How top performers can be a curse for Agencies
If this is your first time reading one of my blog articles, be sure to take a look at my definition of agencies to make sure we're on the same page. The short version is that I'm talking about small and medium sized buisinesses or individuals doing contract work.
Anywhere you work there will always be more experienced and less experienced employees. This usually reflects in their performance and pay. Thus you need to find a way to pay your senior employees according to their experience. If you don't, you might not be able to stay competitive. I would like to lead you through some scenarios that are often used in Agencies, but do not enable that kind of compensation structure.
The fixed hourly rate
To determine the minimum amount an Agency needs to earn per hour sold, we can use this formula:
(Employee Salary + Fixed costs) / Number of hours sold per year
The actual hourly rate (as opposed to the minimum rate) will naturally be higher to include unexpected costs and a decent profit margin.
The problem that arises with this formula is that now suddenly all employees are charged for equally. The comapany is earning the same hourly rate if someone junior or someone senior is working for the client. "But wait!" You might say. That makes total sense because someone junior will need additional ressources like a mentor or unscheduled time to aquire the required skills. That's a totally valid and important point, but let's dig a little deeper.
How does this look form the customer perspective? On one side you have the junior employee that needs more time for everything and might have questionable quality (depending on the quality managment). On the other side you have a senior employee that is faster and thus also costs less money.
- Using a fixed hourly rate will cause your most junior employees to be your most expensive ones (from the customers perspective)
- This clashes with a normal salary structure, which is the direct opposite
Laying out the goal
What we really want is one of two things: Either both junior and senior employees encur the same cost for the customer, or the senior employee costs more. Why not simply cross finance all employees instead? If everyone can get paid, that's a win, right?
Well yes and there are companies that work that way. The downside is that now your incentives and goals are drifting out of alignment with what the customer wants. If your inexperienced employees are earning more revenue than your experienced ones, logically it becomes preferrable for the company to schedule them instead of your more experienced workers.
- Your goals need to align with the customers goals
- In this case that means experienced employees should be the most expensive, while more junior employees are cheaper
Reversing the cost pyramid
The first and most obvious solution is to have at least two seperate hourly rates to reflect the amount of experience each individual employee has. If you can find a way to make this work, this is a very good solution.
Sadly even having two different hourly rates can add significant overhead to invoicing, budgeting and writing new proposals. What if you want to negotiate a special hourly rate for a large project? What hourly rate applies if you exceed your budgeted hours? What happens if some employees have mixed skillsets, being an expert in one field and a novice in another? What happens if the team changes?
The alternative is going for the "Paid by value" model, where the number of hours worked is untangled from the cost of a project or feature. See my article about operating an agency for more details about the "Paid by value" concept.
- Having different hourly rates for different experience levels is the most transparent way of reflecting competency in cost
- Different hourly rates add overhead that cannot be underestimated
- The alternative is to completely untangle cost from the number of hours worked
Untangling cost from number of hours worked
This topic deserves an article of it's own, so I'll stick to what's relevant to the point I'm trying to make. Even when doing fixed bid projects many companies still rely estimates to determine the price. This is a good way to get an idea of the order of magnitude the project is in. However if those estimates are then used excusivly to create an offer for the customer, you've fallen right into the same trap as with the fixed hourly rate. You've created a price that is related to how much effort will be required to complete it and, more importantly, who will be doing the work.
Instead try to think about the following questions when creating an offer:
- How long would our most junior employee need to complete this task?
- Is the customer relying on you for expertese beyond completing the project?
- Are you taking advantage of an investment you made previously (ex. developing a process or framework)?
- Is there any infrastructure (testing devices, machines, printers) you are providing?
Any of these questions could mean that you're not only doing the work, but also providing other services to your customer. That is exactly what you have experienced people for and should be paid in addition to whatever work you're doing.
- Reflect on what services you are offering your customer beyond just implementing whatever the project entails
- Price your offer according to more factors than just how long you will be working on it (see above for some examples)
To answer the proposed premise: Having top performers is great for any agency. However, in order to fully take advantage of their experience you need to organize and charge beyond what is easily measurable. For some that can mean breaking deeply ingrained habbits and processes. This may take time and effort to learn, but in the end it will make your company more sustainable. Additionaly it will be easier to negotiate if you can articulate all the advantages you can offer, instead of only discussing the price and timeline.
Thank you for reading
I hope you enjoyed the article and maybe even learned something. If you would like to stay in contact I have a mailing list or you can reach out to me via social media.