Managing a digital marketing agency requires you to keep an eye on several things at once. You must verify your team is meeting its goals, campaigns are reaching the target audience, and your clients are satisfied with your work.
But what about profit margins? Your last target is to take a risk and see low numbers on your agency’s profit reports. You want to gain money, not lose due to pricing issues, poor campaign performance, and any other problems that might arise.
Based on this, let’s walk through the profit margin for digital agencies’ path. This article will tell you what it is, how to calculate it, and more. Happy reading!
Understanding Profit Margins
Profit margins are a financial metric that agencies use to know their company’s profitability. This metric helps agencies understand how they’re generating profit from revenue when compared to the costs of service delivery.
There are two types of profit margins: gross and net profit margins.
Gross Margin vs. Net Margin
Once you know what profit margins are, it’s crucial to understand the difference between gross and net margins. Both are essential to an agency’s healthy profit margin since they cover different aspects of profitability.
Gross Margin
An agency’s gross margin is the revenue left after deducting the direct costs related to the services the company provides. This type of profit margin covers the expenses of the team directly involved in the projects, any tools and software used for the campaigns, and, if necessary, outsourcing resources.
To know your agency’s gross margin, you must subtract the direct costs from the revenue and divide the result by the earnings again. Then, multiply the resulting figure by 100 and express it as a percentage. GPM= (Income-direct costs) /Income *100= %
To view this formula into action, imagine your agency has a $150,000 revenue and a $40,000 direct cost expense. Then, by adding the data needed, it should look like this:
Gross profit margin= ($150,000-40,000) / $150,000 *100 =
GPM = $110,000 / $150,000 * 100 =
GPM = 73.3%
If you want to know if your gross margin is within a healthy range, keep reading!
Net Margin
Also known as operating margin, net margins combine all the agency’s costs. Employees’ salaries (even if they’re not directly involved in the projects), overhead costs, utilities, rent, you name it. Anything not directly associated with direct costs is included here, too. This profit margin’s main goal is to assess the agency’s profitability after covering all the expenses it has.
You calculate net margins by subtracting direct and indirect costs from the revenue, then divide the result by the income and multiply it by 100 to express the result in a percentage.
NPM= (Income-Total costs) / Income * 100= %
So, working with the same example we did before, we got a revenue of $150,000, and let’s say total costs are $70,000. Here’s what the formula will look like:
NPM = ($150,000-$70,000) / $150,000 * 100 =
NPM = $80,000 / 150,000 * 100 =
NPM= 53,3%
By keeping these margins in sight, you ensure your agency’s profitability is high, and your margins are within healthy ranges. Ensuring your company has a healthy financial outlook is crucial to keeping it going.
Why Profit Margins Matter
It can be complicated to keep up when talking numbers, formulas, and calculations. However, knowing your agency’s margins is crucial to understanding your company’s profits.
While other companies might know exactly what their profit and revenue look like, digital marketing requires a deeper study into their numbers. Furthermore, marketing agencies often run into unexpected situations that, in turn, become unforeseen expenses.
While you might have more than $3,000 with a client in one month, that figure could vary the following month due to some requests and outputs your client has. It is then that profit margins come in handy to help you deal with the uncertainty of these cases.
A HubSpot research showed that within more than 750 agencies, only 49% did revenue per client tracking. And a surprisingly low 24% did a revenue per employee tracking. This research showed that the agencies that tracked their clients’ revenue had higher profit margins.
So, keep an eye on your clients’ revenue to control your agency’s margins.
Calculating Profit Margins
Now that you know the formulas and the importance of these margins, take a deeper look into how to calculate them.
Set Hourly Costs per Team Member
The first step to calculating your marketing agency’s profit margin is knowing the cost of your team members per hour.
Regarding your full-time team members, take the following items into account:
- Gross salary
- Health insurance and other employee benefits
- Miscellaneous team member expenses: trips, equipment for remote teams, etc.
After this, you’ll need to calculate how many hours per year they’ll have available to work. All you have to do is calculate the total available hours in the year (forty hours x fifty-two weeks) minus the national holidays, vacation weeks, and paid leave weeks.
Then, calculate your team’s cost per member by dividing their yearly costs by the total available hours. These calculations will help you see if your group is meeting the standard of your expenses.
Know Your Operational Costs
Your operational costs include an estimate of your overall expenses per year. These should include:
- Office renting and connectivity costs.
- Utility costs like water and electricity bills.
- Any monthly marketing subscription you use, be it email marketing or any other paid services.
- Administrative expenses.
- PPC Ads.
- Maintenance costs.
Learn About Your Overhead per Hour Cost
The next step to take is to calculate the billable hours per year. Once you’ve figured out the amount of available hours your agency has, you must multiply that number by the number of people on your team.
For example, if you have six people on your team, and your available hours are 1,920, your formula would be 6 x 1920. This calculation would throw a result of 11,520 billable hours.
To know the overhead cost per hour, divide your total overheads by the total billable hours.
Overhead cost per hour = Total overheads / total billable hours = $
So, if your total overheads are $150,000 and your billable hours are 11,520, your cost per hour is $13,02.
Calculate Margins for All Your Clients
You will have to calculate your gross and net margins for all your clients. To calculate gross margins, simply subtract your gross sales from the total hours worked by the employee cost per hour.
Gross margin = (Gross sales) – (total hours worked * employee cost per hour) = $
Picture this: an employee who earns $35 per hour works 50 hours on a project. The project has a contract value of $7,000, and your formula would look like this:
GM = ($7,000) – (50 hours * $35) =
GM = ($7,000) – (1,750) = 5,250
To calculate net margins, follow this formula:
Net margin = (Gross sales) – [Total hours worked * (Employee cost per hour + overhead cost per hour)] =
Using the figures of the examples above, this would be the data for your formula.
Gross revenue = $7,000.
Total hours = 50.
Employee CPH = $35.
Overhead CPH = $13,02.
Which would give us this calculation:
Net margin = ($7,000) – [50 * ($35 + $13,02)]= $4,599
Of course, you’ll have to change the employee cost per hour since each member will likely have different rates. This makes the calculation longer, but the process does not change per calculation.
Profit Margins for Digital Agencies
As you calculate your digital marketing agency’s profit margins, you’ll learn that agencies and clients rarely agree on what the margin should look like for marketing companies.
For example, many customers believe a 14% profit margin is acceptable, whereas agencies amount to 17%.
No matter what you agree with your clients, ensure your profit margin is not a single digit. If it’s past 20%, things are going great for you.
My Profit Margins Are Too Low, What Do I Do?
If you find your profit margins are too low, consider taking these measures:
Consider implementing a value-based pricing method
Potential clients might find themselves inclined if they find you don’t charge per cost but based on the value you’ll bring into their businesses. To calculate your value-based pricing, implement this formula:
Value-based pricing = Number of new customers * 10% of Customer LTV
Have a Longeval Capacity Plan
The idea of growing speedily sounds attractive, right? Well, the truth is that it sounds amazing, but in reality, it could cost you a couple of thousand dollars by needing outsourcing (or far more difficult situations like losing clients altogether). Your team could be affected too, so consider creating a long-term capacity plan. Here’s how to create one:
- Make a capacity estimation: Consider dissecting your team’s billable hours. You want to gain insights into your team’s billable time vs. the ones they spend on non-billable time.
- Make a capacity utilization calculation: All you have to do for this item is follow this formula Capacity utilization (%) = Available hours – Billed hours / Total available hours.
- Focus your attention on predictable revenue channels: Many agencies have changed how they do business. Some have implemented monthly billing, which has become an excellent option for agencies and clients since it offers a stable cash flow for agencies and a steady service for customers.
- If it doesn’t work, cut it off: You want to ensure your agency has the best processes within its rooster. If there’s a process that isn’t boosting your profitability, it’s fruitless to keep it around.
Frequently Asked Questions
What Is the Most Profitable Business Model in Digital Marketing?
The retainer business model tends to be the most profitable one in digital marketing. By creating a monthly billing plan, agencies see a constant influx of revenue, and clients tend to find this model more appealing than others, as it can act as a trial in the beginning.
What Are the Top 3 Niches for Digital Marketing?
While there are no established top 3 niches for digital marketing, it is known that email, social media, or SEO marketing are some of the most viable and highly profitable niches. Emails remain one of the most popular communication channels globally. Social media continues to gain protagonism in our daily lives, and companies now understand that being noticeable on search engines is crucial for business and earnings.
Which Digital Marketing Channel Has the Highest ROI?
A poll done by SearchEngineJournal resulted in organic search as the winner of the highest ROI digital marketing channel, with 49% of votes. Additionally, 19% stated that paid practices generated the biggest ROI for their websites.
Wrapping Up
Knowing how to calculate a digital marketing agency’s profit margin is crucial for its success. While it isn’t a simple process, it is an essential one. It may take practice at first, but with patience and perseverance, it can be done. However, don’t be afraid to ask for expert help if you need to.
We hope this article helps you measure your agency’s margin and leads you to victory. Thank you for reading!
Read More: Why Your Business Needs a Digital Marketing Agency
