When you hire an agency, there are two main methods to structure compensation for their services:
In a fixed fee structure, agencies give you a specific and concrete amount due, typically bundled together in a package. For instance, suppose you run an ecommerce business and you need to convert first-time customers into repeat customers. You might approach an email marketing agency that might charge a fixed fee of $10,000 to create a 12-email onboarding sequence that your customers will receive after their first purchase to convert into repeat buyers.
Projects like these are simply defined – you know the fee and you know the deliverable. Of course, the quality of the results should be top-notch if you are working with an agency that you have performed due diligence (e.g. in your initial meetings, a good email marketing agency might discuss with you how the content of the 12 emails varies depending on customer segmentation).
When you hire an agency, the standard guideline is that you want 2x - 3x the return on the investment.
That is, if you spend $10,000 on having 12 emails created for you, then that email sequence should be returning somewhere between $20,000 - $30,000 in additional revenue.
During what length of time should you expect that ROI to be realized? This depends on the context and the project, but we recommend measuring it between 10-18 months.
PRO TIP: Ask your agency for a system to measure the results in order to gauge ROI. In our email marketing example, you should be able to track how much revenue is as a result of that 12-email sequence (and subtract that from the initial revenue you already had with an existing, or nonexistent, email sequence to get the delta between the two points - which will show you the “additional revenue” aka the real ROI - that should amount to 2x-3x of what you paid). As a client, you will like this because you can measure the impact of the cost, but the agency will also be happy to do this for you because they can prove their effectiveness and continue to have you as a client.
The way an agency prices their fees in a fixed structure is by having a concise prediction on how long (in terms of man-hours) it will take to deliver the scope of the project, then multiplying that number by hourly rates, plus overhead fees. We’ll explore this further in Section 3 “Understanding Agency Costs”.
Fixed fee structures are everyone’s favorite because they are simple and to the point. However, some projects are complex and the input (work required) cannot be concisely predicted, which is why some agencies use a variable fee structure.
Welcome to the land of billable hours! For cost-conscious organizations, the variable fee structure can make people feel queasy, but the good news is that the same principles apply here as they did in the fixed fee structure.
The only difference here is one unknown variable - time - that prevents an agency from issuing you with an exact-amount invoice. For example, in complex commercial litigation, a business law firm will invariably (no pun intended) use a variable fee structure. In many cases, a project that extends beyond a month or two, such as a software development project, will utilize billable hours to track the work put into the project and multiply that by the hourly rate of the staff involved in the project.
PRO TIP: When working via billable hours, we recommend creating a boundary to cap costs or place limits. Be specific what the deliverable and outcome will look like to avoid misalignment after the cost cap has been placed. We like the old woodworking quote: “measure twice, cut once” to avoid issues down the road.
PRO TIP: Some agencies will add a cost buffer in the event the client asks for something beyond the scope that, for instance, requires an additional 15 hours. Agencies naturally add this buffer as a natural defense mechanism since some clients add to the scope after the project has started. As a client, it is totally OK to ask if buffers were added and confirmation that it will be returned if the project does not go over the allocated time (answer should always be ‘yes’. In fact, this is a major benefit of choosing the agency route: unlike an employee that you pay regardless of whether work is performed or not, an agency has a concretely-defined deliverable and a specific payment associated with that deliverable. This means you never have to overpay for fake or “quiet quitting” performance).
PRO TIP: Like all things in life, competition is good and you should shop around to get averages to determine how long something should take. If you are looking for an agency you can trust without running up hours, we recommend sourcing an agency from 50Pros since we evaluate each agency on a 4-point vetting process, including a component of ethics and character.
How do you know what’s a good price you’re paying an agency (without underpaying nor overpaying)?
Pricing is a science and should not be ambiguous. So, let’s look at how an agency prices their services.
When agencies price their services, you can expect around 66% of the total cost to go toward salaries. That is, the labor on your specific project. In the past, this number was closer to 50% but data shows overhead costs, like fees for commercial real estate space, have gone down (and wages & salaries have gone up).
The other 33% primarily goes toward supporting an agency’s overhead costs; such as: SaaS subscription fees, travel, and profit or cash reserves.
Remember that an agency is a separate company from yours, and they too do important initiatives to strengthen their team and company; including morale-boosting activities like annual team retreats, pizza parties on Wednesdays, and ping-ponging on Friday evenings. When you hire an agency, you do not hire soldiers, but you hire captains and leaders who run their own firm. These are the kinds of people you want working on your project who care deeply about the work they put their name behind, as you do for your own clients.
This 33% “premium” is typically why hiring an agency is seen as more expensive because you are not only paying for a specific set of labor hours, but you’re in-effect paying for part of the company’s overhead in general. However, the thinking of “it’s more expensive” is misguided. When you hire in-house employees, the same costs are incurred too – but it is billed separately. For instance, the coffee k-cups in the kitchen are not bundled with an employee’s compensation package like they are bundled in the total agency fee. In this context, it would be absurd if an agency modeled it similarly and added a $0.20 fee on a separate line item on a $135,000 project to compensate for the daily k-cup allowance. At the end of the day, our data shows that hiring an agency versus hiring an employee comes down to the same amount (and you avoid huge mistakes with employees as described here).
Now that we understand the overall cost framework, the actual cost can typically be calculated by multiplying the individual man-hours by their respective hourly rate, plus the overhead fee.
Here is a sweet & simple example using the fixed fee variable method:
$100*5 + $120*6 + $140*7 = $500 + $720 + $980 = $2,220
$2,220 are the total salary costs. Plus $1,143, assuming the 33% agency fee mentioned previously:
$2,220 (66%) + $1,143 (33%) = $3,363.
This is the total cost that is due.
Of course, for the variable fee method, the hours are simply multiplied at the end based on what the actual number of hours were.
As a reminder, the 66% + 33% structure is an approximation. Different agencies have different structures and this article is simply intended to create a foundational understanding of agency costs and what you can expect.
PRO TIP: Ask for an itemized cost breakdown. An agency should be transparent in detailing how they arrived at the total price point. Note that an agency can “bake in” the fees into the hourly rates proportional to each person that worked on the project, or they can add it as a separate line item. As a client, it is always great to get a clear-cut cost breakdown; and although negotiations can be reasonable, remember to not overstep by dictating how another agency should operate. At the end of the day, you are trusting a team of professionals to take care of an important project for your company. Be cost conscious, but do not nickel 'n dime.
PRO TIP: An example of being cost conscious is ensuring no shenanigans are occurring by a firm mixing up labor hours. For instance, it is unethical if a consultant charges you $300/hr for a senior consultant, but puts a $120/hr junior consultant on that project. Also, do not be afraid to challenge a firm if you feel like hours are being overstated.
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