Why matching demand with capacity is so important for agencies and professional services firms.
Chris Johnson talks to The Virtù Group CEO, Tracey Shirtcliff about why matching demand with capacity is so important, yet generally ignored in the agency world.
Sitting down with visionary agency CFO, Chris Johnson, he talks about why matching demand with capacity is so important, yet generally ignored in the creative services industry.
[Tracey] So Chris, tell us a little about yourself.
[Chris] A Chartered Accountant with an MBA. I’ve worked as CFO, VP of Operations and CEO for a number of British and American owned multinationals across a range of sectors. That includes 7 years as Regional CFO of a global ad network with financial oversight for 40 agencies operating in 5 countries.
[Tracey] That’s an impression bio Chris. And I’ll add a further accolade. You were one of the first CFOs in that region to implement SCOPE – our pricing and scope management platform. You got it straightaway. A real visionary leader.
"If you can't measure demand and capacity you can't manage efficiently".
[Tracey] Just ahead of this call, we started talking about Gary Hamel and C.K. Prahalad’s insights on competitive strategy. They link an organisation’s growth potential to their ability to identify, cultivate and exploit their core competencies. Can you talk a little more about this?
[Chris] If you can´t measure demand and capacity, you can´t manage efficiently. An improvement of just one tenth in labour efficiency would improve the profit, and the value, of a typical agency by 50%. For an agency group such as WPP, that would be an additional £5 billion in market value.
An agency is a money-making machine. If you cannot build a more efficient machine then, to get more out, you need to build a bigger machine. Increasing efficiency by 10% is equivalent to growing revenue by 50%, which is far less controllable.
It is important to match capacity with demand and ensure that you have the right quantity of people, with the right skills, at the right level of seniority, to meet demand. Excess capacity is a waste of money, but a capacity deficit will result in the late delivery of work, compromised quality and reputational damage that restricts pricing and growth.
As an investor, removed from the daily round of agency management, it would obviously be gratifying to know that agencies are managing their resources efficiently.
Agencies are dynamic environments on both the client and staffing sides. Both the demand side and the capacity side of the equation are fluid. The equation itself changes faster than agencies could ever calculate the answer.
"Agencies are being challenged on pricing, not creativity, and they haven’t learned how to defend themselves."
[Tracey] With this sort of impact, you’d expect agencies to be focused on analysing demand versus capacity. Why do you think they are not. Is it because they haven’t got the right tools?
[Chris] It’s an intertwined question of cultural legacy, mindset and yes, not having the right tools. Without the right tools it is difficult to do the job, but agencies also lacked motivation.
Agencies once won lucrative contracts on the basis of their creativity and service levels. They provided a Rolls-Royce service at Rolls-Royce prices. Creativity was the critical success factor and cost efficiency wasn’t important. Creative people feel comfortable in flexible, spontaneous environments and resist the restriction of planned, controlling environments. Not only did high fees render the pursuit of efficiency unnecessary, but cultural preference also rendered the pursuit of efficiencies, and the introduction of the required discipline, undesirable. Agencies didn´t want to plan, they didn’t need to plan, and because they never attempted to plan, they never developed the tools.
Now, the balance of competitive criteria has shifted. Agencies are being challenged on pricing, not creativity, and they haven’t learned how to defend themselves. They have not been exposed to planning and capacity management disciplines in the past, they have not seen them applied, they do not know how to apply them. Developing the disciplines and tools is not something that agencies are equipped to do from scratch.
"...describe and quantify your units of output, and units of input, and determine standards for the expected rate of conversion (i.e. inputs into outputs). Agencies do none of this."
[Tracey] How do agencies go about measuring demand and capacity? What practical tips can you give?
[Chris] Agencies sense pressure on capacity, or a lack of it, and they respond to that pressure, but they don’t measure it. When they win new clients they hire new staff, when they need to cut costs, they fire some staff. It is a very imprecise methodology and is biased in responding to shortages rather than excesses in capacity.
Before you can measure capacity, you must describe and quantify your units of output, and units of input, and determine standards for the expected rate of conversion (i.e., inputs into outputs). Agencies do none of this.
In manufacturing, a product has a bill of materials and a routing; these show what material is required, what processes it will be subjected to, using which machinery, for how long, in what sequence, and what labour is needed at each stage of operations. All of this is scheduled to minimize conflicting demands on labour and machinery and to optimize the efficient, coordinated production and assembly of thousands of components. This is the sort of thing that must be done. Project management tools don´t do this.
"Agencies have not adopted efficient management policies. They have attempted to cut costs, which is not the same thing."
[Tracey] There are clearly benefits to measuring demand and capacity. What are the repercussions of ignoring it?
[Chris] The inverse of the benefits. Which, broadly speaking, amount to a long-term decline in profitability and value.
To be clear, the extent to which the benefits and repercussions manifest themselves is proportional to the extent to which efficient management is important. If prices were extremely high or resource costs were very low, then efficiency wouldn´t matter very much. It matters today in the agency space and that is why agency values are in decline, despite falling interest rates.
Agencies have not adopted efficient management policies. They have attempted to cut costs which is not the same thing. Efficiency is like, improving an aeroplane´s aerodynamics so that it flies further with less fuel. Cost cutting is just buying less fuel. The consequences of that are obvious.
"Quality doesn´t mean ´absolute best´ - as in ´Rolls Royce´ it means ´consistent delivery of what was promised'..."
[Tracey] Moving on – agency profitability. How DO agencies make money and increase value? What are the drivers?
[Chris] Agencies make money when they sell their work for more than it costs them to produce it. If they can do this, they generate a positive cashflow and ´make money´.
The value of an agency is equal to the present value of the money it is expected to make in the future. That depends on how much money it is expected to make, when it is expected to make it and the discount rate applied in reducing that future cash to present value. The discount rate depends upon risk, which is inversely proportional to volatility.
To maximise value, the agency must hold prices up, costs down, and grow profits as fast as possible whilst keeping costs variable, rather than fixed, and minimising capital employed.
Product quality is key to pricing and to growth. Efficient resource management – matching demand with capacity – is key to avoiding unnecessary costs. Scale of operations is key for keeping purchase costs down for those resources that must necessarily be acquired, and avoiding fixed costs is key for avoiding volatility in returns. Capital investment should also be kept to an efficient minimum.
The watchwords for value creation are ´quality and efficiency´. Quality doesn´t mean ´absolute best´ – as in ´Rolls Royce´ it means ´consistent delivery of what was promised´ – as in Toyota. In an agency context, quality it is not a question of producing the best ad or planning the best campaign – that used to be the goal when fees were high – it is a question of consistently delivering what was promised and promising the best that can be delivered on time, at a profit.
"...agencies do not measure what they deliver. Without comparing what they delivered to what they agreed to deliver it is difficult to avoid, control, price and recover the cost of excessive rework..."
[Tracey] Where are the gaps? What are the common pitfalls?
[Chris] The first gap is a lack of clarity as to what is to be delivered. If the scope of work is not clearly described, then neither the agency nor the client can be sure about what was agreed. People believe what they want to believe, the client is apt to believe that more services are implicit in a vague agreement than does the agency. This likely results in an unsatisfied client and reputational damage that harms agency growth and value; or in the agency performing work that it hadn´t bargained for, at a cost that harms profit and value.
Secondly, agencies lack consistent methodology for determining the quality and quantity of resources needed to deliver what was promised. Consequently, they cannot accurately estimate their costs. Over-estimating cost will lead to over-pricing; they will lose business and miss out on opportunities for growth in profits and value. Under-estimating cost will lead to under-pricing; they will sell at a loss, realizing negative growth in profits and value.
Without a clear statement of work, and a consistent framework determining what resources are needed to deliver it, an agency has no way of measuring demand for resources. It will either waste of money on excess capacity or suffer a capacity deficit.
Thirdly, agencies do not measure what they deliver. Without comparing what they delivered to what they agreed to deliver it is difficult to avoid, control, price and recover the cost of excessive rework, scope creep or other deviations from plan. They will incur unremunerated costs, resulting in losses that harm profits and value.
Fourthly, agencies have no independent objective standards standard against which to measure efficiency and benchmark their own performance. So, they overlook opportunities for improving efficiency and enhancing profit and value.
These are four critically important gaps in agencies ability to manage quality and efficiency. They have a strongly negative impact on profit, growth, and value.
"With SCOPE, you will not take on loss making business unknowingly. With SCOPE you will, necessarily know what you are committing to deliver and what resources you need to deliver it."
[Tracey] You’ve seen / worked with SCOPE and know what we do. How do you think it can contribute to the way agency leaders think and mange price, process and tools?
[Chris] People – for each engagement, SCOPE generates a report describing and quantifying the deliverables and the resources required to deliver them. SCOPE provides a clear statement of demand both in terms of the quality and quantity of staff resources needed. Aggregating the individual scopes provides aggregate demand for the agency and it is easy to compare this with agency resources to determine whether demand and capacity match.
Price – a lot of pricing agreements come down to determining the size of team and negotiating hourly rates for labour and overhead, plus a permissible margin. It is a pricing disaster that in only vaguest possible terms makes any reference to the detail of the work to be performed. With SCOPE, one can see the price for all planned deliverables, and it is possible to negotiate alternative strategies – different sets of deliverables – that provide greater value to the client, or are cheaper, rather than simply surrendering price.
Process – this connects with the points on pricing and the speed with which different delivery strategies can be formulated and priced using Scope. Agencies share similar skills sets but they can configure very different solutions from those similar ´ingredients´. Different agencies will adopt different approaches to solving the same problem, and different staffing solutions for any given approach. Scope makes it possible to view and discuss these customized solutions, not simply the gross staff allocation and the hourly rate.
Tools – this is the critical point, computers need data, humans need information. SCOPE processes data and presents information that empowers leaders to make decisions with confidence. SCOPE does this fast enough to be deployed in real time discussions and to allow for multiple strategies to be considered on a collaborative basis. This boosts client engagement and ´buy-in´. It allows for interactive, intelligent discussion.
When working with SCOPE, you inevitably come to a level of understanding of your business that qualifies you to manage it properly. With SCOPE, you will not take on loss making business unknowingly. With SCOPE you will, necessarily know what you are committing to deliver and what resources you need to deliver it.
"The pandemic has broken down many pre-existing systems. It has created space for change, and it has reduced resistance to change."
[Tracey] Finishing on a positive, what silver lining have you witnessed in the COVID fallout? How should agencies and professional services firms be looking to the future post COVID?
[Chris] The pandemic has broken down many pre-existing systems. It has created space for change, and it has reduced resistance to change. There will be new entrants pushing for access into all sorts of markets, new ways of working will find fertile ground, and some will take root. I think that’s a positive
For professional service firms, offices have become largely redundant. As the physical presence of firms diminishes, the essence of the firm as a developer of methodologies and a coordinator of professional staff comes to the fore. The diminishing importance of geography and physical space will facilitate the expansion of small, regional firms and the entry of new firms.
So, I think service firms should be looking to ensure that their methodologies are brilliant and purposeful, and to promote the advantages of those methodologies, and to build digital infrastructure for training and coordinating remote teams – as an alternative to the physical infrastructure they can leave behind. Covid has accelerated the digital transition. There are no boundaries in the digital landscape so finally, I´d say that service firms should be looking to expand digitally, across geographical boundaries, and should also prepare to face inbound competition from firms that are smaller and cheaper. At the end of the day, it is going to come down to methodology, process, and connectivity.
[Tracey] Thank you Chris. It’s been a real pleasure talking to you about the importance of matching demand and capacity during this fireside chat.
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