The Digital Agency business model is under pressure.

A mix between technology and churn (due to misaligned incentives) are taking the punch out of a lot of digital agencies who have thrived over the last decade or more.

What is the outlook going forward for the (above-average) Digital Agency?

Digital Agency Business Model

The definition of a Digital Agency can vary greatly depending on:

  • the service provided
  • the vertical(s) targeted
  • method of charging clients

As we can see in the diagram below, there are a multitude of possible pricing models to deliver the service to the end customer:

SEMRush – How To Start A Digital Marketing Agency (2023)

The Digital Agency model can be broken down into a few broad buckets:

  • time based (hourly rate)
  • project based (flat fee)
  • performance based (results based)
  • commission (% of sales)

The Digital Agency model can work really effectively at times because it allows businesses to ‘outsource’ their creative talent and digital marketing functions to those with expertise. This reduces the need for businesses to hire internally for every position.

At other times, the model works very ineffectively because a Digital Agency is driven to maximize billings and is thus incentivized to continuously upsell their clients on other services.

In the absence of upselling current clients, a steady stream of new clients is required to keep the business model afloat, as costs related to staff and rent (for some agencies) remain persistent.

Problems with the Digital Agency Business Model

The problems can arise if the results for the client are not proportional to the spend objectives. Not every business aims for Return on Investment (ROI) for their Marketing dollars; some are looking for ‘brand marketing’ outcomes, which can be measured in a number of different ways.

An example would be a Digital Agency that sells social media marketing, typically a top-of or middle-of-the-funnel marketing activity that converts at a lower rate than bottom-of-the-funnel activities. The attribution would be different in this type of instance that performance-based marketing models like Ads.

If a business is spending with the mindset to acquire customers – and seeing results that are in line with brand-marketing outcomes – there will be problems.

Digital Agency Business Model - ROI diagram

As we can see in the diagram above, assuming there is a set monthly contract and minimal upfront Retainer Fees (as would be the case for most Agencies), a business will need to see a return on their spend in the mid to long-term for the Digital Agency relationship to make sense.

Marketing ROI (Return On Investment)

In reality, the cashflow is likely to inflow in a non-linear way, meaning that to see a return requires exponentially larger inflows over time to justify the upfront investment.

Digital Marketing ROI

The nature of the ROI calculation will depend on the amount of money spend upfront, and the expected time horizon to measure results. The higher the upfront costs, the more the pressure builds to perform in the future.

Some Digital Agency work such as SEO (Search Engine Optimization) and Paid Ads are more bottom-of-the-funnel, organic lead generation techniques. SEO will generally take many months to show results but become self-sufficient funnels, while Ads can be instant but require constant investment and optmization.

Below are several more examples from the Small Business Booster of areas a Digital Agency can work on.

80/20 Rule for Digital Agencies

At the heart of the above diagram, we can see the reference to the 80/20 Customer Analysis; simply put, this analysis is centered around the paradigm that, typically, 80% of profits will be driven by 20% of customers.

This rule of thumb is generally true for both Digital Agencies and the businesses they serve. Thus, the goal of the model is not to constantly acquire new customers, but to serve existing customers as well as possible.

Business Model Analytics – Behavioral

The average Digital Agency’s goal is to maximize its billings via growth of both its number of clients and billings per clients; ideally they want to hold on to as many clients as they can for the long-term and maximize CLV (Customer Lifetime Value) or LTV (Lifetime Value).

The average business owner’s goal is to do the same, and the way to do this is through customer retention and strategies that maximize loyalty/spend per customer. Any sort of “high-churn” strategies that focus extensively on new customer acquisition are likely to fail.

Lifetime Value (LTV)

The golden ticket is where both the Digital Agency and the business’s goals are aligned, which means to a certain extent the Agency’s offering needs to evolve over time with the business landscape. The best way to describe this is Business Model Innovation (BMi) and that is where we are at now.

Looking at the marketing world as a whole, most Agency-Client relationships last for a few years.

The industry average for the length of a client-agency relationship is just 3.2 years.

RThree

But for those Agencies at the top of the food chain (Top 40), the average relationship lasts for 20+ years.

The average length of the [Top] 40 was 22 years, showing that creating a good relationship tends to result in loyalty of business

RThree

This is consistent with the general principle stated across this blog for years, that in effect, loyalty is what pays.

As nearly 60% of B2B Brands use a Digital Agency (or equivalent) for the purposes of marketing, the question is how will the model evolve going forward to maintain loyalty and maximize CLV?

Digital Agency CLV (Customer Lifetime Value)

To maximize the opportunity for longevity requires deeper thinking and a commitment to testing certain variables that would have otherwise been considered “essentials.”

The long-short version of this is to:

  • reduce the barriers to onboarding new clients
  • prioritize trust and transparency, especially around billing
  • open the doors to innovation with existing clients to retain them

The advent of the entire digital and social media ecosystem over the last several years has shifted the paradigm for what constitutes a Marketing Agency, but some principles of the past remain tried and true in the modern era.

Prioritize the Customer Relationship

Speaking to many different businesses, it is not an uncommon occurrence for many to have had multiple bad experiences with a Digital Agency in one form or another.

The reasons can be multiple, but where there is a form of ‘trauma’ related to a past experience can only be ‘healed’ through consistent and honest communication from start to finish.

In the case of a Digital Agency, the goal is to maximize incoming billings. That won’t change. But the way those billings are generated and justified on an ongoing basis requires some commitment to metrics that can be tracked and shared.

To prioritize the Customer Relationship means to commit to some kind of objective criteria to assess the success/failures and to be available to answer to the process used to get to that point, whether good or bad.

Build Partnerships

‘Agency’ is in some way a word that doesn’t have the most positive connotations nowadays.

That’s because of either luke-warm/bad experiences in the past, or an interpretation that the nature of the relationship is likely to be short-term.

As stated earlier in this post, the top agencies are those that create long-term relationships with a core group of customers. These end up becoming much more akin to partnerships, and that’s where new value layers can be extracted.

Evolve the Model

Reducing barriers means making it clearer in terms of Value Proposition, delivery times, and price for the work being done.

An example is UK-based Now Comms that has created ”Hack Packs” around the key functional areas of web development and digital marketing.

Digital Agency - reduce barriers example
Now Comms

Upon clicking on one of the products, the terms of the delivery are explicitly stated (“completed within 30 days”). Although the pricing is not stated, it gives potential clients a much clearer ideas of what can be expected and by when.

Digital Agency - Marketing Automation Setup example
Now Comms – Hack Pack example

Evolving the model involves reducing ambiguity and giving potential clients more incentives to ‘get their feet wet’ and give it a shot.

Naturally, technology is another area that must be discussed, especially in relation to Artificial Intelligence (AI), but it requires its own whole section.

AI and the Digital Agency Model

Despite the uncertainty of how exactly Generative AI technologies will evolve in the world of business, there is a certain inevitability to it completely upending the Digital Agency model more so than other models.

That’s because a lot of Generative AI touches on creative disciplines such as photography, writing, video creation, and art. Whether or not we are interacting with bots or bot-created creative work will be a difficult undertaking in the future.

But as it pertains to the Digital Agency model itself, the challenge with these technologies is that they decrease the marginal pricing power of a lot of average Agencies because tasks such as copywriting, or email creation, or product photography become less valuable.

As we have seen through an analysis of most disciplines relative to the Creator Economy (including music, photography, and others), the top of the market generates the vast majority of the revenues for any given platform.

The skew towards the top performers will likely multiply with AI as applied to the Digital Agency business model; those who already are at the top of the heap will be able to leverage Generative AI technologies to increase reach and output. Those who are average or below average will lose their pricing power in the market.

There will be questions about ethics, sustainability, and end results relative to a lot of marketing disciplines and AI, such as SEO, web design, and others. But it seems undoubtable that AI will impact the core of the Digital Agency business model now and into the future.

Digital Agency Business Model Canvas

Digital Agency Value Proposition

Enable businesses to outsource certain elements of their marketing functions in places where building the in-house expertise is too costly or difficult.

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