Episode 40

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Drew McLellan is the Top Dog at Agency Management Institute. He has also owned and operated his own agency over the last 20-years. And all through the year, he straddles the fence of working in his agency and working with 250+ small- to mid-size agencies in a variety of ways.

AMI works with agency owners by:

  • Leading agency owner peer groups
  • Offering workshops for owners and their leadership teams
  • Offering AE bootcamps
  • Conducting individual agency owner coaching
  • Doing on-site consulting
  • Offering online courses in agency new business and account service

Because he works with a lot of agencies every year — he has the unique opportunity to see the patterns and the habits (both good and bad) that happen over and over again. He has also written two books and been featured in The New York Times, Entrepreneur Magazine, and Fortune Small Business. The Wall Street Journal called his blog “One of 10 blogs every entrepreneur should read.”



What you’ll learn about in this episode:

  • Gross Billings vs. Adjusted Gross Income
  • How agencies lose money when pricing
  • Why scope creep leads to little or no profit
  • Why your agency needs to issue change orders and how to turn this into a process
  • Why you need to use the one page business plan
  • How to know if you need a better new business plan (hint: you probably do)
  • Why you need a tax advisor not a tax preparer


The Golden Nugget:

“Teach everyone in your agency what makes/costs the agency money every day.” – @DrewMcLellan Click To Tweet
“New business is like investing. You need to always be working on it.” – @DrewMcLellan Click To Tweet


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Ways to contact Drew McLellan:

We’re proud to announce that Hubspot is now the presenting sponsor of the Build A Better Agency podcast! Many thanks to them for their support!

Announcer: If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Build A Better Agency, where we show you how to build an agency that can scale and grow with better clients, invest in employees, and best of all, more money to the bottom line. Bringing his 25 plus years of expertise as both an agency owner and agency consultant to you, please welcome your host, Drew McLellan.


Drew McLellan: Welcome to another episode of Build A Better Agency. Today’s episode is one of my solocasts. That’s where it’s just you and me. We’re talking about a topic that I think needs to be on your radar screen. No guests. Just you and me talking about something that I believe is pivotal to agency ownership and being successful in that in a way that makes you want to go to work every day. Today, I want to talk about mistakes that agency owners make that cost them money. At the end of the day, the reason why you have an agency is because you are trying to make a living.


  You’re trying to take care of yourself and your family, take care of your employees. And no matter how hard you work and no matter how well you serve clients, when you don’t make money, it’s pretty tough to sustain the business and the enthusiasm for working so hard in the business. It’s a tough business whether you’re making money or not, so the least you could do is make a little money. I want to talk about some mistakes that get made around that and specifically some money mistakes. First thing I’m going to do is I want to sort of set the table.


  At AMI, when we talk about agency billings or money, we always talk about adjusted gross income. I know you probably know what this is, but just so I know that we are all talking about the same thing, I just want to define that. When you read Ad Age or Adweek and you are hearing about how much an agency bills or the size of an agency, remember that those numbers are always reported in gross billings. That is everything an agency built a client. It might be for media.


  It might be for out-of-pocket expenses like printing or photography, and it’s also for the agencies services and time. Gross billings is the big number. It’s also an absolutely meaningless number. The reason it’s meaningless is because depending on the kind of agency you are, a lot of that money, a lot of that money that shows up in gross billings is really just a pass through, that you are, in essence, serving as the bank for your client and you’re buying media for them or trash and trinkets, or you’re paying for trade show booths, whatever it may be.


  And you are just basically a pass through entity. They’re giving you money and you are turning around and giving it to someone else. The number that matters to us is the adjusted gross income. You take your gross billings, everything that you bill a client, you subtract all of the costs of goods sold, so any vendors or outside expenses that you incur on behalf of the client.


  By the way, one of the costs of goods sold needs to be any freelancers that you use, any contract labor that you use, whether it’s someone you’re using just for a specific project, or let’s say you outsourced your web development, all of that fits into the cost of goods. What’s left after you take all the cost of goods away from the gross billings is the adjusted gross income. That’s the money that you get to spend on your agency. You spend that money in three different ways. You spend that money on salaries for your people and for yourself.


  When I say salaries, I mean, loaded salaries, so salaries, benefits, all that sort of thing, payroll taxes, you name it. Some of that money gets spent on overhead, rent, supplies, professional development, lawyers, accountants, that sort of thing. And then hopefully there’s something leftover, which is the profit. As I talk today in this podcast, I’m going to refer to AGI I’m sure many times, and I just want to make sure that we’re talking about the same thing. So again, gross billings, big, big number, meaningless number.


  Because if you’re a media shop, you may have 80% or more of your gross billings go right back out the door through media expense. Your AGI is 10 or 15 or 20% of your gross billings. If you’re a PR shop and you do most of the work in-house, you may keep 85 to 90% of your gross billings, and that all drops down to AGI. But to compare apples to apples, when I work with agencies across the land, what we care about is AGI because that is the money that agencies have to spend on salaries, people, owner salaries, overhead, and profit.


  All right. With that level set, let’s talk about the first mistake. The first mistake that agency owners make is your pricing strategy. Way too many agencies present a client with a single price option. And about 90% of the time… I’m just going to give you an example. Let’s say that you are presenting a client with a proposal or a scope of work for helping them with a trade show, and you’re going to give them a single price and option. And what happens about 90% of the time, and this is all based on human psychology. This is not, by the way, specific to agencies.


  It’s true in any sort of buying and selling situation. But when you present a client or a prospect with a single price and option, about 90% of the time, they will push back on that price and say that it’s too high. They’re going to negotiate that price down. If you give a client or a prospect two prices or two options, so think of it as a silver and a gold option, 95% of the time human nature drives them to choose the lower priced option. The good news is they’re probably not going to try and negotiate that price down.


  The bad news is you’ve left money on the table because they didn’t even consider the gold option. But there’s this magical thing that happens when you present a prospect or a client with three prices or three options. Over 96% of the time, they will choose the middle option. So what I want you to do is I want you to start building your proposals in a different way than you have been. I want you to always… And when I say always, I’m not talking about piddly little projects. I’m talking about anything that’s let’s call it five or 10 grand or bigger, right?


  I want you to always give them three options. What I want you to do is I want you to build the middle option first. Remember, this is the option that 96 plus percent of the time they’re going to choose. I want you to build that option to be your ideal sale and what’s really best for the client. It’s got the right stuff in the mix. It’s got the right frequency, reach, whatever it is, quantity, amount of time, whatever it is. Then I want you to strip some of those deliverables away from option two to create option one.


  I want you to kind of think of option one as the bare bones option and price it about 20 to 25% less than option two. So again, you’re going to build out option two. It’s what you believe is in the best interest of the client, and you’re going to price it appropriately so that it’s profitable for you and good for the client. Then to create the down and dirty option, option one, you’re going to strip away some of the deliverables so that it’s really basic, and you’re going to reduce the price between 20 and 25%.


  and then to create the option three, so again, if we’re doing silver, gold, and platinum, if you will, to create the platinum option, I want you to add some bells and whistles and some other things. Not things that are meaningless to the client, but things that perhaps take things above and beyond where you think they absolutely need to be. So if they buy it, great. It’s going to help them, but they don’t need it to be successful, right?


  You’re going to add those bells and whistles to option two to create your option three or your platinum option, and I want you to price it about 30 to 35% higher than option two. Now, when you present those three options to the client, 96% of the time the client will talk themselves into option two. And what’s beautiful about that is that they feel like they have control over their budget. They feel like they are in control of the work that they’re doing with you.


  If you don’t get an initial or an initial no or at least some hesitation, about 25% of the time when you’re presenting project pricing to your clients, that means you’re underpricing your services. This three-tiered options is also a great way for you to learn whether or not you are underpricing. If they always choose the platinum option and they don’t even blink an eye, then you know that you’re underpricing your services.


  But if most of the time they kind of grimace a little, but they choose option two, then you know that you were pricing it kind of at the sweet spot for you and at the right spot for your client mix. I want you to try that because I think you’re leaving money on the table by offering… Most agencies offer a client one or two options. Now, what you’re really doing is you’re coaching the client or the prospect to negotiate you down if you only give them one option and choose the lesser of the two options if you give them two.


  So try the three-tiered option. The second mistake that agencies make, and I know that you’re going to recognize yourself in this, maybe not you, but other agencies you know, you give it away for free. Honest to God, if we could control the scope creep in our shops, you all would be driving nicer cars and going on better vacations, and your kids would not have to worry about college tuition. Every agency has a gaping hole in it. Now, okay, I’ll amend that. 99% of the agencies I know have a gaping hole, which is scope creep, and some of that is uncontrollable.


  Some of that is just the nature of the beast. You’re always going to over-service your clients, and there’s nothing wrong with that. I’m not suggesting that you nickel and dime your clients to death, but we’ve got to find a way to put some sort of blockage in the way of that seeping hole that you have in the bottom of your boat where you are just giving away services to your clients all the time. The reality is, honestly, while we can look at our clients and be frustrated with them that they keep asking for more and more and more, the blame sits squarely at our feet.


  It is our problem to control. Oftentimes, it’s your scope documents or your proposal documents. The odds are, they are too vague, they don’t clearly define the deliverables in a way that there is no room for interpretation, or they’re too broad, or they don’t have boundaries or limits. Any or all of those mistakes, and most scope documents have a mix of all of them, any or all of those mistakes lead to scope creep. And scope creep leads to over-servicing your clients, which leads to lower or no profits altogether. There are a couple of ways you can fix this.


  First of all, if you have account people who are managing client projects and they are in charge of monitoring the budget, one of the problems in many cases is that your account folks do not understand agency math. They don’t understand the thing I opened up this podcast with, which is the cost of goods and all of that and how you spend your AGI. First of all, they need to be taught that.


  In both the entry-level and at the advanced bootcamp that we have at AMI, we spend a good portion of a morning going over agency math so that these account people understand how you make money and how they can help you make money or how they influence you losing money. The problem is you expect them to be good stewards of your profitability, but they don’t understand the game that they’re playing, so how in the world can they be? No one has taught them. In most agencies, the ownership has not taken the time to teach the employees.


  And by the way, I believe you should teach all of your employees, to teach the employees how an agency makes money and how everyone in the agency every single day either makes the agency money or costs the agency money. And that’s in either over-servicing clients or not negotiating better with vendors. There’s lots of ways that that happens, and we talk about a lot of that in the bootcamp. But in essence, what I’m saying to you is make sure your account people understand how your business makes money.


  When they don’t understand that, then they believe that their job is not about helping you make money, but it is about keeping the clients happy. And the easiest, fastest way to make a client happy is to over-service them, which, of course, is absolutely counterproductive to what you want them to do, which is to help you make money. Here’s another issue. Many, many agencies do not issue change orders. So again, your scope documents are too vague.


  And when a client seriously exceeds what the scope document says and they’re asking for revision 12 or whatever it is, agencies don’t issue change orders because, A, you’re not running profitability reports by client, so you don’t know that you literally, in some cases, are paying for the privilege of working with those clients. You absolutely need to be looking at profitability by client. And by the way, your account people need to be looking at profitability based on their clients.


  They don’t need to see the numbers if you’re weird about that and you don’t want them to see all of that, but they can at least see percentages. They should have a goal from you of how profitable their clients should be, and they should be getting reports that say to them, “You’re on target or you’re not.” Number one, you don’t issue change orders because you don’t really understand the profitability of your clients. And in some cases, you are literally paying for the privilege of doing that work.


  Number two, no one wants to stand up to the client, especially if your scope documents are loose. You know that you are standing on really shaky ground, and so it’s much easier just to do what the client wants. But the biggest reason why change orders are not issued is because by the time it’s far enough along that it’s time to issue a change order, here’s what your AE is thinking in their ad. Client wants to make a minor change. By the time I calculate the change order costs, write up a document, send it to the client, get them to sign off on it.


  We could have just made the change. So I’m going to waste more time and irritate the client by issuing this change order. Screw it, I’m just going to make the change. And that is a terrible, terrible thought process. So here’s the easy fix. I think that you should have in all of your scope documents language that has a flat fee for changes beyond the number of changes allowed in the scope documents. Number one, you need better scope documents. They need to be very specific. They need to be detailed. They need to really define the deliverables and the timetable.


  And then on top of that, it needs to say… So let’s just say, you’re working on a brochure for a client and you’re going to give them four revisions. There needs to be some language that says, “With this estimate, you are going to be granted four revisions. Any revisions after the fourth revision will be a flat $250,” or whatever number you want. But the minute you do that, and again, remember the client is going to sign this scope documents, so they’re agreeing to that. Now you don’t have to have a big discussion. Does that mean you always want to charge the change order fee?


  No. There are going to be times when, depending on the client or the circumstance, you want to waive that fee, but it gives you some teeth in the document to go back to that client and say, “Hey, don’t forget, this is your fourth revision. Make sure everybody sees it. Because after that, I have to charge you that flat fee of $250 for any more revisions.” The client says, “Okay, great, fine,” gives you back the revision. And sure as God made little green apples, they’re going to come back to you with a fifth revision.


  Now the AE can say, “You know what? That’s outside of scope. I’m going to go to fill in the blank and see if I can get that waved. But I guarantee you, this is going to be the last one. So make sure everybody sees it.” So after the fifth revision, which by the way, go ahead and give them one more for free, it beats giving them another 10 for free, which is what you’re doing now, after the fifth revision, you start dinging them for that change fee.


  And one of two things is going to happen, either your client is going to recognize that they cannot get their act together and they’re going to know that on occasion they’re going to be paying the change order fee for exceeding the scope document, or number two, and ideally, you’re going to train your client to make sure that they get their ducks in a row before they give you changes or revisions or whatever the scope document is talking about so that you are not doing change after change after change and watching your literally go down the drain.


  It’s a tough love thing. But when delivered inside your agency’s culture and voice, I think you’ll be surprised how receptive clients are. They know that they are being exceptionally demanding. But if you don’t call them on it, they’re going to keep doing it.


  And with that, it seems like a really great time to take a brief pause and then we will get right back to the mistakes that are costing you money. I hope you’re finding this content really helpful. I just wanted to take a quick pause and remind you that on top of the podcast, we also do a lot of live workshops for agency owners, agency leaders, and account service staff. If you’re interested in the schedule, check it out at agencymanagementinstitute.com/live. Let’s get back to the show.


  Okay, welcome back. Now what I’d like to do is I’d like to dig into mistake number three. The third mistake that many agencies make that cost them money is that you don’t really have a plan for your business. You are so busy running from fire to fire to fire and putting those out and chasing after whatever the drama of the day is, whether it’s a client drama or an HR drama or whatever it is. But you don’t really have a vision for where you want to move your agency forward and how you want it to be different a year from now.


  So in an earlier solocast, I talked about the AMI One-Page Business Plan, and I am going to highly recommend that you go back and listen to that solocast and that you download that One-Page Business Plan. Because I promise you, if you use that tool, it’s super simple. It’s really straightforward. If you use that tool, your agency will be more profitable and will look different and will be closer to what you want it to be a year from now. If you don’t have a plan, I promise you, you’re going to look a lot like you look right now.


  So if you really do want to grow your business, and again, I don’t necessarily mean grow in terms of number of bodies, but if you really want to grow your business and be more profitable and have the business be what you envision and hope it be, that does not happen without planning. So go back, check out that solocast, and download that One-Page Business Plan. We will also put that One-Page Business Plan in the show notes with this solocast.


  So even if you don’t want to go back and listen to the solocast where I sort of explain how to do it, it’s pretty straightforward and you probably can just get it just by looking at it. All right. And the last mistake I want to talk about is that your new business plan sucks. You know this, and I’m going to do a solocast specifically on your new business plan down the road. But the reality is, you don’t h