Advertising agencies make money by charging their clients an hourly fee for their services. In addition to the fee, an agency places a markup on the price of all outside service work that is used, such as type, printing, photography, video production, etc., to complete a client's project. The markup varies with each agency, but the standard is 15 percent to 20 percent. Some agencies will charge as much as 30 percent to 50 percent. If they are asked to produce a rush job for a client (24 hour turnaround), it is not unusual for the agency to charge the client 100 percent markup on both agency fees and outside services. Along with fees and markup, an agency also earns a 15 percent commission from most media companies for the advertisements they place. So if an agency buys $10,000 in television time to run a client's commercials, the station that sold the time to the agency will give them a 15 percent discount off the total price of the purchase. That means that the agency will actually bill the client for the entire $10,000, but the agency will only have to pay the station $8,500.
Years ago, many advertising agencies were able to operate their businesses on commissions only. But the growing competition among media companies (newspapers, magazines, television, and radio) for a larger share of the advertising dollar caused many of them to eliminate commissions and begin charging agencies and direct clients the same discounted price. That decision opened a new market of business for the media companies from clients who no longer wanted to use advertising agencies, since it was now less expensive to place their own ads. In addition, these clients could hire a freelancer at half the price an agency would charge to produce their ads. A lot of agencies went under when this happened about fifteen years ago. The agencies that survived had to quickly restructure their pricing policies.
While some media companies were still offering discounted rates to agencies, the available client pool had thinned out, so agencies began to charge a fee for their creative and production services. Those fees today range anywhere from $50 to $200 an hour, or even more, depending on the location, size, and reputation of the agency. Few agencies charge a single rate across the board for all services. Their rates will vary depending on the service being performed. For instance, creative services may be billed at $120 an hour, layout and copy at $90. Mechanical preparation might be $60 an hour while clerical is only $35.
An agency operates on a profit margin of 1 percent to 10 percent, depending on how the agency is run and structured. So that means if an agency has a $100,000 account, the agency will end up with anywhere from $1,000 to $10,000 in its pocket as profit. The rest of the money will be spent on buying commercial advertising space and paying the agency for marketing advice, creative and production costs. It may sound like the agency will be making money on that; too, but that money paid to the agency from the client will be used to pay staff and operating expenses. The profit is what is left over when all the money has been spent to pay salaries and other expenses.
The question most often asked is how does an agency decide how much to charge for its fees. The agency does that by determining the total cost of its operating expenses. The operating expenses include rent, utilities, supplies, equipment, perks (cars, insurance, bonuses, and commissions), furnishings and salaries. As an example, if an agency's total cost to operate its business is $20,000 a month, and we multiply that by 12 months, we get a figure of $240,000. That is the minimum amount of money that must be earned in a year by the agency to pay for its operating costs. Of course, that leaves no profit. From there, to figure out how much the agency must charge its clients to bring in the minimum necessary to pay its bills, we need to go back to the operating cost of $20,000 a month and divide that by 4 weeks a month. That comes out to $5,000, which is what the agency now has to bill in a week. Then we will need to divide the weekly amount by 5 days, which will give us $1,000 each day. In order to determine how much the agency must charge to earn $1,000 a day, we need to divide that by 8 hours, and we get an average hourly rate of $125 per hour. That now becomes the base figure the agency can work with to structure its fees.
Since most agencies have more than one person doing billable work in a day, the agency can use the top figure of $125 as the maximum amount it will charge a client for work that represents its most valuable services. Those services generally include client meetings with agency principals (other employees might be billed at a lower rate since they are not being paid as much), and creative concept development. Then design and copy work can be billed out at a lower rate. And other services such as mechanical preparation, subcontractor consultations, and clerical can be offered at an even lower rate. With three employees working at an average rate of $60 an hour, for 5.5 hours a day (the average amount of billable time an employee is usually able to clock in a given day), the agency can still earn $990 a day, which is close enough to our $1,000 minimum needed in a day.
So that gives the agency a fair amount of latitude within which it can structure its variable fee rates. And since an agency will also be charging markup on services and getting commissions for all the media it places, in addition to the $1,000 a day earned in fees, the agency will be earning more on top of that to enable it to realize a profit.
