Turning 45 this week has me thinking about the fundamentals of running a sustainable, profitable agency—and gross margin sits at the top of the list. For many agency owners, terms like gross margin and Cost of Goods Sold (COGS) can feel abstract or intimidating. But the truth is, understanding gross margin isn’t just about knowing your numbers—it’s about knowing your business.
If you’re looking to grow your agency or eventually sell it for top dollar, gross margin is one of the most critical metrics you need to master. A healthy gross margin doesn’t just signal profitability; it shows buyers that your agency is well-run and scalable. So, let’s break it down in simple terms and explore how you can optimize this key metric.
What Is Gross Margin, and Why Does It Matter?
Gross margin is the percentage of revenue left over after covering your direct costs—your Cost of Goods Sold (COGS). In an agency setting, COGS typically includes expenses like:
- Salaries for client-facing employees
- Freelancers and contractors
- Software and tools specific to client work
Gross margin = (Revenue – COGS) ÷ Revenue × 100
For example, if your agency generates $100,000 in revenue and your COGS is $35,000, your gross margin is 65%.
A healthy gross margin for marketing agencies is between 65% and 70%. This means your COGS should stay in the 30% to 35% range. Staying within these benchmarks ensures that you have enough left over to cover operational expenses, invest in growth, and generate profit.
Why Gross Margin Is Critical for Your Agency
Gross margin isn’t just a number—it’s a reflection of how efficiently your agency operates. Here’s why it matters:
- Profitability
If your gross margin is too low, it’s a clear sign that your agency isn’t operating efficiently. Without enough margin, you’ll struggle to cover fixed costs like rent, software subscriptions, and administrative salaries, let alone turn a profit. - Scalability
A healthy gross margin gives you the flexibility to scale without sacrificing profitability. When you onboard new clients or expand services, a strong gross margin ensures you’re not just working harder for the same (or less) money. - Attractiveness to Buyers
If selling your agency is part of your long-term vision, gross margin is one of the first things buyers will look at. A high gross margin signals operational efficiency and long-term sustainability, making your agency more appealing.
Common Mistakes Agencies Make with Gross Margin
Many agencies unknowingly sabotage their gross margin. Here are some common pitfalls to watch out for:
- Underpricing Services
Setting prices too low to win clients might get you in the door, but it will eat into your margins. Pricing needs to reflect the value you deliver and the true cost of doing business. - Overstaffing or Overpaying
Having too many people working on a project—or paying freelancers more than necessary—can quickly inflate your COGS. While it’s important to deliver quality, you need to strike a balance between excellence and efficiency. - Scope Creep
When clients ask for “just one more thing” without additional compensation, your margins take a hit. Clear boundaries and enforceable contracts are essential to protect your bottom line.
How to Improve Your Gross Margin
If your gross margin isn’t where it needs to be, don’t panic. Here are actionable steps to get it back on track:
1. Audit Your Pricing
Take a close look at your pricing structure. Are you charging enough to cover your costs and hit a 65-70% gross margin? If not, it’s time to raise your rates or adjust your service packages.
2. Streamline Operations
Identify inefficiencies in your processes. Are there tasks that can be automated? Can you consolidate tools or streamline workflows? Improving efficiency directly reduces COGS.
3. Manage Your Team Costs
Ensure that your team is working at full capacity without being overloaded. Use tools like time tracking and project management software to monitor productivity and avoid overstaffing.
4. Negotiate Vendor Contracts
If you rely on freelancers or third-party vendors, don’t hesitate to negotiate better rates. Even small savings can add up over time and improve your margins.
5. Track Scope Creep
Use clear contracts and change order forms to ensure that any additional client requests are billed appropriately. Protecting your scope protects your margin.
How Gross Margin Ties to Selling Your Agency
A solid gross margin isn’t just good for day-to-day operations—it’s essential if you want to sell your agency. Buyers want to see that your business is profitable and efficient, with enough margin to weather fluctuations or scale without major restructuring.
When your gross margin is within the 65-70% range, you’re showing buyers that:
- Your pricing is aligned with the value you deliver.
- Your operations are efficient and well-managed.
- Your agency has the financial stability to grow or adapt.
A healthy gross margin can significantly increase your agency’s valuation, making it a more attractive asset in the marketplace.
Final Thoughts
Understanding and optimizing your gross margin isn’t optional—it’s a must for building a profitable, scalable, and sellable agency.
Take the time to review your numbers, identify inefficiencies, and make the necessary changes to improve your margin. It might feel like extra work now, but the payoff is worth it. Not only will you enjoy a healthier business today, but you’ll also position your agency for long-term success—and a potential sale—down the line.
Gross margin isn’t just a metric; it’s a roadmap to a more profitable and sustainable future. Let’s make sure yours is on point.