A small agency can be highly profitable. A large agency can be highly profitable. But there’s a treacherous valley in between where profit takes a hit.
Here’s the three phases.
The founder-led phase: small and efficient
The first profitable phase is when you’re about ten people and around a million in revenue.
You’re optimised here because the founder can carry much of the non-billable weight.
Small and efficient often happens without planning: founder-led new business, a lead generation channel that works, and a delivery team that’s independent and can handle clients.
It’s a common shape.
Most agencies start because the founding team can sell and founder led sales are incredibly effective. This phase it at it’s optimum when they are at the most sales they can handle.
You can make excellent money here. You have a high ratio of billable to non-billable people, and if you combine that with a high-value/high-rate service, then the money flows.
Big and powerful: systems and structure
On the other side of the valley is the big and powerful. These agencies are larger, and they’ve split into departments with people accountable for the return on investment of each.
The founder aligns and steers the department heads rather than being directly involved. This allows the agency to scale.
They build systems and utilise junior resources effectively. They carefully calculate rates and track project profitability. The founder spends time on setting and communicating vision and tracking progress towards it.
When all these elements align, profitability returns nicely.
The Low Profit Valley
Now for the valley. Profit is harder to come by.
A rise in non-billable costs
Above a certain point, the founder can no longer manage the sales and delivery oversight required, so you have to invest some of that profit in building the team that can scale. These are generally non-billable roles.
You’ll need a management layer. Forming a leadership team is immensely rewarding, but the salaries will keep you up at night.
Your billable team will also start to spend time on management. It makes sense that your best delivery people are the ones who start to bill less because they are also the ones you want influencing the rest of the team as they grow.
There is a period before this scale kicks in and starts making more money.
Sales gets hard
At the same time as managing everything becomes more intensive, suddenly your natural ability to close work starts to falter.
Winning work at this level gets harder:
- The buyers are more complex
- The competition isn’t playing around
Right now I expect you are great at winning work.
You are about to meet a new set of buyers who are either tougher to impress or complicated and nonsensical in the way they buy. Either way, it’s harder and you’ll need to adapt how you sell, and adaptation takes time.
I also expect your competition is substandard.
In the early years, your clients will be coming to you from terrible agencies that have messed everything up. Their expectations are low. They’ve shopped around and no one else has answered the phone. When selling, you blow the competition away because, in the words of one of the great business leaders, they aren’t “serious people”. It was easy to win.
Now you’ll be up against people that have it figured out (well, OK, people who look like they have it figured out — don’t let your imposter syndrome creep in now).
Especially when the deal size gets really large. That attracts the attention of the “older kids” — big consultancies who want that client because of the logo.
More than once we went up against big consultancies that would have done the work we were proposing for free because they would make their money back on other services.
You can still win here, but it takes time.
Cash flow and margin are hit
When you do win a bigger deal it pays for everything, right? I’m afraid that isn’t always true.
The clients you meet in the valley are slower to close and slower to pay.
They have procurement teams staffed with negotiators. The person who loves you and wants to hire you disappears, and you meet the legal team to talk about the contract. They have one goal: to squeeze your margin (there are some nice ones who squeeze nicely).
As your cash slows, your delivery costs go up and stay up. Gaps in utilisation suddenly become a big deal. That time you are waiting for the contract to get signed begins to be a problem.
This is all going to chip away at your cash and margin.
Until you’ve found a way to deal with it all, you are firmly in the valley.
What’s important here?
Take a moment now and answer me this question:
Do you want to cross the valley?
There’s no right answer, but there is a right answer for you. And it’s not just about money — it’s about the kind of business you want to run.
You don’t have to get bigger. There are other ways to grow.
The small and powerful peak makes plenty of money. You can stay on that peak or you can plan a way across. What’s important is to have intent.
You’re a great agency and therefore you are in danger of growing by accident.
Sometimes growth just happens to you and you end up in a shape you didn’t want, making less money than you wanted.
Stuck in the middle.
If you want to build something bigger, make it a choice. Just go in with your eyes open and plan for the investment it takes.