AdNews 17 November 2006
Paying to win

Fees have replaced commission as the default method of agency payment. Most clients have moved from what was a volume based system to what is an input, or activity based system, by which agencies are compensated for time.

This change has been a painful process for agencies and clients. Despite its shortcomings, commission + service fee was easy to understand and administer, but few clients find it appropriate today due to the complexity of marketing communication channels and ideas. It also provides no incentive for agencies to reduce costs - an inherent conflict of interest, especially with Procurement departments often involved in agency selection and management.

There are various options for payment via fees. The most common are to charge actual head hours or to estimate the people resource needed to manage a pre-determined scope of work. Both give rise to arguments between agency and client.

If an agency is paid by time, it is in its commercial interest to talk up the number of people and hours required. The client responds by pushing for reductions to lower costs, but they may have no idea at what point reduced service levels impact quality.

These debates are frequently unproductive and potentially damaging to the relationship. And they are not necessary if a more enlightened value-based payment system is adopted.

Clients should be worried about the effectiveness of the work that comes out of the agency, not the time they put in.

In the excellent paper "Magic & Logic" produced in the UK by the IPA, ISBA and CIPS (agency, advertiser and procurement industry organizations) author, Marilyn Baxter, says:

"The agency role is to produce ideas that make profit for their clients' brands and businesses".

So why don't clients reward them for doing that?

Australian Agency income from performance based fees is believed to be only about 5% of total income. A pathetically small amount.

Much of that income will be based on qualitative performance criteria - typically using a relationship monitor such as APRAIS or Decideware's Agency Relationship Optimizer (which The Clinic uses). These are both excellent products for measuring and tracking performance and satisfaction in client/agency relationships, accommodating both qualitative and quantitative assessment criteria.

The Clinic refers to qualitative assessment criteria as 'soft', quantitative research criteria (brand awareness, brand health, purchase intention etc) as 'intermediate', and sales data as 'hard'.

Whatever performance-based payment methodology is adopted, experience shows that one size does not fit all. Every business has its own characteristics, goals, data sources and style of agency relationship.

Let's look at some of the options for PBR - performance-based remuneration (or payment by results) which are based on quantitative assessment.

The P&G Method

Procter & Gamble, the world's largest advertiser based on expenditure, pay their agencies a percentage of sales. The percentage varies by brand. P&G investigated over 20 possible approaches while developing their system.

P&G are not the only company to use a sales-based payment method. I claim to have initiated one of the first entirely performance based systems in Australia 15 years ago, when my agency charged Jaguar a fee for every car sold. We received no other income. The interests of client and agency were in harmony and we were paid by the same principle as the dealers.

It is a big step to move to a system whereby income is entirely dependent on sales. The detractors of such systems argue that there are too many things outside the agency's control. True. But there are many things outside a sales rep's control too, or the Marketing Director or anyone else. A bigger concern for agencies should be their clients' abilities to set achievable targets. However, if income is directly related to sales, it is easy to calculate the potential upside and downside.

The 'Hollywood' method

I am not sure who coined this term but I first heard it used by Russel Howcroft. This is a usage fee for the work. The same as residual talent fees for a television commercial, or 'trail' commissions paid to financial planners. The client pays the agency when their work is used. Pink Floyd are still living off their royalties from "Dark side of the moon". And deservedly so. Can't this work for agencies? It probably can, but there are difficulties. How do we define the idea? What constitutes a new campaign, no longer subject to copyright? What happens if the agency is bought? Who should get the reward - agency or creator? Rewarding an agency in this way is much more complex then paying talent fees.

Agencies will like the fact that it makes it harder for clients to change agencies. Clients won't like this. Indeed this is one of the biggest stumbling blocks against agencies' attempts to retain intellectual property rights in their work.

Clients will expect agencies to forego full income initially in return for usage fees, while Agencies see it as potential additional income. The 'Hollywood' system asks actors to forego fees for a slice of the action. Agencies will have to do the same if they want to seriously explore this option. (Note that it's much easier to measure the success of a movie (sales) than a multi channel advertising campaign.)

So I think it will be hard to get this method off the ground, although I like the fairness of agencies being paid when their work is used.

The Clinic's '3-tier' method

The three tiers comprise

  • Monthly Retainer
  • Creative "Scale Fees"
  • Performance Bonus.

The agency is paid a fixed monthly base fee to cover account management and strategic planning for an agreed scope of work. The fee is based on estimated head hours x market salary. This fixed retainer provides the agency with some cash flow and covers its direct costs. It is reviewed annually, or if the scope of work changes significantly.

Creative development and implementation is a variable cost. So, rather than pay fixed fees, we recommend payment for creative by way of a percentage of the marketing communications budget managed by the agency - in effect a royalty payment for use. The advantage to agency and client of including this variable component is that the agency earns more when the budget increases and less when it decreases.

A third tier income stream is by way of performance incentive based on hard, intermediate and soft criteria, as outlined earlier. KPIs should be in sync with the client's own KPIs.

The size of the potential bonus depends on the client and agency and their mutual confidence. 10%+/- is a good starting point. This can be increased as confidence in the assessment process increases.

All three of the above payment methodologies help to focus the agency on the client's objectives and reward them for achievement. They help to create a situation in which the result should be win:win for client and agency or, perish the thought, lose:lose. Arrangements like these can make the word partnership a reality for agencies, rather than a wish.

Colin Wilson-Brown is principal of The Clinic, a consultancy which advise advertisers on agency relationships, reviews and remuneration.

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