Strategy but for Agencies: How Agencies Differ
The broad-strokes differences from one agency to the next.
There’s a bit of a common debate in the realm of business strategy about where the starting point is. Do we look at the market, the customers’ needs, the competitors’ offerings, and identify what the business should be? Or do we look at the business, its competencies and resources, and identify ways they can create value and which strengths to build on?
That is, do we do strategy inside-out or outside-in?
I’m not alone in finding it a bit of a false dichotomy – that strategy ends up being an iterative interplay between the two facets. The success of any strategy depends both on environmental factors and facts about the starting point of the business. A business with strengths that are irrelevant to profitably serving a market is doomed. A business which identifies a best way in to the market but which requires an utter rebuild of the business from the ground up will similarly struggle.
That said, we have to start somewhere, and while my usual instincts are to start with the market, this time I want to start with some aspects of the businesses in the industry.
How do agencies differ from one another in ways that are relevant to creating value for the market – and therefore ways that are relevant to strategy?
Agency Size
The first dimension on which agencies vary greatly is size. And by “size”, I mainly mean headcount. Some agencies are just a handful of people and some employ hundreds of full-time employees. Thousands or tens of thousands if we expand our definition of a business to include global agency networks.
Size also typically correlates with revenue or the volume of billings. That is, an agency employing 100 staff will be turning over tens of millions of dollars in revenue. They must – assuming an average salary of $70k, the payroll alone is $7 million. Without a staggering competitive advantage, an agency of 10 people could never deliver $7 million worth of value.
But there’s an important point here. When we talk about industry profitability and the ability of some agencies to deliver outsized returns, we’re talking about margins/percentages and not volumes. That is, an agency which bills $10 million and spends $9.5 million to do it has a 5% profit margin. An agency which bills $2 million and spends $1.6 million to do it has a 20% margin. The profit for the larger business is higher ($500,000 compared to $400,000), but the return on the smaller agency’s efforts is greater.
In other words, for the purposes of business strategy, bigger is not necessarily better. (I am oversimplifying things a little.1) That said, there are advantages to size which have a direct impact on profitability.
One advantage is hinted at above. There are simply more clients available to a larger agency, because the larger clients have a volume of demand which can only be met by larger agencies. In essence, smaller agencies can only serve a smaller-than-total segment of the market, while the largest agencies can serve all of it.
On the other hand, a small agency may have an advantage in selling to a smaller client if the small client doesn’t believe it will receive enough attention from a large agency with its range of large clients. I’ve lost pitches by over-emphasising the size of a global network and left the prospect feeling like they’re too small for the agency.
Another advantage to size is in capacity management. Agency work typically comes and goes as projects, which require chunks of capacity at a time. The ups and downs of this variable demand have a bigger impact on smaller teams. When too much work comes in at once, an agency is forced to either bring in expensive freelance labour or turn down the work. In either case, profit is lost.
The larger agency wins twice in this regard. Firstly, with a larger pool of workers, excess demand can more likely be spread across team members who might not be working at capacity. Secondly, with a larger roster of clients, the peaks and troughs of client demand even each other out. For the extreme one-person agency with one client, billable work is always feast or famine. For the extreme 1000-person agency with 100 clients, overall demand averages out to a manageable consistency.
One aspect of size that doesn’t typically come into play in agencyland is economy of scale. Generally, economies of scale are achieved when fixed costs can be spread over a larger number of sales, reducing the per-unit cost of goods or service. As mentioned in the post about Five Forces, agencies’ dominant cost is labour, which is basically a variable cost. If demand increases, agencies hire to meet it; if demand drops, agencies make roles redundant. But labour billed out as head hours doesn’t typically scale.
These days, there isn’t even much gained in the spreading of administrative costs like accounting, HR, etc., as smaller agencies can affordably outsource many of these functions without the fixed cost of a salaried role. And tools like Xero, Bamboo, Checkmate, Google Suite, Office 365, etc., reduce the need for staff performing many administrative functions. Still, large global agency networks theoretically enjoy some economies from centralising certain functions (covered below).
Agency Scope
Another big dimension along which agencies differ is the scope of services offered. While the last article about operational excellence focused on idea-having services, agencies in general include a range of service types, like:
Creative ideation
Media planning and buying
Brand design
PR and earned media
Social media content/management
Brand and marketing strategy
Website and app design and builds
Video production
We can talk about the poles of this dimension as being specialist on one end and generalist or integrated on the other.
Agencies benefit from specialisation in a few ways.
The first is in value perception and creation. If an agency does just one thing, clients will reasonably assume that the specialist agency is better at that one thing than a more generalist agency is.
Related to this, if an agency does just one thing, it actually will find it easier to be better at doing that one thing. Investment decisions are much easier – all training, equipment and software purchases are directed towards doing that one thing. All experience built up in the people and processes of the agency will be directed towards improving doing that one thing.
The second benefit is in capacity management again. If all of the work that comes into the agency is just one kind of work, and the agency employs only workers who do that kind of work, spreading demand among salaried roles is easier.
Consider a sudden high volume of social-media work coming in to an agency. If it is a 30-person generalist agency, it may employ only one or two people who can do that kind of work, and if they don’t have capacity, the generalist agency is forced to pay freelancers or turn down the work. If it is a 30-person specialist social agency, maybe any of 15 people could soak up the excess work.
Similarly, if two people’s worth of social work dried up, the social agency has every other client’s work to share among underutilised staff. For the generalist agency, it’s paying two people to sit on their hands until more social work comes in.
The third benefit is a bit of a mix. And that is that specialisation negates one of the size disadvantages mentioned above. While only the largest full-service agencies can meet the full-service needs of the largest clients, a relatively smaller specialist agency can meet the specialised demands of any sized client. And so, with specialisation, the market is less limited by size. The “mix” part is that the overall size of the pie is smaller, as they can only capture a share of the market’s total spend in their domain.2
There are benefits to generalisation too. For one, there can be a cost efficiencies. For example, the same number of client-service team members3 can service a single client which uses the agency for multiple services. If the client were to have different agencies for five different services, they end up paying for at least five different suits.
There’s a value-perception advantage too. When all you sell are hammers, you’re incentivised to see every problem as a nail, and clients know it. The more generalist an agency, the more credibly they can claim that they will recommend the right solutions for a client, rather than finding excuses to sell their particular services even when it might not be the best use of the client’s budget.
In an “agency village” scenario with multiple specialists serving a single client, there can be a lot of competitive muscling for budget between the agencies, which can incur costs in time – and even quality if communication between agencies suffers as a result.
There’s another value-perception advantage, which can potentially be an actual value advantage, in synergies between the different departments of a generalist agency. For example, the same experts who designed the client’s brand identity might be involved in the design of the client’s website. That’s more efficient than a separate web-design agency being briefed on the brand identity by a separate brand-design agency.
Generally speaking, the advantages at one end of the spectrum translate to disadvantages at the other. Generalists face greater challenges in capacity management and perceptions of specific expertise. Specialists face greater challenges in perceptions of bias, inefficiencies of inter-agency relationships, and a smaller total revenue pool to win.
Global Networks versus Local Independents
Another dimension to touch on briefly is whether an agency is a standalone entity or the local presence of a global network.
Networked agencies enjoy scalable efficiencies in brand equity. For example, even if a local office hasn’t won any big global awards recently, it can make some claim to their promise of quality by association. There is also a basic sense of credibility and reliability that comes from big brand name recognition. No one was ever fired for buying IBM.
Networked agencies also enjoy scalable efficiencies in expertise. For example, a single agency might not be able to justify the expense of employing one world-class expert in a particular field, let alone many. But by spreading the cost of a six-figure salary among 30 offices, all 30 can claim access to that expertise – or at the very least, association with a well-known name.
And networked agencies can often benefit from some degree of arbitrage – that is, taking advantage of price differences from one market to another. An office in New York can sell in a website build priced with a rate card that’s very competitive in the US, while much of the work is done by workers in an office located in a lower-wage economy.
On the other hand, networks can be very slow ships to turn. Levels of administrative and technical bureaucracy build up – intended to bring scale efficiencies but imposing global uniformity which can hinder individual offices’ agility. Obligations to the global network can incur costs which eat into profitability – fees paid to the global entity, costs required to keep up appearances to a global standard, etc.
Independent agencies typically enjoy greater agility, lower overheads, and the flip side of the networked agencies’ brand perceptions – that is, they’re more credibly local, more credibly experts in local audiences, and aren’t distracted by issues overseas.
It seems to me that those are the three big dimensions along which agencies differ, as businesses. There is some correlation between them – the more generalist an agency, the larger it tends to need to be in size, and networked agencies are naturally bigger on average than independents. But there are still different combinations out there in the market – larger and smaller independents, large specialist networked agencies, independent generalists.
There are plenty of other ways agencies can differ from each other within these dimensions, but these ones set us up to talk in broad strokes for the next topics – the five generic business strategies as they are applied in agencyland, and mapping out the strategic groups.
Technically the owners are looking at return on equity rather than net margin, but in a industry so driven by variable costs (head hours) rather than utilising fixed assets, margin will do for comparing performance.
If you’re paying attention, this is a bit of a red herring. The profitability (margins) of a specialist agency could actually suffer if they diversified into another service, firstly if the margins on the new business are smaller, and secondly if the distraction reduced the profitability of the original specialisation. Revenue goes up, profitability goes down. If possible, more of the original business type would be preferable, rather than more types of business.
See how much easier it is to say “suits”?