October 21, 2012
This post is by Darren Woolley, Founder of TrinityP3. With his background as analytical scientist and creative problem solver, Darren brings unique insights and learnings to the marketing process. He is considered a global thought leader on agency remuneration, search and selection and relationship optimisation.
With the majority of agency remuneration being resource based (head hours / retainers) it is important for those working with these models to have a practical working understanding of the model to avoid confusion and mistakes.
This is why several years ago we developed the agency remuneration calculators you can find on our website here. It is also why 12 months ago we developed the TrinityP3 Resource Rate Calculator for iPhone and now have just released this Business App for Windows, Android and HD iPad.
But while the process is now easier with these apps and calculators, I have found that some do not understand the underlying methodology. So I thought it worthwhile to explain this in step by step examples.
So here we go. Lets take this in three simple parts. You need to consider three things:
1. The resources and their cost – A resource is a person. They get a salary. And they can work a set number of hours a year for you – Billable hours per annum.
This is the easy part. What do they get paid? Some people use the Direct Employee Benefit including compulsory pension / superannuation / health insurance etc. Others use Cost To Business which includes payroll tax and other directly related salary costs. Cost To Business is fine as long as you do not also account for these in the Overhead.
B. Billable Hours
Then you need to work out how many hours a year that person can be billed out / work for you so that you know how much they need to be charged out at to simply recover their salary. Billable Hours Per Annum is a factor of the number of working hours a year after you have taken out public holidays, sick leave, annual leave and non-billable time.
C. Salary Cost Per Hour
Then if you divide their salary cost by the number of billable hours per annum you get the cost per hour to recover their salary cost only.
But there are more costs in a business to be recovered than just the direct salary costs.
Those resources not billed directly to the client, such as the receptionist, the executive assistant, the finance team and the like are Indirect Salary Costs.
They appear in the overhead costs of the business. Or the costs associated with providing the resources.
2. The cost of providing resources
The next part of the calculation is the cost of business. This is the overhead cost of the business and the profit mark up or margin.
A. Overhead Mark Up.
This is typically expressed as a a percentage of the direct salary costs. So in an agency there are the salaries directly associated with providing services and then all other costs provided with those services. Ideally you should calculate the Overhead Mark Up for the whole agency and recover the overhead cost across all clients. You can of course calculate this by client, but it requires apportioning the fixed costs of the business against each client, often based on a percentage of their contribution to total revenue.
For a view of what is and is not included in the overhead calculation, check out this post.
B. Overhead Cost
When you add up all of the direct salary costs you can multiply this by the overhead mark up and add it to the salary costs to calculate the cost of resources. This is sometime expressed as a multiple, which is what you multiply the Direct Salary Costs by to get the Overhead Multiple.
C. Profit Margin or Profit Mark Up.
There is a difference and so it is very important to be clear if you are discussing a mark up or margin. Profit mark up is the percentage mark up of the initial cost to get the final price. While profit margin is the difference between the the initial cost and the final price expressed at a percentage of the final price.
Therefore if you are targeting the agency to achieve a 20% profit mark up and the agency is calculating a 20% profit margin there is a 5% difference between the two.
For simplicity lets stay with profit mark up.
D. Putting It Together
The profit mark up is applied to the direct salary cost and the overhead and not the direct salary cost alone.
That means that the profit mark up is rightly based on the cost of the resources which is the direct salary costs and the business overheads incurred to deliver these direct salary resources.
This is sometime expressed as a multiple, which is what you multiply the Cost of Resources by to get the Profit Mark Up.
If this is too hard, then simply check out either the agency remuneration calculators you can find on our website here or download the TrinityP3 Business App – the Resource Rate Calculator for either iPhone, Windows, Android or HD iPad here.
There are instructions on how to use it here.
Let me know what you think by leaving a comment.