A Down Under Look At Advertising Agency Compensation.
Here is some real fine thinking on the ‘art’ of advertising agency compensation from my book on pitching and presenting: The Levitan Pitch. Buy This Book. Win More Pitches. Do yourself, and even me, a favor and buy the book right HERE.
For a very experienced expert opinion on compensation (or as the down unders say: remuneration), I turned to Darren Woolley, Manging Director of Australia’s TrinityP3 for his views on something of great import for agency CEO’s that often wake up in the middle of the night screaming…
“Show me the money.”
FYI: Darren is one of 20 advertising search agency consultants in the book that offered their perspective on what agencies do right and wrong when pitching for new business.
Trinity P3 is an independent strategic marketing management consultancy based in Melbourne, Australia. Trinity P3 works across continents and has 40 of Australia’s top 100 advertisers using its services. The company assists marketers, advertisers, and procurement with agency search & selection, agency engagement & alignment, and agency monitoring & benchmarking to ensure maximum performance in efficiency and effectiveness of their advertising and marketing budgets.
Darren started as a scientist, got into advertising as a copywriter, and ended up a creative director. After 15 years in advertising, he realized when marketers and their agencies work well together, amazing things happen. He established TrinityP3 in 2000 as an independent marketing management consulting company that provides marketers and advertisers with benchmarks, training, and advice on how to maximize the value of their marketing budgets.
Regardless of your word choice (and you will see that it is important), how agencies get paid and then make a profit needs to be considered during the agency selection process. Too often agencies wait until they win an account to find out if the account will be profitable.
PL: You work across Asia. Are agencies compensated differently in each country? Is Asia different than Europe or the U.S.?
Darren: The basic methodologies for agency compensation are the same. The application varies across various markets due to culture and government legislation. As you may know, in Brazil, media and creative are legislated to remain together, and the commission system therefore continues to dominate. In India, the commission system is also more common than other markets. But increasingly, the dominant model is the resource-based model as either a retainer or project basis.
The other big difference is the term used. In the UK, and markets previously colonized by the UK, it is called remuneration. While US and US influenced markets call it compensation. While many think the two are synonyms, the fact is they reflect different philosophies. To compensate is to make good for damage or loss. While to remunerate, is to reward for output of effort. To provide the difference, you would never say, “The middle-aged executive purchased a new sports car to remunerate for his flagging libido.”, would you?
But I think that the use of each reflects a very different underlying philosophy to the payment of agencies for their services and efforts.
PL: What compensation systems are your advertiser clients using?
Darren: The majority of clients are moving to or sticking to a resource based model using direct salary costs multiplied by the overhead and profit multiple, and divided by the number of annual billable hours in the year. In fact, it is so common that we created a smartphone business app that calculates the cost of resource per hour using this approach or can calculate the salaries from the hourly rate. It is called the TrinityP3 Resource Rate Calculator and is available in all smartphone app stores. This is not an ad, as the app is free.
PL: I am not sure that all agencies understand the difference between fee, resource based, and performance models. Can you help with definitions?
Darren: There is much confusion about many of the terms supporting agency compensation. And the interpretation seems to vary depending on the interests and position of the person using them. Therefore, it is important to ensure that all parties to the negotiation are working to the same set of definitions. The definitions we use are as follows:
Fees: This is where a fee is agreed on between the advertiser and the agency for the services provided. These can either be an hourly or daily rate to be applied by role and multiplied by the number of hours or days taken.
Project Fees: This is usually where a project is defined and a project fee with a fixed price is set, usually based on an estimate of the time and resources required, but charged on the output, no matter what the outcome.
Resource Based: This is the most common and is where the cost of the resource provided is based on a formula where the direct salary cost of the resource is multiplied by an agreed overhead and profit multiple to determine the annual fee for the resource, and then divided by the percentage of their time required. This is the underlying approach for most retainer arrangements. It is also considered the ‘cost recovery’ method because it recovers the agencies largest cost, people, and the associated overhead.
Performance Based: This is where some or all of the agency compen- sation is put at risk, with payment determined by meeting or delivering a pre-determined set of results or performance criteria. These performance criteria usually fall into one of three categories: Soft (relationship, service delivery, client satisfaction), Medium (marketing and advertising metrics), and Hard (sales and financial performance). I will expand on these below.
Value Based: This is relatively new compared to the other approaches, but basically it is where the advertiser determines a value or price they are willing to pay for specific services and outputs, and the agency works to deliver these within the set price.
PL: Do you see any trends? For example, are you seeing an increased use of performance-based compensation models?
Darren: Performance based models are increasingly common, but many struggle with these models in implementation and execution. We have also noticed that some advertisers are moving away from retainers to fees again as they look for more flexible compensation models in the face of less predicable market conditions and therefore, less defined requirements of their agencies.
PL: Many agencies like the theory of performance-based compensation systems but are wary of how these will be calculated. Have you found a way to make this work?
Darren: The problem is that few can get to the balance between risk and reward. The lower the risk, the lower the reward, and so we see as a default that the measures are reduced to the lowest common denominator such as client satisfaction. This has low risk for the agency, but also low value for the advertiser, and so we see this as a performance payment of 5% or 10% of the agency fee. Not a huge incentive, and besides, you end up simply rewarding the agency for doing their job.
But, at the other end is a huge risk for the agency with many factors they cannot directly influence. Then to pay a bonus reward becomes prohibitive, as the budget process most companies use would not allow this level of funding required.
The best situations for performance-based compensation are where the agency or agencies are responsible for direct response. This is increasingly common in the digital domain where consumer behavior can be tracked and the agency rewarded with significant bonuses for delivering increased leads or sales and reducing the cost per acquisition.
PL: What metrics are being used to judge agency success or failures? You’ve mentioned soft, medium, and hard performance metrics. What are these?
Darren: We see the use of various metrics. Business Performance (Hard):
Examples include: sales, traffic, profit, market share, volume growth, etc. These can be measured by the same criteria that the advertiser uses for their internal bonus systems.
Agencies often claim that business results may not be within their span of control as many factors besides advertising can affect business outcomes.
Advertising Performance (Medium):
Examples include: product awareness, ad awareness measures, consumer measures, attitude ratings, persuasion, purchase intent, awards, brand equity, image, effectiveness awards, etc.
This kind of performance assessment is vulnerable to research technique, statistical anomalies, and discussions of creative philosophy.
Agency Performance (Soft):
Relates to the evaluation of agency functional areas: account services, creative and media in terms of performance, service, relationship, cost efficiencies, etc.
This is highly subjective and may be affected by entertainment on the upside and personality problems on the downside.
PL: Can an agency be paid more for a big business-building idea than just for hours worked?
Darren: There is always an opportunity for agencies to charge for value. The problem is that often the agency and the advertiser’s idea of value is misaligned.
Agencies are in the business of ideas and the execution is campaigns, and these are the two areas where they get paid. But for the advertiser, the realization of the value of the big business idea can take months or even years, and the agency wants to be paid now for the idea and not later.
Besides, agencies have been giving away these big business ideas for years as a way to secure the revenue for the implementation and execution. Why should the advertiser start paying for these now?
PL: Scope of work would seem to be a good starting point for compen- sation discussions. Are clients willing to sit down to discuss scope before budgets are set?
Darren: Scope of work is essential if you are using a resourced based model. How else are you able to determine, with any accuracy, the resource required to deliver the outputs required? The problem is that advertisers are increasing- ly less inclined to project or commit to a scope of work for their requirements for the coming year as they deal with less certain market movements and increased market complexity.
But we have found that the actual variation is relatively small, year on year. This is because in actual fact the changes in the scope, year on year, still need to be delivered within the marketing budget, which also changes in a defined way. Therefore we have used the previous year’s scope of work and adjusted for any overall budget change as a base.
PL: Are retainer models still in use? I could see retainers working best in social media and content creation.
Darren: Retainers are still popular due to their convenience. Think of it as an ‘all you can eat’ buffet for advertising agencies. But with the change from a campaign or project based services model to an ‘always on’ model found in social media, SEO, content, and search, the retainer is particularly useful in setting resource expectations and to link these expectations to a scope of work.
PL: Has the use of procurement increased over time? Has this helped or hindered the agency selection process?
Darren: Procurement is more involved than ever before. The involvement of procurement often brings a greater level of discipline and accountability to the process.
When the procurement process is simply applied to reduce agency fees without the required improvements in the advertising and marketing process, it leads to a commoditization of the core value creation in the process, the human resources within the agencies.
Instead of simply focusing on costs, where the procurement team focuses on process improvement, performance management, and developing ROI methodologies, the cost reduction is driven by greater efficiencies and proven value creation.
PL: Agencies have complained that they are asked to pitch before knowing how the client is going to compensate the agency. Do your clients set and discuss budgets during the pitch process? If not, why not?
Darren: Under a confidentiality agreement, we always reveal the size of the potential engagement either in fees, budget, or an approximation of FTEs. Many marketers and procurement people are concerned with this approach, as they feel it is revealing too much to the agencies. But for us, it is the ideal way to set agency expectations, so they are better able to decide how much
to invest in time, money, and resources to win the business. It is a business decision after all.
PL: Finally, can there be a perfect client and agency compensation model? I miss the days of the 15% media commission. It made life so simple, and of course, highly profitable for agencies.
Darren: The world is a much more complex place than the 1960s reflected in Mad Men. There is no longer a one size fits all. Certainly there are preferred models such as retainers and fees, but all of these have failings, driving marketers, procurement, and agencies to find better and improved models. This is complicated even further by the driving change of technology and the impact it is having on consumer behavior and the media. So in a word, while you may miss the old days of 15% media commission, no – the world is no longer one size fits all anymore.
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