately calculating and reviewing net profit margins to adjust and improve profitability.

There are two key types of profit margins that digital marketing agencies typically analyze: gross profit margin and net profit margin.

Gross Profit Margin

The gross profit margin represents the percentage of revenue that remains after deducting the direct costs directly associated with providing services. These costs typically include expenses such as employee salaries directly involved in client projects, software and tools, and any outsourced services related to campaign execution. To calculate the gross profit margin, you subtract the direct costs from the revenue and divide the result by the revenue, then multiply by 100 to express it as a percentage.

For example, if a digital marketing agency generates $100,000 in revenue and incurs $60,000 in direct costs, the calculation would be as follows:

  • Gross Profit Margin = (Revenue - Direct Costs) / Revenue * 100

  • Gross Profit Margin = ($100,000 - $60,000) / $100,000 * 100

  • Gross Profit Margin = $40,000 / $100,000 * 100

  • Gross Profit Margin = 40%

A higher gross profit margin indicates that the agency is effectively managing its direct costs and generating a healthy profit from its revenue, driving strong financial performance.

Net Profit Margin

The net profit margin takes into account all the operating costs incurred by the agency, including both direct costs and indirect costs such as employee salaries not directly involved in client projects, overhead expenses, marketing expenses, rent, and utilities. The net profit margin reflects the overall profitability of the agency after considering all operating expenses.

To calculate the net profit margin, you subtract all costs (direct and indirect) from the revenue and divide the result by the revenue, then multiply by 100 to express it as a percentage.

For example, if a digital marketing agency generates $100,000 in revenue and incurs $75,000 in total costs (direct and indirect), the calculation would be as follows:

  • Net Profit Margin = (Revenue - Total Costs) / Revenue * 100

  • Net Profit Margin = ($100,000 - $75,000) / $100,000 * 100

  • Net Profit Margin = $25,000 / $100,000 * 100

  • Net Profit Margin = 25%

The net profit margin provides a comprehensive view of the agency’s profitability, accounting for both the direct costs of service delivery and the overall operational expenses.

Analyzing and monitoring these profit margins over time allows digital marketing agencies to assess their financial health, and make informed decisions about pricing strategies, cost optimizations, and business growth initiatives.

By striving to improve and maintain healthy profit margins, agencies can ensure long-term sustainability and success in the competitive digital marketing industry.

Why Profit Margins Are Important

Calculating margins for a digital agency can be notoriously difficult. But it's important to understand how much money your agency actually sees in the profit column at the end of the day.

While eCommerce and SaaS companies typically know exactly how much it makes for each product sold, digital agencies often have to deal with unforeseen expenses and client budget changes.

The account that made you $2,000 this month at a 20% margin sounds great! But a couple of revision requests from the client and your profit drops to $200. Spend 2.5 hours putting together their client report at the end of the month, and that profit drops even further.

In this uncertainty, the first thing you need to do is to calculate your own margins.

Surprisingly, in a survey of 750+ agencies, only 49% said that they tracked revenue per client. Even fewer (24%) tracked revenue per employee.

Marketing KPIs

The same survey found a correlation between profit margin and revenue tracking. Agencies that tracked revenue per client had higher profit margins than those that didn't.

Bar chart showing profit margin by KPIs tracked

The first thing you need to do, therefore, is to track your profit margins for each client. Then, you’ll want to communicate how your campaigns are contributing to your clients’ overall revenue.

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How To Calculate Your Profit Margins

Now that we know why it's important to understand the profit margins that are behind the curtain, let's look at a step-by-step process for calculating them.

Step #1: Determine Hourly Cost per Staff Member

Your first step should be to calculate the hourly cost for each staff member.

For your full-time staff, this should include:

  • Gross wage

  • Pension (if applicable)

  • Insurance & other benefits

  • And other expenses, such as equipment, travel, and training

Next, calculate how many hours per year they're available to work. To do this, simply calculate the total available hours in the year (40 hours per week x 52 weeks) minus the number of paid holidays, sick leave days, and national holidays.

If you assume a 40-hour work week and two weeks each of vacation and sick leave, you get 1,920 total hours of available work.

To calculate your hourly staff member cost, simply divide their total annual cost by the total available work hours. For instance, an employee with a $70,000 salary, $12,000 in benefits, and a $4,000 budget for travel and training costs a total of $44.79/hour ($86,000 / 1,920 hours).

That's a lot of money to waste on tasks that are not driving the bottom line.

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Step #2: Calculate Operational Costs

To calculate your agency's operational costs, you need to estimate your overall expenses for the year.

Your operational costs should include every single foreseeable expense, such as:

  • Renting office space or connectivity costs and tools for remote workers

  • Associated maintenance costs (e.g., monthly cleaning services for the office)

  • Utility costs (e.g., electricity, water, and internet bills) 

  • Monthly marketing subscriptions (e.g., an email marketing service like Mailchimp, or a CRM such as HubSpot

  • PPC advertising efforts to boost your agency's brand presence (e.g., Facebook Ads, Google Ads

  • Administrative costs (e.g., purchasing office stationery) 

  • External support costs, such as freelancers or suppliers

Agency Tip: If your agency uses suppliers or freelancers when fulfilling client projects, use this same procedure to calculate their hourly costs. Factor these costs into your profit margins for a more accurate picture.

Step #3: Calculate Cost per Hour for Overheads

In the next step, calculate your total billable hours for the year.

For example, if you have 5 employees, you get 9,600 billable hours for the year (@ 5 x 1,920 hours).

This effectively means that you have 9,600 billable hours to pay for your overheads.

You can calculate your cost per hour for overheads by dividing total overhead with total billable hours.

Overhead costs per hour calculation

For example, if your overheads are $192,000, your cost per hour would be $20 (@ $192,000/9,600).

Step #4: Calculate Gross and Net Margin for Each Client

The gross margin is easy enough to calculate – just subtract your total revenue by total hours worked per employee and cost per hour of the employee.

Gross margin calculation

For example, if an employee costing $30/hour works 100 hours on a client project, your total cost is $3,000. Assuming a contract value of $6,000, your gross margin is $3,000 (@ $6,000 – $3,000) - or 50%.

To calculate net margin for a client, you need to add your overhead costs/hour to employee cost/hour.

That is:

Net margin calculation

In the above example, your net margin would be:

  • Gross sales = $6,000

  • Total hours worked = 100

  • Employee cost per hour = $30

  • Overhead cost per hour = $20

  • Net margin = $6,000 – (100 * ($20 + $30)) = $1,000

Expressed as a percentage, your net margin is $16.67%.

In reality, you’ll have employees working at different rates and a variety of recurring and one-off clients. This makes the calculation more complicated, but the overall process remains the same.

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Using a Profit Margin Calculator

Thankfully, you don't have to go through the entire process yourself; there are plenty of profit margin calculators to help you out. And we've made one just for agencies!

Start with this profit margin calculator. Just make a copy of the Google spreadsheet to plug in your numbers!

Download Your Agency Profit Margin Calculator

Keep a running, interactive calculation of your entire book of business for your agency.

Marketing agency profit margin calculator spreadsheet

This calculator works wonderfully well for larger agencies with a wide variety of clients and employees. Instead of the tiered "levels" used in the spreadsheet, you might just have 3-4 employees at the same rate.

Modify the spreadsheet accordingly. These calculators will help you figure out your profit multiple, annual salary, and head-hour rates.

What Is the Average Profit Margin for a Marketing Agency?

As of 2023, the average profit margin for marketing agencies in the United States is around 10%​​. This margin can vary widely depending on factors such as the size of the agency, the services offered, overhead costs, and operational efficiency. Some agencies report profit margins in the range of 6 to 15 percent​​, while others may have higher margins based on their specific business model and operational strategies.

Another interesting note is that, when it comes to agency margins, what's acceptable to clients, and what's acceptable to agencies themselves are seldom the same.

Case in point: according to one study, clients believe a 14% profit margin is acceptable. Agencies, on the other hand, see a 17% margin as more acceptable.

Bar chart showing the difference in acceptable agency profit margin by client and agency.

In HubSpot's survey of digital agencies, a majority of companies were either not sure of their profit margins, or reported margins between 11 and 20%.

A bar chart showing profit margins.

As a rule of thumb, margins in the single digits are probably too low to run a viable business.

Anything above 20% means you're doing great. Beyond that and you're doing spectacularly well.

What To Do if Your Profit Margins Are Too Low

While we'd all love to make 20%+ margins, unforeseen costs, unpredictable clients and an uncertain business environment can eat into your profits.

In such a situation, there are a few things you can do to boost profit margins:

1. Switch To Value-based Pricing

Most agencies use a cost-based pricing model. They calculate their cost for each resource, add their profit margins, and quote a price.

The problem with this model is that it creates an adversarial relationship with your clients.

If you're an agency veteran, you already know this – clients will question you on everything from your efficiency and quality to your expertise and personnel selection.

One way to solve this problem is to shift from a cost-based to a value-based pricing model.

This essentially means that instead of charging clients on your costs, you charge them based on the value you bring to their business.

There is a simple formula for calculating your pricing based on value:

LTV calculation

An Example of Value-based Pricing

If you bring in 10 new customers each month with an average customer LTV of $10,000, you've just helped the client make an extra $100,000.

And if you were to charge even 10% of that, your pricing would be $10,000.

It doesn't matter whether you spent $1,000 or $5,000 on acquiring these customers, what matters is the value you provide your clients.

Of course, this is a big shift in the way you structure your pricing. It's also radically different from the pricing structure your clients are used to.

However, if you can convince your clients to adopt this model, you'll never have to struggle with low margins.

As MIT Sloan Management Review notes, value-based pricing is the "most preferable way to set new product prices or to adjust prices for existing product", and that "customer value-based pricing is especially relevant in highly competitive industries".

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2. Create a Long-term Capacity Plan

On paper, this is a problem every agency would love to have – growing so fast that you can't keep up with the demand.

In reality, if you don't have a capacity plan to deal with rapid growth, you'll end up outsourcing work or even losing older clients.

Not to mention the effect on your team's morale of pulling far too many all-nighters to meet deadlines.

The result? Lower profit margins and poor hiring practices.

One way to solve this problem is to create a capacity plan.

Here's how you can do this:

A. Estimate Capacity

Start by auditing your existing staff and estimate your total billable hours for each service type. This should include their total billable hours each week minus their non-billable hours (i.e., time spent on administrative tasks).

You might have a table like this:

Billable hours spreadsheet

This gives you a fair idea of your existing capacity and what kind of talent you need to hire for future growth.

B. Calculate Capacity Utilization

Dig through your data to see how much of your existing capacity you're currently utilizing for each role.

Pricing model equation

Doing this for each month will tell you which roles are being fully utilized and which areas need more attention.

For example, suppose your data shows that you bill for 60 hours of design work each week. However, your existing capacity is 90 billable hours/week, which means that 30 hours, or 33% of your capacity is being unutilized.

In contrast, if your data shows that you consistently bill for 100% of your copywriting work available hours, it's probably a good sign to hire more copywriters to meet future demand.

Do this for all your roles and you'll have a good idea of projected demand and your existing capacity.

3. Focus On Predictable Revenue Channels

It's estimated that 70%+ of US agencies rely on per-project or hourly billing pricing.

The problem with this approach is that it creates a "feast or famine" cycle. One month you're drowning in work, and the next there's a sudden glut.

This affects not only your cash flow and profit margins, but also your team morale and the long-term financial health of your agency.

To solve this problem, shift focus to more predictable revenue channels such as marketing services with recurring billing or selling products (both digital and physical).

Omelet, an LA-based digital agency, experimented with a physical product – a brand of peanut butter named "Betsy's Best".

Betsy's Best website

Similarly, there has been a shift towards subscription billing among digital agencies to create more predictable, monthly recurring revenue streams.

For example, WebPageFX, a leading Pennsylvania based digital agency, offers monthly plans for nearly all its services.

SEO pricing packages

This shift towards subscription billing has been facilitated by the rapid adoption of SaaS tools among enterprise customers.

Since companies are already used to paying a flat monthly rate for software, subscription billing for services doesn't seem like a radical idea.

It also helps that the subscription billing model is both agency and client-friendly. Clients don't have to worry about agencies billing them for non-productive hours, and agency employees don't have an excuse to slack off and inflate work hours.

This also ties into the value-based pricing model discussed earlier. With recurring billing, you have more room to deliver the best possible solution and not necessarily the solution that will take the most man-hours—a win-win for both clients and agencies.

4. Reduce Inefficient Processes That Reduce Profitability

To ensure that your business is profitable, you must have the right agency processes in place. Without a systematic approach, you'll end up using your valuable resources for manual, time-wasting tasks or taking on more than your agency can realistically handle.

For example, say your agency currently has a roster of ten clients. It’s a relatively manageable number of clients, and all seems well for a while. It’s tedious to copy and paste analytics into a manual spreadsheet when the monthly reporting period rolls around, but your staff has no issues so far.

Business starts booming and in a short space of time, you’ve onboarded twenty new clients. It’s great news! But now, your staff spends countless hours with client reporting and things are slipping through the cracks. After all, they’ve still got project execution and other things to attend to.

As a result, client retention suffers, and guess what? So does your agency’s profitability (and brand reputation).

To avoid these mishaps when scaling, invest in the right infrastructure such as an automated reporting tool like AgencyAnalytics. That way, you won’t have to worry about making errors, taking on more than your agency can handle, or losing out on profit.

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Summary and Takeaways

If you find that your marketing agency margins are too low (< 10%), try the three strategies outlined above to shift to better capacity utilization and more profitable pricing models.

Here are the top takeaways to consider:

  • Average agency margins are in the 11-20% range. Single-digit margins are a sign of trouble.

  • Use a profit margin calculator to figure out your margins.

  • If your margins are too low, adopt value-based pricing, switch to recurring billing and create a capacity plan.

Calculating your agency margins is the first step in raising your prices and profits. By tracking profit and revenue per client and per employee, you'll not only have a better picture of your company's financial health, but will also be able to spot areas of improvement.

Create custom marketing reports that streamline your agency's processes while showing your agency’s value each month. Sign up for a free 14-day trial today!

Christian Sculthorp

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Christian Sculthorp
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