Profitability curves upward

Business terms explained

The October 1994 edition of Willott Kingston Smith’s Marketing Services Monitor showed design consultancies reversing the decline in operating profit per head, and more recent results show a continued improvement.

The index for operating profit per head (calculated by reference to a base figure of 100 for financial periods ending in 1985) is 55.4, according to the most recent figures. While this means that consultancies are only a little over half as profitable as they were back in 1985, the figure does, nonetheless, represent a considerable improvement over the low of 44.8 that was published in May 1994.

The total amount of money spent on design (measured by the aggregate turnover of the consultancies we monitor) has fallen once again – by a further 7 per cent, according to the most recent figures. This may be due to a change in the mix of work (more fees and less recharges), price pressure or reduced demand. Design Week’s last survey of industry trends (DW 5 August 1994) reported workload up in volume but static in value. This finding could be reconciled with consultancies’ actual financial results if it resulted from an increase in design activity when rechargeable production work was running at much lower volume.

Our figures show that, although invoiced value may have been lower, the gross margin generated was higher. This suggests that fees formed a greater proportion of turnover at the expense of lower recharged production costs, as the average gross margin on turnover has increased from the 40.3 per cent reported in last October’s Monitor to 46.3 per cent now.

Certainly, the increase in the index for gross income per head does not suggest there is reduced demand. So the most likely explanation is that clients are taking more production costs in-house in an effort to control costs. It also suggests that designers generate more income per hour on creative work than on handling production.

Attempts to increase fee income may reflect a growing trend for design consultancies to reposition themselves as “communications consultants” so as to distinguish their offer from that of the number of talented designers working from home, with low overheads and correspondingly low prices. Anecdotal evidence suggests this is of increasing concern as designers face continued price pressure. It has become more important to demonstrate the added value a design consultancy can offer.

Willott Kingston Smith’s monitoring shows that the number of people employed by design consultancies fell in the period under review – confirming Design Week’s last survey which also reported a decline in staff numbers. The sector has suffered high exceptional costs as staff and other commitments were cut – tough management decisions taken in response to continued pressure on income. Consequently, ongoing staff costs and property commitments have been reduced considerably.

In Design Week’s last survey, designers also reported that the use of freelances had levelled off. If this is the case then productivity has improved considerably. Nevertheless, the use of freelances to cope with busy periods, rather than increasing the permanent head count, must continue to be a sensible strategy while income is unsure.

The aggregate gross income of design consultancies has increased by 6 per cent since the last issue of Monitor. The gross income per head index also increased by 6 per cent in the same period. This compares extremely favourably with a 0.5 per cent increase in Retail Price Index. Employment costs per head only rose in line with inflation while employee numbers reduced. The consequent improvement in the ratio of gross income to employment costs – now at 156.9 per cent and approaching 1985 levels – is encouraging, although both fall short of the “ideal” 200 per cent.

Disappointingly, the rise in gross income has not all been translated into profits. Operating profit per head increased directly in line with gross income and so the ratio of operating profit per head to gross income remained constant at 6.5 per cent. So designers have a long way to go before achieving the 1985 operating profit margin on gross income of 25.2 per cent. To their credit, there are a number of individual consultancies included in our survey which are achieving ratios in line with the 1985 average. The sector average is driven down by the inability of a couple of sizeable businesses to reduce fixed costs, principally property costs, sufficiently to match lower income.

Given the level of exceptional property costs and provisions in the most recently published figures, it is to be hoped the next results to be published will show an improved position. The biggest danger is that any uplift in client spending will trigger a new burst in recruitment and other costs before consultancies can really afford them.

Design consultancies have worked hard to restructure their cost base and bring fixed costs more in line with lower income levels.

Productivity is up. If clients start to spend again (and the general feeling is that they are beginning to do so), design consultancies should be well placed to turn income into bottom line profits.

Amanda Merron is a partner in Willott Kingston Smith & Associates, which specialises in advising people and businesses on financial and business management matters.

SBHD: Business terms explained

* Operating profit per head: The profit the company makes before interest income or charges.

* Gross margin: Proportion of income generated per ú of turnover.

* Gross income per head: The sum of fee income and the mark up the company makes on recharging production costs.

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