Not All Revenue is Equal

TL;DR

The shape of your agency’s revenue can have a massive impact on your valuation and your ability to grow sustainably.
The balance between projects and retainers is the main component of your revenue profile.
Fast-growing agencies completed about 25% more projects than the slow-growing ones while having about 20% fewer retainer clients.
Recent market dynamics are forcing a shift away from retainers and toward projects.
Client concentration is another major revenue profile component.
For your largest client, try to keep them below 20% of your total revenue. Keep your second and third largest clients below 10% each.
Client dilution is another issue, especially for consultancy-style agencies. These should try to keep clients above 5% of total revenue if under 50 FTEs and above 2-3% of revenue for agencies above 50 FTEs.
Client tenure is the last major component of your revenue profile; the industry average is 27.2 months. Note that this changes significantly based on agency size, target prospect size, service mix, etc.
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This newsletter adds context to our latest Agency Chats episode with Productive about how the shape of your revenue profile impacts agency valuations.

Digital Agency Revenue Profiles

The shape of your agency’s revenue can have a massive impact on your valuation and your ability to grow sustainably. The main components are recurring vs. project revenue, your client concentration, and your client tenure. There’s some nuance to these, so hopefully, I can capture most of it here.

Recurring vs. Project-based Revenue

The balance between projects and retainers is the main component of your revenue profile. During the latest Agency Chats episode, we discussed the balance between project and retainer-based revenue.

I dug into this a bit and looked at the relative split fast-growing digital agencies had in 2023 vs. the slow-growing ones. The fast-growing agencies completed about 25% more projects than the slow-growing ones while having about 20% fewer retainer clients. (I’ll be publishing a full report on this in the next newsletter that defines “Fast” and “Slow” growth agencies.)

I expect the ideal balance between project and retainer-based revenue shifts with the market. In past years, my research showed that retainer-heavy agencies grew more quickly during challenging economic times, while project-heavy agencies (especially those who could employ value-based pricing) grew more quickly during positive economic times. Last year was strange as many agencies struggled with sales, but the overall U.S. economy did well.

Recent market dynamics are changing what agencies are able to offer. The ease at which agencies can sell a retainer agreement vs. a project engagement is shifting. Many leaders report pushback from prospects on retainers as prospects are less interested in being locked in. I’ve heard similar stories about projects being split into smaller phases.

Prospects seem less eager to commit.

This seems to be forcing a shift away from retainers and towards smaller projects, regardless of the specific service mix offered.

Client Concentration & Dilution

Another significant component of an agency’s revenue profile is its client concentration.

Everyone’s heard how big of an issue this can be, so instead of harping on it, here are some guidelines from my Digital Agency Benchmarking Service:

For your largest client, try to keep them below 20% of your total revenue. Keep your second and third largest clients below 10% each. This will limit your overall exposure to your top three clients to 40% of your revenue.

Those lower yellow bars are the ones that don’t get enough time in the spotlight. They’re client minimums. This is especially important for consulting-style agencies that offer unique solutions to (supposedly) a few high-value clients.

This is client dilution risk.

Spreading your agency’s focus across too many clients can result in worse client satisfaction and, thus, retention.

To guard against diluting your client base, I recommend keeping them above 5% of your total revenue. That’s for consultancy-style agencies with <50 FTEs. As you grow above 50 FTEs, this can fall to 2-3% or lower. Likewise, the guidance is also different for factory-style shops. They’ll have many more clients that represent tiny fractions of their overall revenue. Most agencies have shifted toward consultancy-style shops over the last 5 years, so I benchmark against them.

Client tenure

Finally, I’d like to address client tenure.

Here’s more data from our Digital Agency Benchmarking Service (Ignore the “Your Agency” and “Peer Average” lines, I pulled this chart directly from the benchmark report):

The overall average client tenure is just over 27 months. (Note that this changes significantly based on agency size, target prospect size, service mix, etc.)

Consider the effort, months, and resources to acquire a new client. Then, realize that, on average, you’ll need to replace them every two years.

That changes the ROI calc a bit.

Client satisfaction and tenure start within production, but there’s a lot the account management team can do to lengthen these relationships. It’s a space in which I see a bunch of agencies underinvest.

A bit more sophistication here can go a LONG way.