Nick Petroski, Managing Director at Promethean Research

Nick Petroski, Managing Director at Promethean Research

About two months ago, we invited digital shops to help us shine a light on market trends, by sharing business conditions in 2018 and expectations for 2019. Nearly 170 shops responded, sharing a general consensus that business was good in 2018 with healthy revenue growth, solid employee efficiency results and strong profits. But there were some unexpected findings on how generalists did compared to specialists and different characteristics that had some shops growing much faster than others.

Thanks to our partner, Promethean Research, we were able to dig deeper into the data and collect insights across many key performance indicators for our annual State of the Industry Report. Nick Petroski, Managing Director at Promethean Research, joins us to talk about what the research revealed, a few surprises and where the industry is headed.

 
 

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Carl Smith: Hey everyone and welcome back to the Bureau Briefing. It was the week of Owner's Summit, the fifth one. And we are back after hanging out with 150 digital shop owners and reviewing a little thing we call the State of the Industry. Now earlier, about two months ago I guess, I got in touch with Nick Petroski who's the Managing Director of Promethean, so a great research firm. And Nick reached out to me and said "Hey you've got this great community. I've got this great skillset and great team, we would love to do some work together." So we did and we're going to talk about it today. But first welcome to the show Nick Petroski.

Nick Petroski: Thanks for having me. I appreciate being here.

Carl Smith: Yeah absolutely and thank you for all the work. There was some really crazy insights I didn't expect and if it's alright with you Nick I think we just go through it. What do you think?

Nick Petroski: Yeah definitely.

Carl Smith: So one of the first things was we had about 170 shops reply and we saw that a lot of them had been around for quite a while. Now the makeup of them was we had smaller shops that made up about 27 percent, we were calling those studios, they were fewer than 10 people. We had small shops in the 10 to 25 range and that was the bulk, 47 percent. Medium in 26 to 50 range was 16 percent. And then the large shops, greater than 50 people, were 10 percent. And that was kind of the same makeup I'm used to in the Bureau. That was my gut feel, it felt right. But the thing that kind of got me was when we saw how old these companies were, how long they've been around, and 92 percent had been around more than five years and 62 percent had been around more than 10. That kind of got me, I was like did not realize that the shops that were hanging out were that established. I knew some that were but I didn't know they all were. So was there anything when you started seeing the responses come in that just took you aside and you were like, "Whoa, didn't expect that."

Nick Petroski: Yeah I think the thing that really threw me off in a good way was just the health of the companies that were responding. So usually you see a few that come in they're good. A few come in they're bad. If you come in and everything is just on fire and they're sitting they're just shivering like "Is my company going to die?" But when the responses started rolling in I kept looking through them and I kept waiting for those companies that said, "Growth is falling off a cliff and we're never gonna be profitable again." But you just didn't see that. The vast majority of them were healthy just across the board.

Carl Smith: See this reminds me of something somebody said last year. So we put out a blog post which had kind of our 12 predictions for what would happen in 2018. Everybody does those things but evidently ours were super positive. And the person shot me a note and just said, "Hey, you're calling this the State of the Industry but I don't think that's right. I think it's the State of the Bureau." And they used this phrase the Bureau effect and basically they were saying that anyone who's part of the Bureau has made a decision that they want to work with other shops, share what they're doing, tell the truth about what's not working so they can get better and as a result lift up everybody in the Bureau to that higher level. To which I said, "Hell yes". I'm like, "OK, let's call it the Bureau effect and slap a TM on that thing" because if we all work together and we have some way to show that it's even better. But again it's just a gut feel because we don't know what's going on in the industry overall. But do you think, and I know it's not data and you're a data person, but do you think there's something to this in terms of the Bureau effect?

Nick Petroski: Yeah there could definitely be something there. Because you're dealing with a group of companies and individuals that have said, "Hey I'm interested in being better. I'm interested in improving our skillsets, improving our teams, figuring out best practices." And we've looked at this industry for about three years and on the whole best practices are pretty hard to come by. Everybody says they have them but what are those true best practices that have taken 20 years to learn. And I think that that Bureau effect is the facilitation probably of the transfer of best practices.

Carl Smith: That's awesome. When I was running my shop we used to call things industry standards just because we knew they couldn't find anything else. [inaudible 00:04:49] industry standard, net 10, that's industry standard. "What?", "Well show me that I'm wrong." But that is one of the things we've talked with people in the community about too is we do have this opportunity to kind of set what the standards are, to set what the best practices are, based on seeing what's working kind of across the board. So yeah it's one of the things that just gets me the most excited about the potential that we have as a community. Now we also saw that everybody reported that they grew with their year over year revenue in 2018. Now the largest shops, those with more than 50, grew almost 30 percent. And it kind of stair stepped down to the studios with fewer than 10 people who were kind of almost up to that 10 percent, like somewhere between five and 10 percent. Was there anything there that surprised you? Because to me this seemed to kind of make sense.

Nick Petroski: Yeah. The surprising piece was that is usually your large organizations have been around longer. They're the older ones. It's taken time to build up and get bigger. So you naturally think that they're going to be slower growing. They don't have as much market to go capture. And usually you see the smaller ones are the ones that say "Well we'll have 1000 percent year over year growth because we went from 1 million to 10 million." That was vastly different with this. You saw these large companies, some of which have only been around for a little while, and they were going gangbusters. They were growing twice what the medium sized firms are. And I think a lot of it is that figuring out what you're doing and what you're good at and that takes a lot of time, that takes a lot of effort to figure that out and you don't figure it out until your past that 50 employee mark a lot of times.

Carl Smith: And that's one thing that we've talked about in the Bureau for a long time. Between 20 and 50 employees we used to say is kind of where shops go to die because you get past 20 and suddenly the "Fred knows how to do everything model" or "Martha can show you all of the history model", doesn't work. Because those people are just not able to keep running it so you have to get more official systems, you have to get some level of structure, all these things that you weren't doing originally and when you start to do that the people who were there at the beginning start to get disillusioned as to what's going on so they leave causing more turmoil. And we used to say it's a race to 50 because if we can get to 50 you can get enough cashflow, enough revenue, that you can figure out the systems but you also have this culture struggle because you're bringing in people from the outside who now are in charge, I mean there are all these interesting things around that. So now that you mentioned it I'm like 'Oh wow that is kind of interesting."

Carl Smith: And then the thing that really kind of just punched me in the head, not the gut but the head, was this idea ... or not idea, it was data Nick, it was data. Generalist shops revenue grew 30 percent faster than specialized shops. We were talking about it at Owners Summit, we've been talking about in the community, that specialization is the way to go. And I still think that. But I'm curious with the generalist shops like how do we define that if you were a generalist or a specialist.

Nick Petroski: Yeah so I'm with you, I definitely think that the specialist way usually is easier. As far as how it was defined, we let them self-identify. So we didn't throw out a definition, we let say are you a generalist or are you a specialist.

Carl Smith: And so it didn't really ... Did you see once they identified that was ... because we asked them for a number of services as well or what they did. Did you see that generalists generally had five or more services or anything of that nature?

Nick Petroski: Well what we found when we really dug into it, we found that the ones that self-identified as specialists grew slower. We've been over that. The ones that offered fewer services though definitely grew faster. There was a positive relationship between fewer services offered and higher growth rates.

Carl Smith: OK so in that sense they may be seeing themselves one way but the reality is actually back into what we kind of thought.

Nick Petroski: Yeah. Or they could be defining themselves as specialists or non-specialists in different verticals. So they can pick ones that just handle oil and gas or a certain industry. And that's very different than the type and number of services that you're offering.

Carl Smith: Right. And then we did see that specialists were slightly more profitable.

Nick Petroski: Right. Right.

Carl Smith: So what does that say when you have generalists who are seeing this revenue growth, some of it quite large, but they're not necessarily making more money than they did?

Nick Petroski: Well it kind of ... you always tie it back to what your goals are for your firm. And a lot of times when you're growing that comes out of cashflow. You take a hit to not only cashflow but profitability. So you can dip into negative profitability for a while to get those higher growth numbers. And the converse is true also, if you're really good at web dev and design and UX/UI strategy you're probably going to be good at providing that service too, not just doing the work but the process of providing that service. So that's going to impact your profit margin if you're better at doing that.

Carl Smith: Well that makes sense for sure. You get better at it. You do it more. You learn to eliminate the fluff. It's like Robert [Sphere 00:11:10] was saying in his talk he gave about process for profit, you figure out that you can do this in a certain way and eliminate six hours of waste but not [inaudible 00:11:21] quality so. So that makes good sense. And it's interesting when we do look at the profit margins for the different sized companies. Their studios again with fewer than 10 people they had great profit margins. So did the large shops with greater than 50. But the 10 to 50, when we put the small or mediums together, it wasn't that they didn't experience a good profit margin as part of that revenue but they didn't do as well as the two ends, the two extremes of large and small. What is that about?

Nick Petroski: That's that goes back I think to the figuring it out. You just said the valley of death for a lot of your companies is 20 to 50. Your processes are breaking down there. When you're a small team you can move really fast and be really efficient because there's not a lot of overhead in the sense of process overhead. And once you start needing that overhead though to keep things on track and you don't have it, efficiency falls through the floor. So I think you see that in not so much in a small but in that medium, 26 to 50 employee sized firms. They're figuring those processes out. And once they get them, once they get those nailed down, profitability can shoot right back up.

Carl Smith: That's so true. I remember when I had my shop and we were just four people and we could get through 30 marketing sites in a month. And I mean they were good. I mean these were high quality. Now granted, CMS's weren't as big of a deal and all this kind of stuff. But once we got up to be like 35-40 people oh man one of those projects could've taken us a month where we used to get 30 done and it's just so ridiculous. But I think you're right, the medium, the 26 to 50, they have the lowest profit margins of all four groups and a lot of that probably is that they're going through that growth, the cashflow is weird, they're trying to build the team, like all kinds of things are happening.

Carl Smith: So I have publicly expressed my feelings about RFPs. I had a blog post that was titled Really Effing Pointless I believe, to the dismay of a couple of our clients who got the RFPs. But I really thought looking at the three years’ worth of research that we had from 2016 through the end of 2018, in 2016 about 75 percent of the shops reported that they responded to RFPs. And then in 2017 it dropped down to the low 50 percent, I think it was like 53 percent. And I wanted to do a happy dance man. I was like yes, because as an industry we were so young and cocky and we're going to do it our way. And then in 2018 I thought for sure it would go down again and it jumped right back up almost to those original levels where I think it was like 72 percent or something like that. I mean but it was a serious increasing of like 20 percent of shops who said they responded to RFPs again. Any thoughts on that, like what leads to that?

Nick Petroski: Well so we were chatting a little bit at the Owners Summit and I think it really has to do with the function of how much work is coming in the door. How easy is new work to find and to capture. And when new work is plentiful I mean you don't need to do RFPs. When it gets a little dicier and you're competing more and you're seeing maybe the industry that you've been serving for a while is having a hard time, you start doing more RFPs because your pipeline starts getting a little narrower. And I think this could be ... I don't want to say it yet but this could be a leading indicator of the health of revenue for the next coming months. I mean you look at the RFP response rates and that could really tell you how easy is work coming to these companies.

Carl Smith: And so when you say that, when you say leading indicator and I'm obviously not a researcher although I played one the past years at the Bureau, what would that mean for us? Like if we could start to pay more attention to who's responding to RFPs, the number of RFPs, that sort of thing, what would it mean to have a leading indicator?

Nick Petroski: It lets you plan out farther. So if you have visibility into the next 9 to 12 months of revenue these kind of leading indicators are things we look for to give us even further visibility. And so we try to find ways to be more predictive, to be more accurate in our predictions. And as long as we can manage our businesses with good and accurate predictions it's going to make it a million times easier.

Carl Smith: Well after this podcast let's figure out what we're doing here Nick. We need to get more access to this information. The other thing about our RFPs we found was that shops that did respond to them grew 33 percent faster than shops that didn't. And obviously again what we're kind of looking at it and I'm backing into a rationale a little bit but I think for a lot of shops that have decided that it's time to hunt again, the gathering's going great, account managers are getting hired throughout the community. We're seeing account managers one of the fastest growing hires, just based on seeing it not necessarily any data there. So people they are farming those current accounts but the ones that are going out after RFPs and some of the ones I've talked to I think they've made decisions that there's certain type of work they want, there's certain things they're focusing on and they're just going to go for it. So that's also a growth mindset, right?

Nick Petroski: Right. Definitely. It goes back to that how much effort are you spending on generating new business. And ones that go and spend effort to do that and then they make a conscious choice that "Hey I'm going to go after new stuff." I mean I think it permeates the firm.

Carl Smith: And if we look at our larger shops, the 50 plus, they probably have dedicated RFP people or at least a really well-honed process that the core people on the team can grab and go with that helps them go faster.

Nick Petroski: Exactly.

Carl Smith: And then we also get to the discussion that always gets people's backs up is that idea of billing methodology and how people go for it. And we have seen over the three years of doing this the value base has gained more and more traction. But so have retainers. So when we started looking at it and saying "OK what are we going to do?", if we looked at three years ago it was retainers and then time and materials ... oh no I'm sorry, retainers, fixed bid, time materials and value based. And then two years ago it was retainers, time and materials, value based and fixed bid. And then last year it ended up retainer, value based, time and materials and fixed bid. So it was amazing to see value based overtake. But then we also see the optimal pricing models, not necessarily what they were acting on the most. So talk about that a little bit. What do you see when you see this?

Nick Petroski: So I think the value based coming up is like we said that's pretty poorly defined. Really that could mean a lot of different things to a lot of different people. But I think that that's really getting at the heart of what are your services' value to your clients. And when you think about that and you think about how you make decisions when that's your mindset throughout your company you're going to make more decisions to create more value for your clients and you're probably going to earn more on those decisions.

Carl Smith: Yeah and I think you're right, it's a mindset, right?

Nick Petroski: Yeah.

Carl Smith: You're looking at what is the value versus what is the market necessarily.

Nick Petroski: Right.

Carl Smith: And again, until the community can come to an agreement on what value based pricing is and I've mentioned to you when we were in Austin, we asked for the community to define value based, just an open ended question, what is value based pricing. And of the 130ish answers we got that year I could only cull it down to seven definitions. I tried really hard but it's going to be impossible for clients to understand when there are a retainer model that's firmly in place in time and materials that's easy to understand for value based, called value based to get traction. But at the same time you've got Rob Hart talking about the value based hour. Because look, lawyers charge 350 and plumbers charge 80 and that's value. Just put into that that smaller mark. Or if you're charging for sprints like how much do you charge for that sprint. But if you have that mindset, if you offer value based pricing, not necessarily follow it with everything that you do, those firms grew significantly faster than those that did not offer value based pricing. Do you think that is really about the mindset or is there something else at play?

Nick Petroski: I mean it could be a few things. I think the mindset thing makes the most sense. You look at de-risking and de-risking your revenue sources and retainer is I think it's going to be hard to dethrone just because of how much risk it takes off of the agency and off of the digital services company. Value based does it a little bit in the sense that you're typically earning more so you can build up larger reserves even though your revenue might stay a little lumpy. But I think that the retainer thing is still going to stay pretty large and the value based being a mindset. You might see a mix where retainer starts adding more ... like the value of the retainer starts driving up a little bit.

Carl Smith: Well that would be interesting. And I know from shops that I've talked to that when they've got those retainers in place ... and the term membership is becoming much more frequent, the membership model, which is kind of like a very personalized retainer that also has a dedicated team and there's many other elements to it but at its heart it's still that monthly number that's getting charged. What's interesting to me is that it seems like the ones that have the strongest base of retainers are the ones that are talking about value because they probably feel they can add a little more risk into what they're doing.

Nick Petroski: Right. Right. I agree with that.

Carl Smith: And then we start to look at the services that are offered and one of the things we thought based on the trends we saw last year were that ... well it was that we were going to see more strategy and more research in terms of the revenue, in terms of what was generating the most revenue. So when we looked at it we saw digital strategy make a jump almost two spots up right behind web design and development in terms of the highest revenue generating services. Now web design and development is such a big bucket but we all do so many customized things that fall into those skillsets, I don't think that one is going anywhere for a while. But to see digital strategy and UX strategy jump up, that felt pretty strong.

Nick Petroski: Yeah I'd agree with that. I think it's good for the basket of companies even because you're going to be able to charge more for that, you're going to earn higher margins on that. And companies like your end users, your brands and your companies that you're working with are demanding more of that. There's a lot of in-housing happening as the different agencies picking ... or different agencies getting bought up by brands. And you have that how do I differentiate myself, how do I insulate myself to that. And the strategy piece is one piece that they really have trouble replicating in-house.

Carl Smith: And that's been true since the early 2000s when Include, Marty [inaudible 00:24:22] shop got bought Twitter. They bought the front of the house and it was strictly for the R&D that they were doing it Include. They didn't care about the development side. They took design side because it was implementing that strategy. But I think you're dead on there.

Carl Smith: And the other thing is as the baseline of web, micro sites and a lot of the things like that, the strategies, meh, UX is kind of dependent on the tool that you're using. So when you have a shop that's saying, "This is going to be the highest return for you, this is how you're going to build it", they're also building in their own design and development from that strategy. So strategy is kind of like that that lead service that you're offering so that you can get everything else.

Nick Petroski: Right.

Carl Smith: So 2018 was a good year and people overall had a good year in 2019. Everybody's feeling pretty good.

Nick Petroski: Yeah there's definitely optimism. We sliced it a number of different ways and pretty much everybody is optimistic.

Carl Smith: Yeah. Based on size, based on years that you've been around. And everybody is just saying, "It's looking pretty good." Now don't get mad at me but we do need to address that elephant which is that people are talking. There's a perceived chance, a potential for, a recession.

Nick Petroski: I knew you were gonna say it. I didn't want you to but I knew you were going to say it.

Carl Smith: But none of the numbers are looking at that. Yes, the world's in a weird place and good God what's going on in America. But it doesn't look like anything is pointing towards a problem in our space.

Nick Petroski: No and we do, Promethean, my partner developed a pretty predictive recession model. We use a number of leading indicators that some of them are flashing warning signs. I don't want to say it's impossible, everything's rosy.

Carl Smith: [inaudible 00:26:31]. Get him. Get him.

Nick Petroski: Right. There are some warning signs but on the whole things look pretty solid still. The consumer is still decently strong despite the recent retails numbers that came out. And you're going to lose a lot of money if you bet against the American consumer.

Carl Smith: I will say when I have been told that the economy was on the ropes I still can't get a parking spot at the damn mall.

Nick Petroski: Right. Well a mall might not be a good barometer yet but maybe a-

Carl Smith: It's a very nice outdoor mall Nick. They have an Apple Store.

Nick Petroski: Oh yeah, that's all?

Carl Smith: Oh okay, I see what's going on. Well if we're going to get a little chippy here let's talk about some of the challenges we are going to face then. Right? So attracting and retaining qualified talent.

Nick Petroski: Yeah that's always gonna be a challenge. I mean you look at the number of firms that are competing for really high end talent and it's ... I mean you look at the growth numbers and the optimism that some of these firms have and you can't grow just by throwing somebody fresh out of school in there, you need qualified talent.

Carl Smith: No that's it. And there's so many different companies showing up to educate people on building for the Web, research for the Web, strategy for the web, writing for the web, being a generalist for the Web. There are universities, I guess how they're defined or maybe they're called schools, showing up. There's a lot of talk about Google and Apple and Instagram and all of these types of organizations starting their own schools. And then we've seen it in the community. We've got a lot of people who have basically started their own apprenticeship programs and they're putting 20 or 30 people through them and taking three or four of the best and saying you're on the team now. So I think we'll see a lot more of that coming through 2019, just people growing the talent that they need.

Nick Petroski: Yeah I think you're going to have to. The in-house built talent it gives them a reason to stick around too because the retention number ... I mean you can attract all the talent you want but if you can't retain them, you're going to be spending so much on recruiters that it's just going to be put under. So building that talent in-house and showing that frankly you give a damn about people goes a long way.

Carl Smith: And realizing that your talent pipeline is every bit as important as your work pipeline. And so you're going to have to keep filling it because, guess what, it's the nature of it, people are going to move. In this industry people move really quickly. That would be something you and I should look at is like what's the average length of stay for different people in different positions because I think that would help the whole community as well to just understand that it's just the nature of it.

Nick Petroski: That would be ... yeah. Because we look at it on a whole. We look at what's your average turnover in a year and it's around 30 percent.

Carl Smith: Yeah. So let's drill into that for the next report to figure out what are those roles and how is that working. And then managing cashflow and growth. I mean we talked about it a couple of times but that's definitely one of the big struggles too.

Nick Petroski: Right. Right. They go hand-in-hand. You need to ... you're working capital expands when you try to grow. And unless you have the cashflow and the access to capital to finance that, you're going to be in a world of hurt. And it's going to look great from the top line but once you get to that free cashflow calculation that it just makes it so much more difficult.

Carl Smith: And then we get to sales and new business development. That's kind of the trifecta of our challenges here. And I think a lot of that comes from a lot of organizations realizing they're going to have to go after some of these higher level, different skillset, types of work. And as technology changes and the types of projects we want changed and what clients want changed, it changes everything about the process. So not only do you have to find people that you can trust that are doing a good job, you have to figure out how to implement them within your organization and you have to keep them educated because everything's changing so fast.

Nick Petroski: Yeah. It goes back to that attracting and managing talent a little bit because a lot of owners in the smaller end of the spectrum are handling all of the sales or a large portion of the sales and new [inaudible 00:31:09]. And once you have to transition that off to another person, figuring out how to hire through that, what type of sales organization you want to have. I get why that's a key challenge. It makes a lot of sense.

Carl Smith: Well Nick, thank you. We've kind of gone through and hit on the highlights. And is there anything you want to share about Promethean? I mean I know you from having worked with you now but just for people listening?

Nick Petroski: Yes. So we're problem solvers. We come in and we say "We do research and strategy and we're good at it." But what we're really doing is solving some of the hardest challenges that agencies and studios and digital services firms face. We try to put better inputs into our strategies. We do better research we think. So that should turn into a better strategy for clients at the end of the day.

Carl Smith: Well I will say you definitely did a better job than I've done in the past but that's a pretty ... I was a theater major. Let's just remember that. Pretty low hanging bar there.

Nick Petroski: You're not a bad analyst yourself.

Carl Smith: I appreciate it . When it comes to spinning up some stuff I have been told I'm good. Well thank you so much. And for those curious, there are two ways you can get a copy of this report. The first was to have participated. So if you're listening and you did participate and you included your e-mail address, you had the option to be anonymous, I will be sending that out very soon. If you didn't, the other way is to consider membership with the Bureau. So we've launched membership and we've got three levels.

Carl Smith: Very simple level which we call Learn which gives you access to our resource library, allows you to attend online events at no cost and also get to see all the event videos that we've got going on from our events.

Carl Smith: And then the middle tier which we call Connect and at the Connect tier you also get access to research like the report that Nick and I were just talking about. So that's a great opportunity for you as well.

Carl Smith: And then at the highest level we have our Lead level. And at that point we even throw in a concierge service so if there's some special you want to find out. If it's a certain piece of research or you're trying to find a certain shop, let us know. But we'll put links to all this in the show notes so you can find out more. And with that, Nick thank you so much, I appreciate your time today.

Nick Petroski: Yeah. Thanks for having me. I had a lot of fun.

Carl Smith: I'm glad. And I should say appreciate your time over the last several months because Nick has heard from me repeatedly. To everybody listening thank you so much and we'll be back again next week. All the best.


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