Some of the simplest questions we have as agency owners can often feel like the most difficult to answer:
- Did you make money on a project?
- Which clients are more or less profitable than others?
- Which areas of the business are more or less efficient?
- Are you utilizing your team’s capacity effectively?
A Google search often does more to confuse us than create clarity, as everyone seems to be measuring things in a slightly different way.
In this post, we’ll break down a simple and tested framework for measuring and improving project profitability based on the work we’ve done with hundreds of digital agencies over the years.
This resource will be a high-level, one-stop shop to get you 80% of the way to measuring and improving your project profitability with 20% of the effort -- leading to agency profitability in the long run.
3 Effective Ways to Measure Project Profitability
How can you measure a given project’s profitability?
The first place your mind may go is toward attempting to measure “Net Profit” on a per-project basis. While this may seem logical (more precision = more accuracy, right?), as a practice, it’s fundamentally flawed in several ways.
Not only is it significantly more work, and typically leads to a severe delay in your ability to get feedback on the performance of projects, but there is a multitude of constantly changing variables involved in that calculation that have nothing to do with how profitable a given project was.
This makes it both harder to compare projects to each other, or measure changes in performance over time as well as discern what is driving improvements in project profitability over time.
Was this project more profitable than the last, or did the number of projects we were allocating our overhead to change since the last time we measured this?
For those reasons and more, we encourage agencies to use alternative methodologies for measuring the profitability and performance of individual projects.
Delivery Margin
Thankfully, a more reliable way to measure project profitability is through a metric we call Delivery Margin (sometimes thought of as Gross Margin or Contribution Margin).
It allows you to measure the fundamental profitability of your work without needing to account for changes in things like utilization rates and overhead costs., removing the guesswork and getting you to insights in a more direct and efficient way. Delivery Margin asks:
For every dollar of revenue we earn from a client, how much of it is left over to run the business after we’ve delivered the project?
Its formula is as follows:
Delivery Margin (%) = (AGI - Delivery Costs) / AGI
To determine how profitable a project (or other subset of the business) is, you’ll need to know your AGI and your Delivery Costs. We’ll be going through an example on calculating Delivery Margin later, but let’s define those two inputs first.
AGI
AGI is short for Agency Gross Income. It’s commonly referred to as Contribution Margin or Gross Margin by accounting professionals. It’s a way to look at your revenue number without it being fluffed up by any pass-through work that you’ve been doing. The formula is:
AGI = Revenue - Pass-Through Expenses
Pass-Through Expenses describe expenses that flow through your agency onto other vendors. Common examples would be things like white label partners, external contractors, print budgets, materials, advertising spending, etc.
By anchoring your agency’s income to AGI, you’re removing any revenue in there that you’re simply passing on to other vendors. More on AGI here.
Example:
Imagine you’re a creative agency or digital marketing agency specializing in copywriting, charging $5,000 a month for content, but your client wants SEO services as well. So, you decide to hire out a vendor to complete the services, and pass on that expenseto
your client for an extra $2,000/month.
In this instance, the revenue for this project will be $7,000, but your AGI will be $5000 ($7000 in revenue, minus the $2000 in pass-through expenses. Your firm is only responsible for delivering $5,000 worth of work, therefore the number on which you base your performance should be AGI ($5,000) and not Revenue ($7,000).
The next input into the Delivery Margin formula is Delivery Costs.
Delivery Costs
Delivery Costs are what it costs you (and your team) to deliver the project. You’re going to want to calculate your employees' Average Cost Per Hour(ACPH) and tally that up to get a number for total delivery costs. For contractors, you can use their hourly rate.
Consider that $5000 copywriting project, where you had 3 team members work to deliver on it.
Here is what that Delivery Cost could look like:
| Employee | Hours Worked on Project | ACPH | Delivery Cost |
| Amy | 9 | $50 | $450 |
| Allan | 35 | $30 | $1050 |
| Amad | 6 | $10 | $60 |
| | 50 | | $1560 |
Delivery Margin Walkthrough & Benchmarks
Now that we’ve got our two main inputs (AGI & Delivery Costs) we can measure our profitability for this copywriting project.
Remember, the formula is:
Delivery Margin (%) = (AGI - Delivery Costs) / AGI
So, we can plug in our inputs:
Delivery Margin = ($5,000 - $1,560) / $5000
Delivery Margin = 68.8%
This project had a Delivery Margin of over 68%, which is considered healthy in the industry. To give you an idea of what to aim for, at the per-project level, you’re looking to hit a 60-70+% Delivery Margin. At an agency-wide level, a 50-60% Delivery Margin is considered healthy.
The agency-wide scope is lower, since it’s factoring in time off, lulls in utilization rate, training, and something we call shared delivery expenses (they’re expenses that can’t be attributed to one particular project, rather, the delivery team as a whole…such as a Figma subscription for a design team).
What about Overhead Expenses?
The way that you’ll be able to factor in Overhead Expenses (which aren’t included in the Delivery Margin formula, but still matter towards your agency’s performance) is through a benchmark.
Generally, you will want your overhead costs to be between 20-30% of your agency’s AGI. That means if you’re doing a million in AGI per year, you should be spending 200-300k on the following departments:
- Administration
- Sales & Marketing
- Facilities
Knowing that you’ll be spending 20-30% of a project’s AGI on overhead, you can factor that into your Delivery Margin target to ensure you’re hitting a healthy margin each time.
While Delivery Margin is likely the most precise way to measure project profitability, the downside is that it can still rely on financial data to be calculated which can lead to delays and high costs in measurement.
Thankfully, there are alternative metrics that can be used to more quickly and cost-effectively measure project performance and act as a directionally accurate proxy for delivery margin.
One such metric is Average Billable Rate (ABR)
ABR asks the question:
For each hour my team worked on this project, how much revenue did we earn?
It’s important to note that Average Billable Rate behaves the same regardless of how you bill for projects, whether it be by the hour, flat rates, retainers, value-based, or any other form of pricing model.
Its formula is as follows:
ABR = Agency Gross Income (AGI) / Delivery Hours
Where AGI is your revenue minus any pass-through expenses, and Delivery Hours are any time your team spent delivering a project or set of projects.
If you’ve taken on a project for $1000, and it will take you 5 hours to deliver, you’re looking at a healthy $200/hr ABR. On the contrary, a $1000 project taking 20 hours to deliver is a $50 ABR. It’s a simple way to measure across service lines, products, clients, and more. We’ll build on this later.
Estimated Delivery Margin
Building upon your ABR metric, you can estimate your Delivery Margin in a specific area of work to get a clearer picture of potential profitability and performance.
All you have to do is figure out the ACPH for that same area of work. This way, you can get a more detailed idea of how well you're doing and how much profit you're making:
Estimated Delivery Margin = (ABR - ACPH) / ABR
If you’re considering comparing two of your service offerings, and you’ve got your respective ABRs and ACPH figures for each one, you can do a quick calculation to decide which one needs improvement:
| Service Offering | ABR | ACPH | Estimated Delivery Margin |
| Content Writing | $145 | $45 | 69% |
| Website Copywriting | $167 | $78 | 53% |
2 Proven Ways to Improve Your Project Profitability
The ability to measure your profitability metrics is only half the battle. After you know how you’ve been performing, how can you take steps to improve these metrics and make them worth the time that they took to measure in the first place?
Improving Delivery Margin
As you can see by reviewing the formula for Delivery Margin, there are two levers we can play with to influence project profitability:
Delivery Margin (%) = (AGI - Delivery Costs) / AGI
We can either…
- Increase AGI without a relative increase in Delivery Cost
- Decrease Delivery Cost without a relative decrease in AGI
1. Increasing your AGI
The first way to move your Delivery Margin metric, and therefore increasing profitability is to see a bump in your AGI number.
Remember, AGI is simply your Revenue minus any Pass-Through Expenses. By charging a higher price for the same service, you’re bumping this number and seeing a relative increase in your Delivery Margin because of it. Charging higher prices for your services gracefully comes down to finding an ideal pricing model for your service offering. It will leave room for you to be charging as much as possible for your service while still being competitively positioned, and giving your clients the ROI they deserve.
Note: When you’re scoping out your projects, and pricing your work, ensure that you’re calculating your AGI, ABR, and Delivery Margin so that it’s baked into your offering. If you can’t make those numbers make sense, something will need to change.
2. Decreasing your Delivery Cost
Now, the other way to influence the Delivery Margin formula is to decrease your Delivery Cost. If you’re able to either spend less time doing the same level of work, or decrease what it costs you to do the same level of work, you’ll impact and improve your project profitability.
To spend less time doing the same work, you’re asking yourself:
“How can our team deliver this project in 10 hours instead of 12?”
The answer is to increase your Delivery team’s efficiency – usually through processes and SOPs. When team members are clear on what to do, when to do it, and how to do it, you’re streamlining their time to focus on what matters most.
Invest in processes, and watch the time needed to deliver your projects go down.
To decrease what it costs you to do the same work, you’re asking yourself:
“How can I decrease the cost to have this work done just as well?”
The answer here is to decrease your ACPH.
You can find a free calculator here, but in short, the ACPH formula is as follows:
ACPH = Total Payroll Cost & Benefits / Total Hours
Let’s walk through an example for our copywriting firm. Let’s say your head writer is making $90,000 a year plus around $14,000 worth of bonuses and benefits, for a total payroll cost of $104,000. Then, they’re full-time working 2080 hours a year (typical 40 hour work week).
Your ACPH for this employee is:
ACPH = $104,000 / 2080
ACPH = $50/hr
Armed with this knowledge, your next question is how can I decrease my team’s ACPH? The answer is delegation through processes, systems, and SOP creation.
By investing in processes similar to the above, you’ll set yourself up to be able to delegate the work down the road to more junior employees who are still sharpening their skills, or to outsourced teams where you can utilize the economic differences to your advantage.
By having lower Delivery Costs, you’ll have a direct impact on your Delivery Margin, therefore increasing your agency’s profit margins.
Walkthrough - Delivery Margin Improvement Example
Let’s walk through examples of how your increase to AGI or decrease to Delivery Cost can influence Delivery Margin:
Remember this Scenario? Let’s use it as an example baseline, to see how we can improve Delivery Margin:
| Employee | Hours Worked on Project | ACPH | Delivery Cost |
|---|---|---|---|
| Amy | 9 | $50 | $450 |
| Allan | 35 | $30 | $1050 |
| Amad | 6 | $10 | $60 |
| | 50 | | $1560 |
Delivery Margin = $5000 - $1560 / $5000
Delivery Margin = 68.8%
First, let’s see how Delivery Margin looks when we increase AGI:
| Employee | Hours Worked on Project | ACPH | Delivery Cost |
|---|---|---|---|
| Amy | 9 | $50 | $450 |
| Allan | 35 | $30 | $1050 |
| Amad | 6 | $10 | $60 |
| | 50 | | $1560 |
Delivery Margin = $6000 - $1560 / $6000
Delivery Margin = 74%
Next, how about a decrease in hours to complete a project?
| Employee | Hours Worked on Project | ACPH | Delivery Cost |
|---|---|---|---|
| Amy | 8 | $50 | $400 |
| Allan | 32 | $30 | $960 |
| Amad | 5 | $10 | $50 |
| | 45 | | $1410 |
Delivery Margin = $5000 - $1410 / $5000
Delivery Margin = 72%
What about if we can decrease ACPH through delegation?
| Employee | Hours Worked on Project | ACPH | Delivery Cost |
|---|---|---|---|
| Amy | 3 (minus 6 hours) | $50 | $150 |
| Allan | 35 | $30 | $1050 |
| Amad | 12 (plus 6 hours) | $10 | $120 |
| | 50 | | $1320 |
Delivery Margin = $5000 - $1320 / $5000
Delivery Margin = 74%
Voila! Delivery Margin sees an increase in every area, from the baseline of 68%.
Considering Risk
Away from the numbers side of things, one last thing you should consider when looking to improve project profitability is risk. How much risk are you taking on in this engagement?
- Is the kind of work you’re doing inherently risky
- Is the finish line well-defined?
- What kind of contract do you have in place should things go awry?
- How is this considered in your onboarding process to set expectations ahead of time?
Typically, you’re going to want to price your services to balance the potential downside, depending on how much risk you’re taking on. A safe $5k project could be comparable to a $15k risky project.
Many of the clients we work with get so focused on chasing the upside of larger fees or flat-rate projects, that they lose sight of how much risk they’re taking on in the process.
Often, this can lead to them netting out a lower Average Billable Rate and ultimately having worse margins despite landing larger projects or shifting away from T&M billing.
If you’re always chasing the potential upside, and take on all the risk in a pricing model such as value-based or flat-fee engagements, you may end up on the losing end more often than you would like, therefore absorbing budget overruns.
If you still have uncertainty about the scope of your work, or the process required to deliver for a client may end up being better to take the safe route.
Taking on more risk can create more upside, but it’s important to place those bets when there is a high degree of confidence in the scope of work, your ability to manage it, and your ability to price risk into the flat or value-based rate.
Conclusion
In closing, measuring and improving project profitability is crucial for the success and growth of your agency. It provides the fuel for investment, innovation, and client satisfaction. Strong project profitability won’t guarantee your agency's success, but it will set the foundation for it.
By anchoring your performance to your key metric, Delivery Margin, and using quick wins like Est. Delivery Margin and Average Billable Rate (ABR), you can gain insights into your agency’s profitability and make informed decisions.
Increasing AGI and decreasing Delivery Costs are two levers that can be adjusted to improve project profitability. Efficient processes, delegation, and strategic pricing models can contribute to achieving healthier Delivery Margins. However, it's essential to consider risk and align pricing with the level of risk undertaken.
By focusing on project profitability and implementing effective strategies, your agency can thrive, deliver outstanding work, and make a significant impact in your industry.
