Annual planning season tends to start with revenue.
How much work do you expect next year? How much of that revenue is already contracted? How much needs to come from new business? And what does that mean for hiring and capacity?
But once you have a reasonable revenue target, there’s another number that deserves just as much attention: what your people are going to cost.
For most agencies, people are by far the largest expense. A healthy agency might carry a salary load around 60–65%, which means relatively small changes in compensation can have a meaningful impact on profitability.
That makes raises, promotions, bonuses, and benefits more than HR decisions. They’re financial planning decisions.
And as you build your plan for the year ahead, there’s one principle that should guide all of them:
The average cost of your team can’t increase faster than the rates you’re able to earn from that team.
Here’s how to put that principle into practice.
When you’re planning people costs, there are really three variables:
The first two are largely strategic decisions based on your expected workload, capabilities, utilization, organizational structure, and growth plans.
The third is where compensation planning comes in.
If you already have a team in place, you're starting with existing salaries, bonuses, benefits, and other compensation. Your planning exercise becomes figuring out how those costs should change next year.
For base salary, those changes generally happen in one of two ways: raises or promotions.
And those two things shouldn't necessarily be treated the same way.
One useful way to structure compensation is to establish salary bands for each role and level within your agency.
Someone who remains in the same role can gradually move within that band over time. In that case, annual raises can generally be anchored around cost of living, with some variation based on individual circumstances and performance.
Your strongest performers may move a little further within the band. Someone experiencing performance challenges may receive a smaller adjustment or potentially no adjustment.
But across employees who aren't being promoted, the average increase should generally remain relatively close to your cost-of-living assumption.
Promotions are different.
A promotion means someone isn't simply moving within their existing salary band. They're stepping into a different role or level, and therefore into a new compensation range. That's where you'd expect to see the more significant increases in pay.
Creating that distinction also makes compensation conversations easier to manage. Employees can understand that normal annual adjustments and promotions aren't interchangeable. Larger compensation changes typically come alongside larger changes in role, responsibility, and expectations.
This is where compensation planning becomes a profitability conversation. An agency's service model depends on the relationship between what its people cost and what clients pay for their work.
One helpful target is roughly a 3:1 ratio between your cost rate and realized billing rate.
If your average cost rate for service employees is $60 per hour, for example, you'd want to generate roughly $180 per hour in realized billing rate to support a healthy margin at reasonable utilization.
Now imagine your team's average cost increases 3.5%. If nothing else changes, your margins shrink. To simply maintain the same economics, your realized billing rate also needs to increase by approximately 3.5%.
That's why raises can't happen in a vacuum.
If your annual client rate increases are roughly tied to inflation, but your average people costs consistently increase much faster than inflation, eventually the math stops working.
You're paying more to deliver essentially the same work without generating enough additional revenue from that work to offset the increased cost.
So, how much should you actually budget for annual raises?
One starting point is trailing 12-month CPI, which can provide a reasonable benchmark for changes in cost of living.
From there, individual adjustments can vary. Some employees may receive slightly more. Others may receive less. Promotions should be handled separately based on the market rate for the employee's new role and level.
The goal isn't necessarily to give every employee the exact same percentage increase. Instead, it's to make sure that when you zoom out across the entire organization, the average change in your team's cost remains financially supportable.
You can make different compensation decisions for different people while still managing toward an overall financial constraint.
There's another wrinkle agency owners need to consider: promoting someone can change the entire cost structure of a team.
Imagine you have five employees:
You decide one of those individual contributors is ready to become a manager.
Now you have two managers and three individual contributors.
You've increased the average seniority, and likely the average cost, of the team.
That doesn't automatically make the promotion a bad decision. But you need to understand what else is happening around it. Maybe you're growing and expect to hire several additional individual contributors. Eventually, you could have two managers overseeing eight individual contributors. The promotion makes sense because the broader leverage model remains intact.
Or perhaps you're anticipating attrition or another organizational change that will rebalance the team. But if neither of those things is happening, you've simply made your delivery team more expensive. That increased seniority needs to show up somewhere else in the economics of the business.
Let's say your agency isn't adding junior employees or changing its organizational structure. Instead, you're steadily promoting existing employees into increasingly senior roles.
Over time, your average cost rate rises faster than inflation. At that point, increasing client rates by a standard inflationary amount probably isn't enough. You need another lever.
That could mean changing the work you're selling, repositioning your services, increasing your pricing, improving delivery efficiency, creating greater leverage, or otherwise finding a way to increase your realized rate.
Because there are ultimately two sides to the equation:
What it costs you to deliver the work.
And:
What clients are willing to pay you for that work.
Those numbers can't drift apart indefinitely. If your team's average cost increases materially faster than your realized rate, margin compression is the inevitable result.
Salary is only part of your actual people cost.
When you're building your annual plan, you also need to account for changes in:
Benefits, in particular, may increase at a different rate than salaries.
Bonus and incentive structures can also vary significantly between agencies. Some may be tied to individual roles or performance, while others depend on company-wide results.
Regardless of how they're structured, they need to be included when you're calculating what an employee actually costs the agency.
If someone earns a $100,000 salary, their cost to the agency isn't simply $100,000. You need to account for everything else you're spending to employ and compensate that person.
When you're thinking about your average cost rate, total compensation is the number that matters.
Compensation planning can feel incredibly subjective.
Who deserves a raise? How much is enough? How much is too much? Can you afford a promotion? What will employees expect?
Those questions still require judgment, but putting financial constraints around the process makes them much easier to answer.
Start with your revenue plan. Understand the rates you expect to earn. Build the team structure required to deliver that work. Then model what raises, promotions, benefits, bonuses, and new hires will do to your average people costs.
The goal isn't to minimize compensation; it's to make sure your compensation strategy and your commercial strategy stay aligned. Because if your realized rates are increasing 3% while the average cost of your team is increasing 7%, that gap has to show up somewhere, and more often than not, it shows up in your margins.
The simplest rule to carry into annual planning: if the cost of delivering your work goes up, the economics of what you're selling need to keep pace.
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