Eliminate Fixed Costs: Financial Tips for Marketing Agencies

Are fixed costs threatening your profit margins? Do you need better financial planning practices to weather economic fluctuations that affect your agency? 

In this article, you’ll learn key strategies for managing finances through unpredictable conditions.

Why Are Fixed Costs a Major Threat to the Sustainability of an Agency?

Digital marketing agencies are no strangers to boom-and-bust cycles. As client budgets ebb and flow with the economy's tides, agency owners must adapt their financial strategies to stay competitive and profitable. 

Damian Papworth, founder and CEO of global white-label agency services provider Globital, explores some key ways agencies can better manage their fixed costs and pricing to thrive in uncertain times.

One of the biggest threats to agencies during economic downturns is misalignment between their cost structures and revenue. As Damian explains, when an agency has high fixed costs, expenses stay the same regardless of how much revenue it generates. In tough economic times, as Damian’s company saw in 2023, many agencies struggle to make sales, and their revenue drops.

However, their fixed costs (like rent, salaries, etc.) stay the same while their revenue continues to fall. This squeezes their profit margins, leaving them with less money. It also makes cash flow very tight.  

For example, Globital saw this in 2023 when the agencies they worked with, on average, started paying their invoices 12 days later than usual. This wasn't because clients were being difficult, but because they had less cash due to the lower revenue and stubborn fixed costs. 

This cash flow crunch often stems from agencies locking themselves into fixed costs they can't easily reduce as business declines. The three main culprits are:

• Office space (property leases)
• Human resources (full-time employee salaries)
• Long-term software contracts

While securing discounted rates through longer-term commitments may seem advantageous, this backfires if revenue takes a hit and you're stuck paying for unused capacity. As Damian cautions, “Try not to tie yourself into contracts that don't serve your business, that you can't back out of. You want to be able to dial up and down whenever you want.”

Fixed Cost Management Strategies for Agencies

As a business owner, you need different skills, including understanding your finances. Even with a strong team, the owner is often the first to spot issues by looking at the profit and loss statement.

It's important to have a close relationship with your numbers. When planning, start with your goals. Many agency owners aim to double revenue but have yet to consider their profit and loss at that level.

To be a successful business owner, you must develop strategic cost management skills. When you set a goal, become very familiar with what your business will look like when you reach it. Understand the financial details, cost structures, expenses, and the marketing needed to hit those numbers.

In other words, don’t just set revenue goals—dig into the numbers behind them and plan accordingly. This will allow you to identify cost-saving opportunities.

Damian offers key strategies for effectively managing and reducing fixed costs in your agency:

#1: Shift to a Variable Cost Model

The antidote to a misalignment between fixed costs and revenue is structuring your costs to fluctuate with the natural ups and downs in revenue. “If we can align our costs with the ebbs and flows of revenue, business becomes a lot easier over the long term,” Damian notes.

Some ways to achieve this include:

• Hire contracted specialists or utilize white-label services instead of full-time staff to service client work. If you lose clients, you can easily adjust your costs using fewer services.
• Opt for flexible coworking spaces and short-term office rentals over long leases. You can also utilize free spaces, like cafes, for meetings. 
• Choose software with scalable, month-to-month pricing instead of annual contracts.

Damian shares an example of his agency getting locked into a 12-month contract for more artificial intelligence (AI) software licenses than it needed. Despite initially agreeing to reassess its needs after 6 months, the provider wouldn't allow it to decrease seats until the full year was up.

His takeaway? “With software, it becomes a fixed price or a fixed cost. Start really conservative and build as you need rather than start [generously] and then try to pair back.”

When managing your team, remember people are more than just a cost—they impact team morale and the work environment. So, it's important to consider which roles are essential in-house.

For example, your executive team is crucial. But for other roles, like an in-house lawyer or bookkeeper, ask yourself if they'll add long-term value, especially during a downturn.

Many digital agencies struggle with managing the business and getting the work done as they grow. They often hit a point where they need a manager or salesperson but aren't sure how to proceed.

One solution is to use a resourcing partner like Globital. These agencies can provide teams to handle the work while you focus on management. This allows you to fill the necessary roles without committing to full-time hires.

The main idea is to turn your fixed costs into variable costs that can adapt to changes in your revenue. This helps protect your business during tough economic times.  

Balancing Cost-Cutting With Investing in Growth Opportunities

When you're in a tricky spot where your business has grown, but you aren't making enough money, it's tempting to cut costs in the easiest places, like marketing. However, this is like using a broadsword—a big, imprecise chop that can hurt your growth ability.

Instead, approach cost reduction like using a scalpel—make minor, precise cuts in areas that won't harm growth, like cutting back on software licenses and redirecting those funds to growth areas or subletting excess office space. 

The key is to think about these strategies in advance. Don't assume this year will be like last year. Plan for contingencies so you can surgically reallocate resources rather than making panic cuts. Even within marketing, you can make precise cuts. Redirect resources from underperforming campaigns to those that are doing well. 

By being strategic and targeted with your cost-cutting, you can free up resources to invest in the growth opportunities that will move your business forward.

#2: Base Your Pricing on Real Numbers, Not Gut Feelings

Many agencies struggle with pricing their services profitably. As Damian observes, agencies base set prices on a loose sense of market rates or a coach's advice without rigorous analysis of their actual delivery costs.

“Without any analysis behind what you're doing, you could price so that every time you actually serve someone, you're making a loss,” he cautions. “And that's a good way to go bankrupt.”

The way out is to “back into pricing”—intimately understand your numbers and use them as the basis for pricing decisions. Dig into your profit and loss statements to determine the following:

• Utilization rates of staff (hint: it's usually around 60% of their total paid time once you factor in holidays, sick time, etc., meaning if you have employees working 8 hours a day, they won't be productive for client work that entire time.)
• Average cost per hour of service delivery
• Profit margins needed to deliver services sustainably

To price your services correctly, you need to calculate:

• The number of clients an employee can serve given their available hours (capacity)
• The cost per service or delivery
• Divide the cost by the capacity to get your minimum price to make a profit

If you don't know this minimum price, you might be pricing your services too low and not making money. This can lead to a situation where you run out of time and money—your two most important resources. Without money, you can't buy more time through additional resources. And without time, your resources can't generate more money.

If you've ever felt stuck in this situation, it's likely a pricing issue. The solution is to price your services differently, ensuring you cover your costs and make a profit based on your team's capacity.

Armed with this data, you can set viable price floors and avoid selling at a loss just to land clients.  

Managing Fixed Costs During Periods of Growth

When managing fixed costs effectively during periods of growth, it's helpful to approach it like solving a puzzle. You can nearly guarantee success if you have all the pieces in place. One crucial piece many marketers overlook is knowing their numbers, particularly their cost per acquisition.

The key process to master is “capitalization”—understanding how much money you need to spend to achieve your goals. When setting goals, create a projected profit and loss statement that outlines the infrastructure, software, and staff required to support your growth. Ensure that your pricing can sustain this foundation.

If the numbers don't align, be willing to adjust your plan. Increase prices, change variables, or extend your timeline, such as turning a one-year plan into a three-year plan. Determine the number of leads and marketing spend needed to hit your targets. If it's a significant increase, revisit your profit and loss and make necessary adjustments.

Next, consider how you'll fund the growth through client receipts, a bank loan, or personal investment. Make sure to account for any interest in your planning. Damian says to be wise and strategic with your decisions to optimize your chances of success. Thorough planning makes managing scale much less daunting.

Remember that this exercise aims to push you out of your comfort zone, not necessarily to make you feel good. “It's supposed to make you feel uncomfortable. Because when you feel uncomfortable, you sit back, pay attention, and make better decisions.”

By thoroughly planning and knowing your numbers, you can confidently manage fixed costs and invest in growth.

Tracking Your ‘Effective Rate’

For agency owners, recognize first that your time as owner is the most valuable and expensive resource. We often use our time to balance things out (e.g., coding ourselves if we can't afford to hire someone). Next, record and put a rate on your time, then include it in your financials. This shows if your business is truly financially successful. If you don't, you might unknowingly pay yourself a meager rate, like $8 an hour.

Then, track your “effective rate”—how much you pay yourself divided by every minute you put into the business. If this rate increases each year, you're heading in the right direction. Your “effective rate” is a core metric for measuring the ongoing improvement and value of your business. 

Client Acquisition 

For digital agencies, your client acquisition needs might be relatively small compared to other businesses. You don't need thousands of sales daily like a theme park might. Instead, you may only need to secure three or four new clients monthly.

The numbers become even more manageable if you understand your conversion rates from leads to clients. For example, if you know your conversion rate, you might only need 9 conversations or 15–20 introductions monthly to hit your client acquisition target. That's just 1 conversation or introduction per day. When you break it down like this, the numbers are manageable for an agency.

By stating all the fixed expenses required to reach your target—from new hires to software to office space—you get a clear picture of the pricing and sales volume needed for it to work. If the numbers seem unrealistic, you can extend the timeline or adjust the goal to something more feasible.

#3: Focus on Profit, Not Just Revenue

Too many agencies fixate on top-line revenue growth without paying enough attention to actual profitability. But as Damian points out, “If you sell your agency, the buyer will be paying you a multiple of profit, not of revenue.”

High-revenue-low-margin agencies are really just buying themselves a job, not building an asset. Damian advises setting goals around profit, not just gross revenue, to make your agency attractive to potential acquirers. Setting profit goals is also crucial to understanding the health of your business.   

He suggests every agency leader should be able to answer basic questions like:

• What's our gross and net profit margin?
• What's our average client lifetime value and acquisition cost?
• How much profit do we need to cover at least three months of operating expenses safely?

Knowing these figures provides a solid foundation for investment decisions and a clearer path to a profitable exit.

#4: Have 3 Months of Expenses in Cash Reserves

With economic uncertainty likely to continue in 2024 and beyond, Damian advises every agency to sock away a cash cushion to ride out potential rough patches.

“You should have three months of your expenses in a bank account that you can draw on if you need,” he recommends. “So that will help you get through basically anything you need to get through.” 

Keep that money in a high-interest cash account, which becomes your working capital. 

Give Yourself Some R&D Budget

While avoiding shiny object syndrome is generally wise advice, Damian recommends that every agency carve out a small research and development budget to test new tools and tactics.

The key is placing clear guardrails around your time and money. “Put it in your profit and loss; limit your time and your money for these things so that you're not chasing shiny objects,” Damian says. 

Some things will work, and you can take them into the future. 

#5: Prioritize Sustainable Growth Over Growth at All Costs

It’s paramount to intimately understand your business model and use that knowledge to fuel smart, sustainable growth.

For Damian, that means not just having a clear vision of your agency's future but spelling out in granular detail what you'll need to get there—and pressure-testing whether your revenue model supports it. It means pacing your hiring and investments to what your cash flow can realistically support. It also means structuring your operations to survive and thrive under various economic scenarios.

Above all, it means focusing on profitability, not just blind top-line growth. Because as Damian puts it: “Building a business, you're building an asset. You're going to sell based on profit, not revenue. Big revenues can be [a] profitless churn, and that's something we want to avoid.”

By aligning your pricing and costs with these principles, you'll give your agency the resilience to weather any economic climate while building lasting value. As Damian notes, it won't always feel comfortable in the short term, but that's a positive sign you're heading in the right direction.

Those better decisions will separate the agencies that merely survive from those that truly thrive, no matter what the coming years may bring.

Where to subscribe: Apple Podcasts | Spotify | YouTube Music | YouTube | Amazon Music | RSS

✋🏽 If you enjoyed this episode of the Marketing Agency Show, please head over to Apple Podcasts, leave a rating, write a review, and subscribe.

---

Stay Up-to-Date: Get New Marketing Articles Delivered to You!

Don't miss out on upcoming social media marketing insights and strategies! Sign up to receive notifications when we publish new articles on Social Media Examiner. Our expertly crafted content will help you stay ahead of the curve and drive results for your business. Click the link below to sign up now and receive our annual report!