TL;DR

Digital agencies don't scale
Scaling is when a company can grow revenue exponentially faster than its expenses.
If agency leaders make decisions based on the assumption that their agency can scale, it's bad for everyone.
We see this in wildly different Rev/FTE numbers, the lack of any successful agency roll-up strategy, and the stark differences in GTM strategies and structures employed by those that scale vs. those that don't.
If you’d like help ~~scaling~~ growing a digital agency, let’s chat.

This will irritate a few people.

I hope no one just released a “How to scale your agency” talk or course. I don’t follow many agency consultants, so I won’t know unless I get an angry email. So sorry in advance, but you’ll need to rename it.

Today, I’m trying my best to not be pedantic about semantics. However, a lot of bad can come from miscommunicating, and I’d like to head some of it off.

I’m specifically talking about the term “scaling.”

It seems innocuous, but misusing this term can lead to disastrous decision-making within digital agencies. I’ve watched this happen on multiple occasions.

What “Scaling” Means

Scaling comes from Economies of Scale. A concept from microeconomics that roughly translates to advantages from doing more volume. As a company does more business, they gain certain advantages. Typically, from margin expansion from a primarily fixed cost base, negotiating power with suppliers, improved pricing power, or a mix of all three.

Said another way, scaling is when a company can grow revenue exponentially faster than their expenses. It means that when a company scales, each new dollar it brings in is more valuable than the last.

That’s why SaaS companies have been such attractive investment vehicles over the last 30 years. They can build something once-ish and then resell that same thing repeatedly without significant additional costs from each sale.

Now, that’s an incredibly simplified version, but even when you complicate it with integration, maintenance, bug fixes, additional features, etc., it still nets out to a business that grows its margin with each additional client.

Here’s the bad news: Agencies don’t do that.

Agencies are almost entirely variable-cost based. The major fixed portion died out when most agencies went remote a few years ago.

When an agency that’s tapped out on capacity wants to onboard a new client, it needs to hire more people to do that work. And when they want to bring on a second new client while keeping the first, they need to hire again. The agency’s costs increase proportionally with revenue growth.

This is the opposite of scaling.

There aren’t discounts on PPC costs with scale, or the ability to pay lower salaries because they’re bigger.

Agencies simply don’t experience significant benefits from being larger.

Why This Matters

It isn’t just semantics.

It changes how you view your agency and what you expect from it.

And expectations drive decision-making.

Here are three examples where things can go south quickly if agency leaders make decisions like they’re running a scalable business.

Operational Efficiency

The difference between scalable and non-scalable companies is most easily seen in the Revenue/Full-time Employee (Rev/FTE) metric of a scaled SaaS firm and a mature professional services firm. We’ll use publicly traded ones as proxies.

Rev/FTE at some large (already scaled) public SaaS companies:

Adobe: $907k
Salesforce: $438k
Intuit: $914k

Rev/FTE at the largest agency holding companies:

WPP $136k
Omnicom: $208k
Interpublic: $195k

If we look at the industries as a whole, we get the following Rev/FTEs in 1Q24:

Internet Services & Social Media: $1.4M
Software & Programming: $564k
Advertising: $226k
Consulting Services: $160k
Professional Services: $89k
From my own research, the average digital agency sits around $160k.

As far as where agencies live in the above industry classifications, they’ll typically fall somewhere in the bottom three. Internet Services & Social Media is more Alphabet, Meta, etc., and Software & Programming is more Microsoft, Oracle, Salesforce, etc.

There’s only so far you can realistically push your Rev/FTE.

It isn’t just an issue on the efficiency side of the equation, there’s a cap on pricing too (yes even value-based). We do operate in a fairly transparent market after all.

Common advice I hear around this is typically something like, “Earning less than $200k/FTE is killing your shop!” It’s not. Plenty of shops are thriving at $170k/FTE.

If leadership is guiding toward a $300k+ Rev/FTE goal because they believe the firm should scale, they’ll be making a lot of bad and dangerous decisions.

Outside Investors

It makes sense for a scalable company to accept investors to help build out their fixed cost base that they can grow off of and eventually earn outsized margins (see just about every SaaS company).

It doesn’t make sense for an agency to try this because there isn’t substantial margin expansion available at larger sizes.

Sure, you can expand your margins by increasing your level of sophistication, but it’s not like a 50FTE shop is some knuckle-dragging caveman vs. the highly advanced 250FTE shop. I’ve worked with plenty of both, and the differences are minute.

This is a major reason why the industry hasn’t undergone any serious roll-up. That, and the barriers to entry are so low they’re practically non-existent.

When the Tier 1 consultancies (McKinsey, BCG, and Bain) began to seriously enter this space 5-10 years ago, they didn’t do it by rolling up 1,000 little shops. They made a few sizable strategic acquisitions. They weren’t buying economies of scale, they were buying specialization or geography. They already had connections throughout the rest of the C-Suite, adding in agencies to round out their offerings to CMOs and CTOs was easy.

If leadership is building their company for sale, they need to do it in a way that’s different from how a scalable firm would.

Growth at all costs isn’t it.

That approach and mindset will wreak havoc on a digital agency.

Go-to-Market

My final example is the difference in how sales are structured at companies that scale (SaaS) vs. at companies that don’t (professional services).

SaaS leaders will easily invest in robust sales teams because they know their operations are set up to support an enormous number of new clients. This includes layers of leadgen experts (BDRs, SDRs, etc.), closers (Account Executives), subject matter experts (Sales Engineers), and more. These scalable companies are relying on the ability of their sales teams to drive huge numbers of new clients.

On the other hand, it’s rare to see robust sales teams in professional service organizations (like digital agencies). In most professional service companies, a salesperson may generate and nurture leads, but an expert-level practitioner will close the deal. This expert-level practitioner is typically a partner at the firm.

When we look more closely at digital agencies, this kind of setup works perfectly because most shops don’t need thousands or even hundreds of new clients each year. Most only need to close a few new clients a month. Even if they could close thousands of new clients, they wouldn’t have the delivery structure in place to support them.

A revgen strategy and structure that needs to drive thousands of leads a month is very different than the kind needed to drive 10 good ones.

If an agency’s leadership team is designing a strategy and structure that’s more appropriate for a scalable firm, they’ll have numerous issues down the road with compensation, team composition, and retention.

Please Don’t Try to Scale Your Agency

It really is important for agency leadership teams to understand the structure underpinning how their firms grow. The information they seek out can be colored by misunderstandings that can make them unwittingly make worse decisions for their agencies.

It’s much more than just semantics.

I do a ton of research on the digital agency space. I've used that research to help hundreds of digital agency leaders design reliable growth strategies. If you’d like help ~~scaling~~ growing a digital agency, let’s chat.

Until next time,

-Nick