I know that half the money spent on advertising is wasted, the problem is I don’t know which half.
John Wanamaker, 1886
The most recent 2012 Association of National Advertisers study revealed a stunning two-thirds of advertisers polled plan to change agency compensation in the next 12 months. 27%of advertisers plan to reduce or restructure compensation and 24% plan to include some form of performance incentive in changes.
The following overview cites six major elements that are often overlooked by advertisers as they begin the compensation review process. Without the data these provide, clients are vulnerable to agency negotiating skills and they cannot arm themselves with the facts needed to structure fair and appropriate payment for services.
We provide this overview to readers for their use in developing a sound strategy and execution for structuring agency compensation. The background here can be used independently or as a guide to determine if Wanamaker can be of help to you in the process. It has been refined over the years based on negotiating over $5 billion in agency fees with more than 200 client/agency relationships, large and small.
1. Establish the Proper Philosophy
An advertiser who begins the process with the attitude that agency compensation must be hammered to the lowest possible level will achieve a short-term gain but most likely will suffer in the long run. Driving compensation to a perceived rock-bottom, with no understanding of the basis for that level, requires the agency to ultimately take defensive actions. These generally take the form of putting junior staffers in place, cutting back staff hours or doing both. Work will ultimately suffer and client frustration quickly sets in. There is a proper level of compensation, fair to both client and agency, and the objective for long-term relationships is to find that level through a professional, well-managed process.
2. Consider Alternative Methodology
It is interesting to note that while the trade press and industry conferences are constantly discussing value-based compensation (wherein agency fees are based on the value, not the cost of the service provided) in the latest industry compensation study (2009) no respondents reported actually using this method. The Coca-Cola methodology introduced several years ago, which triggered the interest was deemed by most to be virtually unmanageable for all but the largest advertisers.
Pay for performance (pay-per-click or some other response-basis) has fluctuated over the study periods and has gained no traction. This can be a difficult methodology to measure and value.
Each advertiser’s communications needs generally require a compensation structure uniquely suited to work volume, flow and media mix. Any revision in compensation should begin with a careful analysis of options prior to initiating the process. Many advertisers currently begin with a fixed fee (based on agency hours structured around a formal SOW) with a variable hourly-based addendum for creative and production products. An entirely separate structure must be put in place for the fast-growing digital budgets.
3. Execute a One-time Zero-based Fee Budget
Too often clients are approached by agency management in the fall to discuss “next year’s fee”. It can be as simple as a request for “a 4% increase, as we did last year…” or as complex as sharing reams of time-of-staff data and billable rates…advertisers seem to see the former approach much more often than the latter. Regardless of the process used to establish your current compensation it’s critical to establish a benchmark compensation plan based on substantial analysis of client needs and agency resources. Once this has been accomplished, annual updates based on shifting needs can be a much less cumbersome procedure.
4. Trust but Verify
Time of staff reports and hourly billing rates are usually the basis of compensation metrics, but their accuracy and relationship to real salaries cannot be taken for granted. Testing the correctness of the staff time recording procedures and reporting itself is critical to assure a true analysis.
It is imperative, at least every 3 years, to audit on-site, in agency offices, the time records pertaining to your account. Best practices for agency systems require many key elements, and only by seeing these records first hand can these systems be comfortably signed off on. Many agency contracts attempt to put in place unreasonable limits on access to agency records. A properly executed and/or updated agency contract will assure you have reasonable controls to benefit client interests. In some instances where agency compensation is tied back to hourly rates based on agency staff salaries, these same contractual elements must be in place to provide access to critical financial data which is the foundation for your agency’s compensation
5. Manage the Time of Staff
Driving a $5-$10 reduction in rates is nowhere near as efficient as truly managing hours. Many advertisers today, probably just like you, have regular, annual, sometimes contentious, hourly rate billing negotiations with their marketing communications agencies. In an effort to be as efficient and cost conscious as possible in today’s tough environment, these marketers used to believe that driving agency hourly rates lower was the only path to real savings. We caution clients, based on our 23+ years of experience, that hourly billing rates are only a relatively small part of the real savings opportunity.
If one can drive average agency billing rates down by $5.00 or even $10.00, the total savings is but $50,000 to $100,000 on 10,000 agency hours expended on your behalf. However, if agency hours themselves are brought into line with Industry Norms for the same or similar tactics, the savings can amount to $125-140 PER REDUCED HOUR or even more depending upon the functions involved. A small adjustment to those 10,000 hours proposed on the scope-of-work can produce much larger savings than reducing rates alone.
6. Benchmark Key Elements
Every advertiser at some point questions whether their firm’s agency compensation is in line with other firms of like size or structure. And it is a completely rational concern. The ability to bring professional comparisons into play in the compensation negotiation process allows the client to create true leverage in the process. Industry studies can provide meaningful benchmarks for hourly rates by staff function, region, agency size and other metrics. Some consultancies provide proprietary data along these lines, and advertisers with multiple agencies can develop their own corporate benchmarks.
Clients deserve at the very least a level field for compensation negotiations. Our hope is these six critical elements can be put into play to help you find that all-important mutually beneficial, fair level of compensation for your firm. With it you will set in place the foundation for a long-term productive client/agency partnership.