Pandemic Aftershocks / Leading an agency in a time of high inflation (pt. 2)

In part 1 of this blog, I wrote about the current movement of inflation, in countries across the whole world — upwards 👆 — and about all the signs that suggest inflation might stay high for a substantial period. It may even result in a recession … or worse, a crash.

Leading an agency in a time of high inflation (pt. 1)

Inflation around the globe is escalating quickly. In all likelihood, the world is on the brink of an era of high inflation. A recession may even be on the horizon. This is completely new for virtually all agencies … and most agency leaders, too.

ConvivioJoe Baker

If you've not read that piece yet, pause here now and review that item.

This is a challenge for agency leaders because we have lived (and worked) through a long period of low inflation and grown accustomed to that as the normal business climate. Few agency leaders have any business experience, let alone leadership experience in a high-inflation economy. This lack of experience is a real problem.

In this 2nd part, I'm going to look at a series of practical things that agencies and agency leaders can do to prepare and plan for, and then survive, or even thrive, in an era of high inflation.

Let's dive in.

1. State of Play

To begin with, we need to know where we stand currently, what the threats are to our agency, and where we are at risk.

The Exposure

Begin by asking where the agency is vulnerable.

Agency finances are a delicate equilibrium between the income to the business and the costs it must serve.

• Income will be almost entirely from the rates paid for your services by your clients. You may have some other forms of income as well, from any products you sell (or productised services), say. Overwhelmingly, though, your income is defined by your rate card.
• In agencies, the largest cost is always the wage bill (and related costs for employing your team, like income taxes, National Insurance, pension contributions, healthcare benefits, etc.)  — you are part of the knowledge economy, and your services are delivered by virtue of the talent in your team. Other costs may be high as well — rent for your office space, professional services (accountancy, HR, legal or other things you may outsource), SaaS services, and so on — but they are likely to be an order of magnitude below paying salaries every month.

Your margins are defined by the squeeze between these two dimensions.

To understand where you are most vulnerable you need to assess several things about these aspects, then:

Your income risk exposure:

• When was the last time you raised your rates?
  • If you have not raised your rates in a while, your margins may be squeezed from the top end, where the money is coming into the business.
• Are you still carrying rate fluctuations from the pandemic?
  • Some agencies varied their rates as part of their pandemic response.
    • Some found their market had shrunk back and felt competitive pressure on rates in order to win business.
    • Some did so to help clients who were themselves under pressure.
  • How have your rates shifted through the pandemic? If you reduced them, have they recovered? If not, why not?
• Do you track your rate card with inflation?
  • Review the last 5 or even 10 years of your rates.
    • How often have you changed them?
    • What was the reason you changed them?
  • An annual review of your rates may be a sensible practice.
    • Tools like https://tradingeconomics.com/country-list/inflation-rate may be useful to you. Find your country in the list, and click through to find charts and tables to help you — select the 10Y option on the graph.
• Are your rates too low anyway?
  • It is extremely common in agencies to be very nervous about the level to pitch day rates.
    • You can tell that this is the case if every month you are anxious about the salary bill.
  • A good rule of thumb for a healthy day-rate is the 'rule of thirds' — the day rate should cover three elements in equal thirds.
    • One third pays the salary of the individual and the costs of employing them.
    • One third enables the business to run — that's everything else that goes on in the business so that you can all do your work for clients and have a good life: the management of the business, setting strategy, vision, focus, etc.; your marketing activity; your sales work; the HR, accounting and legal services you need; and so on.
    • One third contributes to profit
  • Assess your rate card against the rule of thirds.
    • Are your rates adequate to cover those three elements equally?

Your costs risk exposure:

• When was the last time you raised salaries?
  • Have your staff been on static wages for a while?
  • How have wages in your business developed during the pandemic?
  • Does your salary structure put you at risk of staff leaving unexpectedly?
    • Staff turnover is normal — it is only natural that talented people should move on in time, to broaden their experience and find new opportunities — but the reasons people leave should not be unexpected.
  • Is high turnover (and all the associated costs) a risk, or even a characteristic, of your business?
• Does inflation feature in your wage increase calculations?
  • When assessing annual increases, do you take inflationary pressures into account?
• Do you have a 'minimum acceptable salary' in your agency?
  • With large increases in the cost of living in countries around the world, it may be important to assess what you deem to be a minimum salary that is acceptable for people on your agency's team.
    • Are the lowest-paid roles in your business high enough that people in your team will not be having to make difficult decisions, between heating and eating, say, as the cost of living increases?
• Are you carrying the weight of an expensive office?
  • It is often the ambition of agency owners to have a posh office for their business.
  • Ambition, though, can drive that toward extremes all too frequently — taking on a high rent for a particular location, or glamorous level of decor, fixtures and fittings.
• Large professional services costs?
  • Are you paying large bills for accountancy, HR, legal or other external professional services?
    • Is that necessary? Can that be streamlined?

Analyse the Risks

High inflation will have a major impact on an agency's profitability. Even moderate inflation will.

By way of an example, if inflation hits 10% (which it seems likely to later this year … and conveniently 10% makes the numbers easier to see in an example), and if it stays there for a while, then your profit margin could be wiped out within a year.

* Assumes income remains constant
** Assumes costs increase by 10%

Example via Simon Collard. See also Simon's video on 'The Agency 10% Inflation Challenge'

So, take stock with some hard questions:

On your agency's talent:

Currently (April, 2022), the UK inflation rate is 7% (and similar rates in other advanced economies). If you give staff an 8% pay increase in 2022, that will only feel like a 1% pay increase in real terms. Not much. And some are projecting inflation to increase to 10% or more.

If that comes on the back of several years, through the pandemic, furlough, etc., of static wages, that will be tough to take.

That may lead to distraction, or to low motivation levels — both can have serious impacts on productivity, further dampening your income-generating abilities.

That, of course, then increases the likelihood of staff leaving to take positions in organisations with deeper pockets, those who can pay more than you, who can pay that 8%, or 10%, or even much higher — businesses with VC funding, say.

On your key costs:

What would a 8%, 9%, 10% or more increase in costs for the services and facilities you rely on look like for your agency? — Rent or other office costs? Professional services? Freelancer rates? Consultancy fees? SaaS services? Other suppliers you depend on? etc.

• Are there any that you can scale back?
• Could you do it quickly at some point in the (near) future, if you need to?
• Can you do that now? Reducing costs on lower-priority services now may help to build up some vital reserves.

Plan and Prepare

Once you know where you're most exposed and what the risks are in those areas, it's time to make some plans and prepare for what's ahead.

"By failing to prepare, you are preparing to fail."
- Benjamin Franklin.

Plan by Running Scenarios

In all of your planning you should aim to model your forecasts on different scenarios of what your clients might do.

You may like to create simple spreadsheet, one that's useful enough to portray what could happen in various conditions, but with the emphasis on simple — you shouldn't be distracted by the elegance of your model from what it is you're trying to do, to understand your potential futures.

With your scenario modelling, you're looking at questions like:

• How does this scenario affect profitability and cashflow?
• What's the best case?
• What’s the worst case? Is there actually a worse case still that we're not letting ourselves look at properly?
• What is the most likely path?

With those scenarios worked through and in the front of your mind, it's time to think about how you might take action.

Strategies for Raising Your Rates

You will need to raise your rates. It is inevitable.

What matters, then, is that you know how you're going to do that. It won't be easy, in all likelihood, but it's important to remember — yes, your clients are also suffering from inflationary pressures, but because of that they will understand when you broach the subject.

Here, then, are some strategies for how you might do that, roughly in descending order of preference.

The whole hog

The easiest thing for you is to just go the whole nine yards — take your current rate card and increase it all, across the board, by 10% (or whatever is the correct amount for you in line with inflation).

Go for it, if you're able.

Consider

• How will you announce this to clients?
• What do existing contracts say? How are they tying you in or limiting your freedom on this issue?
• Who is the best person to have the conversation with clients?
• How will it be handled?

Reaction?

Clients may well try to negotiate with you so that you both take some of the heat, that you both bear a portion of the increases. Try to resist, politely but firmly. They should be increasing their rates also, so it shouldn't be up to you provide padding and help them increase their profitability this way.

Rate escalator

Maybe you want to offer an ‘escalator’ in increases to your rate.

In other words, you may offer to not increase all 10% (or whatever) in one go, but stepped in phases.

Consider

• Is this something to offer to some clients only, or to all clients?
• What is the impact on you if your costs are not increasing in steps? When inflation is high now but your increases are in the future, what squeeze will that create for you?
• Does this approach need to be an above-inflation increase overall to compensate for losses in the short-term?

Blended rate card vs detailed rate card

If you don't already, you may consider a rate card that differentiates between your team members.

Senior staff should definitely be billed out at a higher rate than your standard day rate. That means your design leads, technical architects, project directors, any of your Senior Leadership Team who get involved in client projects, and so on.

That will give you two rates on your card.

You may also consider a third rate, for junior team members.

A blended rate card — where the hourly rate is a blend of the mix of the team — will likely give you lower margins, but you might consider it.

New business only

This is maybe the easiest to implement, and therefore the one you can do immediately.

• You can do this for pitches that you win.
• You can do this for negotiations on contracts, or contract extensions.

It may also be the most problematic if you are working on long projects with large intervals between opportunities for renegotiation.

Client or project review

Assess each of your current clients and client projects and try to understand the margins in the work you're doing.

• What is the overall current margin of that work? Give it a performance scoring.
• Is the scope reasonable? Is there scope creep? I.e. are extra things being brought into the scope without extra billing?
• How was your estimation? Did you under-estimate the work that would be needed?
• Are you over-delivering on the schedule of work, over-servicing the client?
• Are the project outcomes matching both your expectations and the clients?
• What is the client like over all? Are they a high-maintenance customer that requires lots of extra non-billed time to handle them properly?
• Are there other reasons why the work is rendering low margins? The team configuration, for instance? Other inefficiencies?

This should act as a detailed litmus test for the value the client or project has for you, and for what actions you might take — to continue the work, or seek to drop it in favour of work with higher margins.

If you give an overall score — probably beyond the profit or margin from the client or project, but rather a blended score from each of the points above — then you can create a chart of your existing clients. Then you can see those that you may need to drop.

Reduce scope

Reducing scope is a difficult question to discuss with clients. You may just need to bite the bullet with some that you've identified in the review above.

Strategies for Managing Your Costs

You will need to plan also for what will happen to your margins between rising costs and your client rates. That means developing some strategies for managing your costs.

Your Reserves

Every business needs to have financial reserves. Now is the time to reappraise them

• What financial reserves have you got?
• How will they help you ride out any economic storm?

Now is the time to do what you can to increase financial reserves.

• Are there areas where you can reduce spending in order to build up your reserves? You might examine services you can cut, for instance, capital expenditure that can be reassessed or postponed, or marketing campaigns that can have a reduced scope, for instance.

If your finances are good now, it’s the best time to arrange lines of credit that might be needed if you find yourself in choppier waters.

Talent Costs

As I said above, the costs of your team are undoubtedly the biggest ones for you. Without your talented team you will not be able to deliver work for clients. But, people need to be paid, of course. And there are costs associated with staff turnover — the loss of knowledge and skills; the effort to recruit; the time taken to bring someone on board and get them up to speed; and so on.

In the natural turnover in the business, you have an opportunity to re-evaluate your position on team costs.

• Is it better to have someone on staff in that role? Would it be more appropriate to use a freelancers in that position, balancing the positives and negatives of using freelancers?
• Would it be more efficient to have someone remote in that role? What are the benefits? What are the downsides?
• Would it be more efficient to have someone in that role part-time? Or job-sharing? What are the benefits? What are the downsides?

Committed Costs

You might need to take a thorough reappraisal of the costs that you're committed to.

If you have it, then office space is a central part of that.

The pandemic has given a jet-pack to the remote working revolution. You may need to re-evaluate your commitment to your office space. Does it really make that much difference to the way you work as an agency? What have you learned from remote working during the pandemic that you can make the most of to control your committed costs?

In times of uncertainty, there is enormous value in keeping your options open. This is as true with office space as it is with anything else.

• If your office lease is coming up, for example, consider whether (based on your scenarios) there is greater value at looking for a slightly more costly shorter-term lease than a cheaper longer-term one
• Or, there may be value in giving up a full office altogether and renting space in a co-working centre.

In the Event of a Recession …

With inflation rising, if policy-makers and central banks don't take careful but decisive actions, or delay taking action until it's all getting too late, then recession is a real risk.

How that affects you and how you act will take some very serious thought. It's not something of which many agencies have much experience.

If a recession does come, you will need to think about:

• How will that affect each of your clients? How are they likely to behave?
• Is the work you do for each one a nice-to-have or essential?
• If the former, how could you make yourselves more essential?

Now is the Time for Agencies to Shine

The reality is that agencies exist for times just like this — Clients need agencies who can lead them through these rocky patches. Indeed, many agencies are started in times of recession, in part, because the opportunities are clearer than ever.

Now, then — as we're looking forward at the highly-likely future of high inflation or even recession — now is exactly the time to refresh yourself on what an agency is for.

What are agencies for?

Here’s an existential question to start the week. Why do agencies exist? Why do clients need them? My answer is best summed up by this diagram: Client organisations are generally boxy and square, with hard edges. They find it very difficult to change shape and adapt. The world, conversely, is

ConvivioSteve Parks

It’s key, then, in all your scenario planning, in all the strategies you develop to manage your business through an era of high inflation or even recession that you are prepared to position your agency well. In your relationship with your clients, it's vital to move away from being a commodity to being more of a trusted adviser.

You need to be coming up with the ideas of what they can do, rather than waiting for them to issue you with a brief. What activities can you do (events, workshops, training, consulting, content marketing) to position yourselves more as the knowledgeable wise experts than just guns for hire?

If you do that well, then you just may be able to ride the wave in a golden age for agencies.

A golden age for agencies

These times after a crisis, when the world is being remade, are when clients need agencies most.

ConvivioSteve Parks