This is the final piece on our deep dive into the business models of the creative economy (for now): check out audience models, and access models part I and part II if you missed them

Let me start off by going on record: I love services businesses, as a business. 

If audience businesses monetize an audience’s attention, and access businesses monetize a consumer’s willingness to pay, then service businesses monetize something else entirely: they monetize the wants and needs (and budget) of a client. Services businesses are, by my estimation, the most common business model in the creative economy, often sitting inside audience and access businesses themselves. That is because unlike the other models, services businesses do not require significant finance risk to start up; if run well (big if), they are a margin-generating business whose cash flow can be used to offset the financial risks of either of the other business models. So – why are people so dismissive of them? 

Service models get a bad rap around their inherent value; they are seen as “cashflow” business rather than a “terminal value” business. Somewhere along the way, this idea got so pervasive that everyone stopped being an “agency” and started being a “studio”, as if that would somehow change the underlying economics. However, in my humble opinion, they are the most entrepreneur-friendly model that exists; they also form a crucial layer in the creative economy, which is to provide creative ideation and executional firepower, on demand, to bring ideas into the world.

The players:

Who is the boss: 

The client (louder for those in the back). Service providers sometimes fall into the trap of thinking the audience is their boss, and that the “performance of the work will speak for itself”; but unlike in access businesses, where you deal with an intermediary (ie a commissioner) on the way to a bigger boss (the consumer), all of the economic power in the services business sits with the client. In services businesses, the client doesn’t just influence the work — they define its value. Your output’s reception by the audience is of course very important to the relationship with your client; but at the end of the day, the client underwrites the risk in producing the product with their money. Said a different way: bad output in the eyes of the audience can ruin a client relationship, but you run a higher risk of getting fired by doing something the client doesn’t like. 

Therefore, service providers must straddle a difficult line: catering their creative outputs to the eventual audience it’s trying to reach, while also keeping the client happy. Everyone has had a client who claims to “understand” the audience better / more deeply than the service provider, who gives feedback on the creative product that runs counter to that claim. Straddling the line between the client and the audience is the difference between a run of the mill and a truly exceptional service provider - and between a creative who runs a business in service of their own ego, and one who understands that their client is their boss. 

The rapidly changing dynamics of the rest of the creative economy have pushed more and more people into the services field, whether they have realized it or not. In general, advertising (one of the core anchors of the services economy) now takes many, many more forms than the art and copy and TV ad business of yesteryear. This explosion in formats has led to a huge growth in specialized services businesses. Audience business and access businesses have started offering their creative on a for-hire basis. The decline in the typical studio / network cofinancing model and the rise of the “netflix global buyout” has resulted in an increase in “production companies” that own very little IP, but rather act purely as service providers. In short: more formats means more service providers, which means more competition, which in turn breeds more services providers.

That massive increase in formats, and the general pressure on ad budgets to drive measurable ROI, has meant that the longer-term contracts that used to underpin the services model have changed to short-term, project-based contracts focused on specific outputs. On the one hand: it’s never been easier to set up a services business, and win big, important clients. On the other hand: clients are spoiled for choice, pressure on budgets is real, and companies have a difficult time establishing genuine moats around the product they are providing. Services businesses have become high-churn, project-based businesses.

This churn has produced an increased focus (and pressure) on pricing and margins. Our next newsletter will cover the current (extremely hot) topic of outcomes vs time and material based pricing, but in all pricing scenarios, the building blocks are the same: there is some unit of cost (the time of people or the hard spend cost of “doing”) that has a margin added on top of it, that is prettied up and presented to the client. 

The ability to extract that margin is usually based on two things: the perceived value of your work in the marketplace (“the work speaks for itself”) and the length and depth of your relationship with the client. The client is willing to pay more once they know that the execution will be flawless, and that the ideas are good. In a market of increased competition, where everybody thinks “our creative output is the best”, the ability to form lasting relationships with clients becomes the biggest moat, and the biggest lever services businesses have to increase their margin. Once again, the client is the boss. 

It's easier than ever to start a services business; it's harder than ever to run one well. The first step is to determine what it is that you’re actually selling. The second is to figure out how much profit you’re actually making. The third is to better manage your capacity as an organization to that gross margin. 

I think of services businesses as split into two categories of service: paid to think (creative ideation, development, strategy, branding, etc) vs paid to create or do (production, media buying, influencer management, etc). The first (paid to think) is a human-cost based workflow: you’re typically using people to think, strategize, develop plans. The most baseline way to consider this is: is the output going to be a deck? That’s paid to think work.

The second, paid to create, usually has some form of other output: a physical or digital manifestation of whatever it is you’ve been paid to create (a video, an event, a website, an ad campaign, a physical or digital product). Smarter people than I have called this distinction the “strategy vs execution layer”. Most businesses want to do both; paid to think work is seen as “higher value” and “upstream”, but the majority of the revenue lives “downstream” in paid to create, which is more abundant and easier to win (albeit at lower margins).

They also tend to be priced differently: Paid to think work is typically priced on some version of time (whether implicitly or explicitly), whereas paid to create work is valued as some hard cost (Whatever the costs of building the thing was), plus some sort of fee, which can be considered the price of arranging or execution. Services businesses then have two major levers on pricing: what is the inherent strategic value in the "paid to think” work? And what is the inherent executional value in the executional layer “paid to create” work? 

These days, most service providers do both of these buckets, but where they run into a trap is failing to distinguish between the two services they are providing in their pricing. Oftentimes, creators moving upstream try to bundle their paid to think work in their execution margin; and thinkers moving downstream fail to appropriately value the execution layer. Understanding the true cost and value of each piece of service is crucial to maintaining operable margins and pricing power.

Nowhere is the focus on project-level gross profit more urgent than in the services business. That is because there is no long-tail monetization to be had from a client scope; no “audience building” exercise where there might be fruits of labor at a later date. Every client engagement is either a) an opportunity to make a margin that makes the work “worth it”, or b) an investment in a project that may deepen a relationship with a client. That’s it. 

Therefore, precise pricing, plus effective cost management, are paramount. The margin needs to be visible, and protected, at all times. For paid to think work - this means understanding the effort necessary to produce the output. For paid to create work - this means understanding both the effort and the hard costs needed to achieve the outcome. Where services providers traditionally fail is actually building systems to see and monitor those project gross margins; we’ve covered that at length here and here, but if you can’t tell me who your most profitable client is, or your most profitable product, then you do not have the operational grasp you need to effectively manage a services business in today’s environment. Most services businesses will have some grasp on how much they spend externally on a client, but are still vastly under-estimating the cost of their own people and effort. 

A killer in pricing is the cost of managing the client itself - and that is the secret sauce that gets a client to return. Both paid to think work and paid to create work are wrapped in a layer of project management that is sometimes ignored (from a functional perspective) or excluded (from a pricing perspective). Even if you’re just executing against a production budget - appropriately measuring and pricing the support work is crucial for controlling margin leakage and capacity. Appropriately resourcing the support work is crucial for making your clients come back again and again. 

Someone smarter than I am likened to running a services business to running a hotel; each person represents a room. Either that room (that person’s time) is filled by a paying client or it is not; but either way, you need to pay to maintain the room. This is what has made the shift to project-based workflows very challenging for services operators; managing the capacity of rooms, both now and in the near future, is a key job of an operator. Human capital management is the business model. 

All over the services industries, companies are considering their revenue curves vs their headcount. The answer, for many, has been to downsize full time cost structures and lean more heavily on freelance talent. These more flexible cost structures allow companies to decrease the “burn” of headcount in the lean months and bulk up when the dollars are in. This model is not without its flaws: it’s not as easy to wring as much work out of a freelancer, and there is significant operational headache from onboarding and offboarding, but it does generally allow people to better match their demand and supply curves. 

However, the shedding of full time roles at creative services businesses also means that the market is flooded with willing and capable freelancers, who don’t care if they’re working directly for a client or for an agency intermediary. Thus, in their attempt to right-size their cost structures, creative services have actually created a new competitor for themselves: their own ex-employees, which enterprising clients can simply hire themselves. 

If you spend any time on Linkedin, especially in the past few months, you probably think services models are doomed. AGENCY MEGA MERGERS and BRANDS IN-HOUSING and WHAT’S YOUR AI ANGLE seems to echo from all corners, and service businesses owners now (likely) wake up at 3am worried about whether they should “productize” their employees or move to outcomes-based pricing or just give up. 

But I remain anchored in a truth: services businesses remain the most necessary lifeblood in the creative universe. Clients have been turning to creative services businesses for a long time because they need what these businesses provide: fresh thinking, capable hands, and talent alchemy. Services businesses remain an excellent path to creative entrepreneurship, because they remain relatively (vs. access or audience businesses) capital-light. Services businesses aren’t going away — they’re just getting harder to run well. The winners will be those who can manage cost, pricing, and capacity with precision.

Product plug: if you’re a service business operator looking to optimize your cost structure, your pricing, or how you utilize your team - drop us a line.