For the last decade I've been working for Web Development Agencies. All Agencies I've worked with seem to mostly wing it when it comes to operating their business. That's not to say they don't know their area of expertise. Most, if not all Agencies I have worked with know their craft very well. What I'm talking about is that most companies don't seem too care to much about how to operate the system that is their company.
More than once this has led to overworked workers, crunch culture, employee turnover and other negative effects. I believe that what I'm going to show you here is at the heart of why these companies are often compared to "Sweatshops".
Let's go through the different fundamental ways of how these Companies usually operate. For each Chapter there is a simulation you can play by clicking the play button.
In the most basic case, you are your own Agency. Usually this concept is called consulting or freelancing. Let's assume you are only taking jobs paid by the hour. You go ahead and plan how many hours a year you can work for clients and track that number during the year. The percentage number per employee reflects how many hours you have billed, compared to how many you planned to work.
The running percentage will vary depending on how many hours you were working. How many hours you can work then depends on how big your projects are, how independent you can implement then, waiting for client input, personal errands and so on. But all in all, it's a good number to keep track of. Not least so there are no surprises at the end of the year.
In this model there are few operational challenges. Your main focus is on your primary activity: Finding clients and working for them. As long as you keep doing that, you will be fine.
- Freelancing on an hourly basis requires almost no operational skills
- You will need good skills in your chosen area and in sales
- Your income is capped by the number of hours you can work and thus bill your clients for
If we take the single freelancer concept one step further, we can set up a scenario of a small company of consultants that work for an hourly rate. If I recall correctly, this setup is commonly used in Lawyer practices with multiple partners. The advantage here is that a dip in productivity (for example due to a gap in projects or personal reasons) can be compensated by the other members of the team. In addition to the individual utilization, we now also keep track of the company wide emloyee utilization, which is calculated by summing up planned and worked hours. This number, similar to a single freelancer, helps us keep a bird's eye view and warns us if we're running out of work.
This setup brings a certain risk of damaging morale, if one or more team members have to be compensated for more than others. On the flipside, it can provide a lot more security than each person operating as an individual.
- Similar to freelancing, this model requires almost no operational skills
- Your income is still capped by the number of hours you can work as a team
- Be sure to make an agreement about cross compensation ahead of time
The main downside to being paid by the hour (from a financial perspective), is that your income is capped by the amount of hours you work. As soon as you stop working, you stop earning money. So instead, you can decide to set your prices according to the value your work provides to your client, instead of setting your prices according to the number of hours you have worked. In practice, this usually means doing fixed bid contracts. These contracts have the advantage that you can secure larger agreements upfront and you can increase your return on investment if you can negotiate a good deal.
This will be the first time we introduce a new operational concept that will be important to keep track of. Since we now have fixed prices, we need to keep track of our return on investment (ROI) on these projects. To express the ROI as a percentage number, we compare the amount of actual time spent on the project to the amount of time planned for the project. Going above the planned number of hours will reduce our ROI and thus reduce the percentage in our simulation.
Since we now have two key metrics: Utilization and Project Status, we calculate our overall Company Health by multiplying the two percentages with each other. This will give us a new performance indicator that gives us an estimate of how well our company is doing.
The main insight from this simulation is what I believe to be the most important takeaway from this article: Changing from charging hourly to doing fixed bid projects brings with it a paradigm shift that I have seen many companies struggle with. In our example, the freelancer was very productive (the percentages should be almost 100%). Even though the freelancer utilized his time very well, his overall Company Health is low. Why is that? Because all of the projects went over budget; which is easy to see in the simulation and (usually) easy to measure in the real world.
There is a long list of possible root causes for this, but what I want to focus on is that in this case, bad project management caused a lot of headache. Due to how we've set up our measurements, we can also tell that compensating the overdue projects with additional work hours from our employees is fighting an uphill battle. A project that finishes 20% over budget requires an additional 25% billable hours to compensate. This is a problem for two reasons: First, because those hours could have been invested somewhere else. Second, if you ask your employees to work overtime, your workweek will go from 40 hours to 50 hours, which won't be sustainable for long.
- Working with fixed bid (budgeted) projects requires at least some operational experience
- Your income is no longer tied to the number of hours you work
- Inadequate project management can lead to crunch for your employees, if not identified correctly
- Crunch by employees can be a short term solution but will probably create churn in the long run
Next, let's take a look at how our new "paid by value" model works when we add a number of employees and projects. Scaling up this business model keeps the focus on good project management but adds some of the risk we saw in the pay by hour concept.
This simulation has three scenarios you can play through; each has a different problem area. Take some time to play around with them and see what you can learn from the simulation. Once you're done, take a look at my conclusions below.
Starting with scenario #1 (Weak Project Management); this simulation already shows something that I always felt when working in agencies but could never put my finger on: A lot of running projects pulls the average for the "Project Status" indicator way up. So a conclusion is drawn that having as many open projects as possible is good for business - at least statistically speaking. I have seen too many companies cover bad projects with the budget of new ones, sometimes willingly, sometimes because they didn't even realize what was happening. In practice, this approach is neither good for the company nor the customers. The real problem is bad project planning and will continue to be so until addressed.
Most Agencies will be familiar with scenario #2 (Low Utilization) because this is the metric that is most intuitive and easiest to track. Anyone who has had to bill their hours to a client will know the chore of booking your time in whatever software you're using. The only step missing is to sum up the bookings and you've already got a comparable number month over month. Because this number is so easy to track, it's also often mistaken as a solution for everything; be careful of that.
The last scenario - the balanced one - is what you should be shooting for. The most important thing to recognize here is that, as discussed above, you need both a well utilized work force and well planned projects.
- Projects that go bad can cost you more than you can compensate with your own time
- Low Utilization is measurable almost immediately, bad project management will take time to uncover
- Don't fall into the trap of repeatedly filling financial gaps by acquiring new projects
- Plan projects ahead of time to keep employee utilization up
Often Web Development Agencies are founded by young individuals because the initial Business Model is easy and intuitive. They become very good at what they do and focus on their craft, which is a good thing. However, once the size and complexity of the projects outgrows the scope of one or two people, things start to become difficult. That is when internal coordination and planning become more and more important. The biggest danger comes from not recognizing how the concept of your business has changed. It is during this phase that the company leadership needs to initiate change to support new paradigms. Which paradigms are relevant depends an your situation. In the examples above, I would suggest that investing more time into planning and managing projects becomes paramount.
The perverse reality is, that in the early years of a typical Agency, they get extremely good at eliminating most non-Client work. If we reflect on the first two scenarios in this article it becomes obvious why; it is the only way to ensure the company makes enough money. However, as I have hopefully demonstrated, some non-Client work will be needed to ensure your success in large bid based contracts by minimizing the risks.
The introduction of these roles is not an easy task. It is hard to find a balance between reorganising and continuing work for your clients. But in the end, it will be worth it and your company will be better off for it.
- If your business is growing, change is inevitable
- It may be necessary to break old habits
- Doubling down on what you know is not always the correct solution