<br><h3> Chapter One </h3> <b>Eliminate Billable Hours <p> <p> <i>Inefficiency is the enemy of success.</i> <p> <p> DISRUPT OR BE DISRUPTED</b> <p> Disruptive innovation can hurt, if you are not the one doing the disrupting. This term, coined by Harvard professor and bestselling author Clayton Christensen (@claychristensen), and commonly talked about in technology circles, is a very real issue for marketing agencies. <p> According to Christensen, disruptive innovation, "describes a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves 'up market,' eventually displacing established competitors." <p> Disruptive innovation is already happening in the marketing-services industry, and it is going to change everything, including pricing and service models, measurement methods, tools and platforms, higher education, industry accreditation, marketing budgets, organization charts, and career paths. <p> Think about the firms coming up that have superior knowledge and capabilities in the high-demand areas of search, mobile, content, and social. Do you think the status quo is sustainable for traditional marketing firms? The upstarts and innovators may not immediately attack the core larger enterprise markets sought after by the big agencies, but before you know it, the collective ecosystem of emerging agencies will have built a diverse and collaborative empire that will shift the power in the industry. Then, it is only a matter of time. <p> Whether you are an emerging agency seeking to disrupt or a traditional firm on the wrong end of the impending evolution, here are several things to remember about disruptive innovation: <p> • Disruptive business characteristics include: lower gross margins, smaller target markets, and simpler products and services. <p> • It often comes from the outside, and once you realize what is happening, it is probably too late. <p> • Success requires an uncommon tolerance for risk and a desire to embrace the unknown. <p> • Victory favors those who are bold and decisive in their actions. <p> • Traditional agencies that are slow to adapt will fail, and many existing industry experts will become irrelevant. This will be good for the industry. <p> • Unparalleled opportunities will arise for marketing agencies and professionals, and new career paths will be defined. <p> • The underdogs and innovators will become the leaders. <p> <p> Pricing strategy is a key component to disruption. Agencies motivated to change will shift away from the inefficient legacy system of billable hours, and move to more results-driven, value-based models accessible to the mass market. This presents the opportunity for agencies and independent consultants to disrupt the industry with lower prices, and potentially higher profit margins. <p> <p> <b>A BROKEN SYSTEM</b> <p> I started my career in the marketing industry at a traditional PR firm. In those days (1999–2005) we charged a flat rate of $125 per hour, and billed in quarter-hour increments. The flat rate meant that clients paid the same hourly rate for my work as they did for time logged by our most senior personnel. This was easier to track and report internally (when people actually completed their timesheets) than a tiered hourly rate, but from a client's perspective, I always struggled to understand how paying a junior associate and a senior executive the same $125 per hour made any sense. Where is the value in that? <p> Then again, I also never bought into the tiered-rate model. Even today I cannot comprehend how firms justify charging upward of $964 per hour for a senior executive's time, which, according to the 2009 American Association of Advertising Agencies (4A), was an average rate for large U.S.-agency chief creative officers. Even more shocking to me is that there are corporations willing to pay those excessive fees. <p> This is the core issue of what I call the <i>salary-rate fallacy. <p> <p> <b>The Salary-Rate Fallacy</i></b> <p> A standard formula used by agencies to determine billing rates is to apply a salary multiple, commonly a factor of two or three. According to communications industry consultants StevensGouldPincus, the most profitable PR firms should target 35 percent of revenue for base salaries, and 50 percent of revenue for total labor costs, including salaries, bonuses, and freelance/outsourced labor. So, in theory, if employees generate three times their base salaries in revenue, then firms will fall within target profitability ranges. <p> Firms may use variations when determining hourly rates, and take additional factors into account, but a simple salary multiple enables them to account for overhead expenses and employee compensation, while leaving room for net profit margins. Target net profit margins vary greatly based on agency size, growth rate, and life stage, but, most likely, they will fall in the range of 10 to 25 percent, depending on which benchmark report you reference. <p> In order to understand the deficiencies of this approach, let's take a look at an example of how an agency professional's hourly rate would be calculated using a 3× multiple. <p> In this scenario, we will assume the professional's production rate, or the time he is billable, is approximately 57 percent (or 100 hours per month). The remaining 43 percent of nonrevenue-generating time may be accounted for through administrative tasks, account management, business development, professional development, and networking. Here is how it breaks down: <p> Forty-seven weeks number of work weeks in a year after accounting for five weeks of vacation; personal days; and holidays <p> Forty-five hours per week assumes five; 9-hour days <p> Annual available hours = 2;115 47 weeks × 45 hours per week <p> Annual billable hours = 1;200 assumes conservative estimate of 100 hours per month <p> Salary = $150;000 <p> Required Billings (3×) = $450;000 <p> Billing Rate $375 per hour $450;000=1;200 hours <p> <p> Assuming there are 1,200 hours of billable work to be done in the year, this formula seems easy enough, and makes financial sense, at least for the agency. The problem is that the formula is completely agency driven. It is tied exclusively to outputs, not outcomes, and assumes that all agency activities—account management, client communications, writing, planning, consulting, creative—are of equal value. <p> Thus, the fallacy: A marketing agency executive making <i>X</i> ($150,000) per year is worth <i>Y</i> ($375) per hour. The fact is that the amount a professional is paid does not have a direct correlation to the quality or value of the services they provide, especially when you consider the impact of change velocity, selective consumption, and success factors, which were discussed in the introduction. And yet, we have an entire industry built on this pricing concept. <p> Maybe the executive's time is worth $375 per hour to build advertising creative or to consult on crisis communications situations, if that is what he built his career and salary on, but now client needs are rapidly evolving (change velocity). They are demanding different services (selective consumption) and measuring return on investment (ROI) in new ways (success factors). <p> Clients are willing to pay a premium for experience and knowledge they do not have, but the unfortunate reality is that young professionals, who have grown up in a digital world, may be more qualified to provide consulting and services in high-demand areas such as social media, SEO, and mobile. It is almost a reverse of how the industry has traditionally worked. Clients would pay for inefficiencies of junior account executives while they learned the craft and gained experiences, but the labor and hourly rates were cheap. Now clients pay for the inefficiencies of senior executives to learn the digital game, but their hourly rates are not coming down. <p> In addition, as costs increase to run and grow the agency, including rising employee salaries, there are only two obvious options to maintain or increase profits: (1) raise hourly rates or (2) demand professionals work more hours, neither of which creates greater value for clients. <p> The salary-rate fallacy is the core reason that billable hours are a broken system. Unfortunately for many traditional firms, it is the basis for their financial structure and incredibly difficult to change. Even for firms working off retainers, rather than project-based hourly rates, in order for the agreements to make financial sense, retainers still must be based on an estimated number of service hours using the hourly rate formula. <p> For example, if an agency has a $5,000 per month retainer, the number of hours that will be dedicated to the account each month could look like this: <p> Senior account executive ($300/hour × 5 hours) = $1;500 Account executive ($150=hour × 10 hours) = $1;500 Assistant account executive $100=hour × 20 hours = $2;000 TOTAL : 35 hours = $5;000 <p> <p> If the agency exceeds its monthly allotment, they either absorb the losses or request more budget. The other, less desirable options are to push more hours to cheaper junior staff with less experience, record the time against other projects with available budgets, or make it up by shorting time spent on the account during the next month. In other words, traditional retainers do not really solve what is wrong with billable hours. <p> <p> <b><i>The Cost of Inefficiency</i></b> <p> To further explore the challenges of the billable-hour model, consider the case of a press release. What do you think a press release is worth? <p> The correct answer, like any product or service in a free market, is whatever a client is willing to pay. However, in the traditional model, the cost comes down to two primary factors: hourly rate and the producer's efficiency. So let's examine the practical application of billable hours in an agency. <p> <b>Scenario 1</b> Professional A is an assistant account executive and an exceptional copywriter who requires minimal oversight. She is assigned a press release that will be distributed on a national wire service. She completes a strong original draft that is reviewed internally with no edits, and it is then quickly approved by the client. As a result, the cost is relatively straightforward. <p> Hourly rate = $150 Hours to complete = 3 Cost = $450 <p> <p> <b>Scenario 2</b> Now let's look at what happens to the price had Professional B, who also has an hourly rate of $150, been assigned the same press release. Although she wrote a few releases in college, this is her first real-world project. In addition to her raw writing skills, <p> Professional B is easily distracted. She is addicted to her Twitter stream and has e-mail alerts that pop up every two minutes, so she rarely focuses on her tasks for extended periods. As a result, she takes a bit longer than Professional A, and the quality is subpar, requiring multiple revision rounds before it even goes to the client for approval. The cost for the first draft: <p> Hourly rate = $150 Hours to complete = 5 Cost = $750 <p> <p> However, we are not done yet. We also need to account for the one hour of a senior associate's time to edit and revise the original draft, 15 minutes to review the edits with Professional B, 30 minutes for Professional B to make the edits, and another 30 minutes for the senior associate to edit and approve the final version. Oh, and the senior associate's hourly rate is $250 an hour. So, the final cost looks like this: <p> Original draft ($150/hour) = 5 hours or $750 Senior associate edit and review ($250/hour) = 1.25 hours or $312.50 Professional B edits ($150/hour) = 0.50 hours or $75 Senior associate final edit — Round 2 ($250/hour) = 0.50 hours or $125 Total = 7.25 hours or $1,262.50 <p> <p> There is zero added value for the release from Professional B, yet, the client pays nearly three times more for the exact same deliverable. The client is actually penalized, and forced to pay for the agency's inefficiency and professional development. <p> The model is broken. <p> <p> <b>Inefficiency Factors</b> <p> There are countless factors that can affect a professional's efficiency, but distractions, time tracking, and motivation are three of the biggest culprits. <p> <b>Distractions</b> Marketing agency professionals are multitaskers. At any given moment, they are connected through an array of channels competing for their attention—Twitter, Facebook, Internet, TV, chat, e-mail, phone, text, Skype, Intranet—not to mention face-to-face time and meetings. In essence, they are always distracted or anticipating distraction, and, therefore, they are never performing at their peak and never achieving flow. <p> Yet clients are expected to pay full hourly rates when, in reality, professionals rarely are focused solely on the project at hand. I know if I were paying someone for their creative work, I would rather they spent 60 uninterrupted minutes straight on my project than 60 minutes over three hours with calls, e-mails, tweets, and instant messages in between. I will take efficiency with higher levels of creativity and attention every time. <p> Distractions lead to higher costs and lower quality. <p> <p> <b>Time Tracking</b> Time tracking is not exact by any means. Although agencies and professionals may have the best of intentions for accuracy, it is easy to accidentally leave the meter running or even to forget to start the meter as you battle distractions and jump from one project to the next. As a result, it is common to estimate or round your time in logical increments. This means clients commonly pay for time that never happened. A five-minute phone call tracked as 15 minutes may not be a big deal once, but multiply that out over a 12-month campaign, and you are looking at hours of wasted time and money. <p> Plus, professionals responsible for billable-hour quotas certainly do not want to miss any client time, so they try to account for every activity, no matter how mundane. This time adds up and can eventually start to take valuable hours away from more meaningful and measurable work. <p> My experience was that, over time, clients would often avoid calling, or even stop keeping us in the loop on key strategic discussions because they did not want to incur the charges for us to have a chat or read and compose an e-mail. So agencies make a few dollars to fulfill billable-hour goals, but lose out on long-term opportunities. This is the type of shortsighted thinking that will doom agencies. <p> <p> <b>Motivation</b> There is little motivation for agencies or their professionals to complete work more efficiently. The value of employees to an agency, and, therefore, their ability to advance and build wealth, is directly tied to how many hours they log and how many of those hours actually get billed to clients. As a result, professionals often are more worried about meeting hour quotas or staying within monthly retainer limits than they are with delivering the level of service and quality needed to produce measurable results for clients. <p> Going back to the press-release example, which professional looks better on paper based on the standard model? Professional A, who finished the release in three hours for $450, or Professional B, who took more than seven hours with the help of her supervisor for a cost of $1,262.50? <p> Well, if the client had the budget available to allow for the inefficiency, Professional B comes out ahead and the client never knows the difference. <p> Low-quality work should not cost the client more, but that is exactly what happens. Either that or the agency eats time as professional development, but that is not something most agencies are eager to do. <p> Just think what an agency could accomplish, and how much value it could bring to its clients, if it rewarded professionals for retention and growth of accounts, rather than how many hours they bill in a year. <p> <p> <b>THE POWER OF TRANSPARENCY</b> <p> There is a certain mystery to billable hours and agency services. Clients are not always sure exactly what they are getting or what it costs. This works for agencies because billable hours are an imperfect mix of art and science, and as long as the agency produces results, clients are happy. <p> <i>(Continues...)</i> <p> <p> <!-- copyright notice --> <br></pre> <blockquote><hr noshade size='1'><font size='-2'> Excerpted from <b>The Marketing Agency Blueprint</b> by <b>Paul Roetzer</b> Copyright © 2012 by John Wiley & Sons, Ltd. Excerpted by permission of John Wiley & Sons. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.<br>Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.