You say potato, I say potahto

As the line goes in “Let’s Call The Whole Thing Off” sung by Fred Astaire and Ginger Rogers in their 1937 movie “Shall We Dance”:

“You say “either” and I say “either”

You say “neither” I say “neither”

“Either” “either”, “neither” “neither”

Let’s call the whole thing off

You say “potato,” I say “potahto”

You say “tomato”, I say “tomahto”

Oh, let’s call the whole thing off”

You say “mark-up” and I say “margin”… and does it really matter?

Well yes, it actually matters a huge amount when it comes to the contract you sign with your agency. In fact on one recent job, it specified that the agency’s fees were based on the premise of a 15% profit margin. Nothing unusual in that I hear you say – it has been the industry standard for years. Between the client and agency, however, they had been working on the basis of a 15% mark-up for profit, which actually resulted in the agency’s profit margin being understated by 1.96% each year. When the contract is worth not just hundreds of thousands per year, but millions over its life, a reduction in profit margin of 1.96% can be quite a considerable amount of money.

The key points to remember are that a profit margin is a percentage of the selling price…A mark-up for profit is a percentage used to uplift the cost price…

So how do you work out the difference between a 15% margin and a 15% mark-up when calculating a fee rate? Well the key points to remember are that a profit margin is a percentage of the selling price (i.e. the hourly rate charged by the agency) and is calculated using the selling price and what is left after taking costs (i.e. salaries and overhead) into account. A mark-up for profit is a percentage used to uplift the cost price (salaries and overhead) to arrive at the selling price (the hourly rate charged by the agency). The maths is therefore inherently different.

Before I go any further, and for all those agencies and their legal teams who will read this, Financial Progression makes transparent to its clients what is in their agency contracts and how the financial side of things work. We don’t do any fee benchmarking or negotiate rates for our clients. We never advise a client on what they should be paying you, because it’s not what we are in business to do and, furthermore, we don’t know (and as an independent auditor, nor should we). We are in business simply to establish whether what you and your client have agreed has happened or not.

Now with that intermission over, let’s imagine a fee scenario where the model is for the agency to charge an individual’s direct salary + 100% uplift to cover its overheads (office rent, rates, salaries of non chargeable staff, etc.). We’ll then apply a 15% profit margin and a 15% mark-up for profit, each time using use a £100 per hour ‘salary’ and see what hourly rate pops out:

Margin v Markup

As can be seen from the table, the £100 (or $100 or €100) per hour salary and overhead are the same whether we are looking at margin or mark-up – £200 (or $200 or €200) in total. That makes sense in practice as the actual salaries and overheads incurred by the agency will be the same – it’s just the method of calculation that differs.

Based on that cost base, to calculate the hourly rate you will be charged so that the agency makes a 15% profit margin, multiply the £200 by 100 and divide it by 85 (you will see these amounts in the percentage column). Take the resulting £235.29 and subtract £200 and it leaves £35.29. The profit margin is calculated by dividing the profit earned by the selling price: £35.29 / £235.29 = 15%.

Looking at the mark-up for profit, the £230 has been arrived at by taking 15% of £200 (£30) and adding it on to the £200. A quicker way on the calculator is to multiply the £200 by 1.15 (115% of £200). If we then take the resulting £230 and subtract £200, it leaves £30. As before, the profit margin is calculated by dividing the profit earned by the selling price, in this case £30 / £230 = 13.04%, 1.96% less than 15%.

For an agency putting £1,000,000 of cost base on your account each year…that 1.96% difference will make £26,517 difference to its profit figure.

For an agency putting £1,000,000 of cost base on your account each year, with all other things being equal that 1.96% difference will make £26,517 difference to its profit figure. It’s not megabucks, but certainly enough to warrant spending the time to get right. N.B. If you use percentages other than 15%, the difference will not be 1.96%.

If you ever struggle with this (and, let’s face it, who hasn’t at some point, me included!), pick up the phone or drop me an email and I’ll send you a simple spreadsheet that will do the calculations for you using information you will already have to hand.

So next time you sit down to agree a rate card with your agency, do make doubly sure that you are both talking about the same thing when it comes to margin and mark-up. After all Fred and Ginger were a prime example that dancing is more fun when you are in step with your partner!

 

“Let’s Call The Whole Thing Off” (George Gershwin / Ira Gershwin), published by Warner/Chappell North America Ltd.

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