TrinityP3 Advertising Agency Remuneration Principles

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Agency remuneration and compensation models are under pressure with a focus from procurement on marketing budgets. There are basically four types of agency remuneration being 1. Spend based (commissions) 2. Cost based (Head hours, overheads and profit multiples) 3. Output based (Pricing and fixed fee) 4. Outcome based (Performance payments and profit sharing). The last two are increasingly used together in a Value Based Compensation model which fixes the base fee for the agency's outputs and rewards the agency based on performance. This presentation provides an overview of the various advertising agency compensation models and provides guides and consideration to choose the right model for you.

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TrinityP3 Advertising Agency Remuneration Principles

  1. 1. TrinityP3Agency Remuneration TrinityP3 Pty Ltd October 2010 Commercial in Confidence 1 marketing management consultants
  2. 2. Compensation or Remuneration?Compensation: – noun 1. the act or state of compensating. 2. the state of being compensated. 3. something given or received as an equivalent for services, debt, loss, injury, suffering, lack, etc.Remuneration: – noun 1. the act of remunerating. 2. something that remunerates; reward; pay.•  Philosophically we prefer to call it Remuneration – to reward the agencies and suppliers rather than making good for loss, injury and suffering. 2 marketing management consultants
  3. 3. Moving from Input/Costs to Outcome/Value •  Most of the existing models are input / cost based that reward volume of work and not effectiveness. •  The current best practice is to move to an output based / pricing model that fixes the value based on output. •  The leading trend is for a value based remuneration model where the reward is based on the value created or contributed. •  Therefore the global remuneration trend is summarised by: Output / Outcome / Input / Cost Price Value 3 marketing management consultants
  4. 4. Inputs vs Outputs vs Outcomes Model Positives NegativesInputs / •  Resource / Head hour •  Simple to implement •  Rewards increasedCosts based •  Multiple points of volume rather than •  No direct link to volume negotiation including effectiveness or scope of work salary cost, overhead •  Based on head hours / and profit timesheets which are unreliableOutputs / •  Based on scope of •  Values the output •  Rewards increasedPrice work / outputs / rather than the cost volume rather than deliverables •  Makes budgeting effectiveness •  Price agreed and set easier •  Issues arise when work on historical basis •  Adjusting commissioned then remuneration easier cancelledOutcomes / •  Based on the value •  Links agency •  Requires measurementValue created by the activity remuneration to of marketing •  Either all or the bulk of outcomes / value effectiveness remuneration / profit •  Brings alignment •  Difficult to get many •  More like profit sharing between suppliers agencies to agree on than bonus and marketers if measures correctly implemented 4 marketing management consultants
  5. 5. Principles of Remuneration•  It is generally accepted by the ANA and the AAAA in the US, the ISBA and the IPA in the UK and the AANA and the Communications Council in Australia, that agency remuneration agreements should be:1.  Simple to understand and easy to administer.2.  Fair to both advertiser and agency.3.  Aligning advertiser and agency interests and priorities.4.  Finalised before agency resources are committed.5.  Recorded in a ratified advertiser / agency contract.6.  Flexible enough to accommodate changes in the future.7.  Involving senior management stewardship, with principles clearly communicated to the teams on both sides.8.  Capable of standing the test of time and being understood by any future Marketing Director.9.  Based on agreed and understood terms and definitions.10.  Inclusive of specified tracking and review dates. 5 marketing management consultants
  6. 6. Remuneration Models•  Most common remuneration models: •  Commission Service Fees •  Resource Package Fees (Retainer) •  Variable fees based on actual hours •  Project Fees •  Hybrids•  Less common remuneration models: •  Scale Fee Win Bonus •  Concept Fee •  Licensing Fees•  Other remuneration considerations: •  Production mark ups •  Payment by Results (PBR) 6 marketing management consultants
  7. 7. Commission Service Fee•  Based on the traditional media commission paid by the media proprietor (10% or 11.1% mark up) and a service fee (7.5%) compounded to over 19% paid on all external costs including production to cover the full service offering of Creative concept, Media planning and buying.•  Continued to be used primarily in Media buying and to a less extent Media planning remuneration.•  When used, is used in combination with other models such as project fees or head hours.Advantages Disadvantages•  Simple in the case of mainstream •  Based on volume of Media spend, advertising. not scope of work.•  Easy to calculate and administer. •  Inappropriate were Media is not a•  Parties focused on quality not major component of the output such cost. as DM or Digital.•  A crude form of PBR with a higher •  Does not encourage Media neutral Media spend leading to greater solutions. agency earning. •  Cancellations of spend has a severe effect on agency income. 7 marketing management consultants
  8. 8. Resource Package Fees (Retainers)•  Based on an agreed detailed scope of work and a resource plan for a defined period, reflecting the workload requirement of the agency.•  Based on salary costs of the required number of people at a % of their annual billable hours by an overhead factor and the agreed profit margin.•  Usually this base formula is agreed in the contract and only the scope of work and the associated resource requirements are calculated and adjusted annually.•  Calculated annually and paid monthly.•  Most common remuneration model in the market.Advantages Disadvantages•  Agency knows its income and can •  Requires the scope of work to be resource appropriately. accurately defined.•  Advertiser knows cost and can •  Does not allow for major changes in budget appropriately. scope of work with falls costing•  Encourages more Media neutral advertiser and rises costing agency. solutions. •  Input based and therefore less accountable. •  Often time consuming to negotiate and administer. 8 marketing management consultants
  9. 9. Variable Fees based on Actual Hours•  Fees are based on actual time spent using an hourly charge out rate for individual staff.•  Charge out rates calculated to cover staff salary, plus overhead factor and agreed profit margin.•  Fee is paid after work is undertaken based on actual recorded hours.•  More common in marketing services contracts such as Sales Promotion, DM and PR, rather than Creative agencies.Advantages Disadvantages•  Relatively easy to administer, •  Difficult for advertiser to budget. provided agencies maintain •  Difficult for agency to resource. accurate timesheets.•  Reflects advertiser needs and •  Requires accurate time sheet agency activity. process and requires audit in•  Allows flexibility should scope of disputes. work changes. •  Lack of accountability with no•  Allows agency return based on incentive for efficiency. clearly defined process and actual deliverables. 9 marketing management consultants
  10. 10. Project Fees•  Project fees is an alternative to fixed annual fees, determined and paid on an individual project basis.•  Often used for simply ad hoc projects, pre-agreed project fees can be paid either on completion of the individual project or for projects completed in the month, quarter or year.•  Used extensively for specialist services such as Direct Marketing, PR and Sales Promotion.Advantages Disadvantages•  Easy to control expenditure. •  Inclined to encourage a short term•  Often used to top up retainers for focus rather than longer term work outside the agreed scope. relationships.•  Reflects specific advertiser needs. •  Agency does not have the same•  Suits integrated or niche services. level of confidence in remuneration unless scope of work defined up front. •  Tends to come at a higher cost compared to the retainer. 10 marketing management consultants
  11. 11. Hybrids•  Very few advertisers use any one of these remuneration models exclusively.•  There are a number of components in the services required including: •  Account management •  Strategy development •  Creative concept development •  Creative production supervision •  Production management •  Production •  Channel planning •  Media planning •  Media buying•  The application of the remuneration model needs to be defined across the services included and excluded. Eg. Account Management and Strategy may be retained, the Creative concept may be paid as a project fee, while the Production may be paid based on hours. 11 marketing management consultants
  12. 12. Less Common ModelsScale Fee Win Bonus •  Advertiser pays the agency a “salary” based on a fixed percentage of either sales or annual marketing budget. Win Bonus is built into the sales model with increases in sales leading to increased agency fees and must be added as a more traditional PBR for the marketing budget model.Concept Fee •  One-off fee to cover the development of the Creative concept. Fee based on the estimated value to the advertiser’s business and its anticipated use in an agreed context over an agreed period of time. Used where the work falls outside the current advertiser - agency agreement or in ad hoc projects.Licensing Fees •  The advertiser pays the agency a reduced concept development fee and then agrees to pay a license fee for use of the concept once it has been approved. Rather than the advertiser owning the rights, the agency retains the rights. 12 marketing management consultants
  13. 13. Production Cost Considerations•  “Mark up” versus “At net” •  Traditionally external Production costs were marked up under the commission and service fee model. The majority of remuneration agreements today have the external production costs at net. •  The increasing diversity of agency networks means that often agencies have affiliate or subsidiary relationships with companies that may superficially appear as external suppliers.•  Variable versus Fixed •  The market is split between the use of fixed cost rate cards and variable head hour rate cards. •  Agencies typically prefer and encourage variable rate cards, but these rely on proper and robust recording of head hours and reconciliation to actual from the approved estimate. •  Increasingly the market is moving to fixed fee rate cards, especially in situations of high volume, as they make it easier to budget, reduce estimating time and do not require reconciliation of internal agency resources. 13 marketing management consultants
  14. 14. Performance Based Remuneration•  “Payment By Results” describes a service relationship in which some part of any associated remuneration is contingent on results or other performance assessment measured against pre-determined criteria.•  Benefits: •  Improved agency performance. •  Improved advertiser performance. •  Goal alignment and congruence.•  Types: •  Bonus - additional to the agreed profit margin. •  Cost recovery - represents all profit. •  Shared risk and reward - agency puts % of margin at risk and advertiser meets that % in pool. •  Earn back - agency puts % of margin at risk to be paid in results. •  Combination - usually a mix of earn back and bonus. 14 marketing management consultants
  15. 15. Performance CriteriaBusiness 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. •  Agency often claims 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. 15 marketing management consultants
  16. 16. Performance CriteriaBusiness Performance Advertising Performance Agency Performance•  Sales Volume •  Advertising Awareness •  Agency Service•  Volume Growth •  Brand Image Shifts delivery*•  Relative Brand •  Attitude Ratings •  Relationship Performance •  Ad enjoyment Management*•  Composite •  Functional •  Brand personality Performance competencies* •  Predisposition to buy•  Market/brand share •  Contribution to •  Ad scores ‘branding’•  Customer loyalty •  Persuasion index •  Project management*•  Brand equity•  Brand profitability •  Administration* •  Cost Efficiency* •  Pro-activity* •  Collaboration* * Can be measured, managed and maximised using Evalu8ing. Find out more at www.evalu8ing.com 16 marketing management consultants
  17. 17. Critical Success Factors•  PBR is not suitable for all client/agency relationships. Implementation may not be possible or suitable for a number of reasons; however the process of examination and discussion can still be very beneficial.•  There must be TRUST and mutual respect.•  There must be a fundamental acceptance of fairness and equity. PBR is not a means to reduce agency revenue and margins. The agency needs to be fairly remunerated and make a fair margin before PBR is considered.•  Consider the current client/agency relationship. PBR is not a prescription for improving advertiser / agency relations (even though relationships are said to improve under PBR).•  Be very clear on the objectives, measurement criteria and performance standards that will determine the PBR bonus.•  Recognize that there may be some difficulties involved, particularly in the early stages of implementation, the negotiation process can be protracted and there can be disagreements on the risk/reward, measures, objectives, methodology, size of the PBR pool, weighting, etc. 17 marketing management consultants
  18. 18. Critical Success Factors•  Incorporate a mutual performance review to improve fundamentals for both parties. Conduct the performance reviews frequently (every 3 - 6 months), particularly during the early adoption of PBR.•  Clearly establish roles and responsibilities for both partners, through development, implementation and monitoring.•  Keep it simple - develop greater complexity as you move forward together and increase learning.•  Start out with a lower level of PBR remuneration, then grow the percentage over time.•  Establish ‘hard’, quantifiable measurement criteria to the extent possible and control ‘soft’ qualitative measures.•  Give serious consideration to drawing down the PBR ‘pool’ as frequently as possible.•  Continually refine and enhance the process, criteria, measurement, weightings, etc.•  You will need greater communication, openness and transparency. Training of the participants can be an important element in success. 18 marketing management consultants
  19. 19. Critical Success Factors•  Provide protection against plan changes. The agency’s commitment to deliver results is based on the expectation that the advertiser will execute it’s plan in terms of media spending, product introductions, distribution initiatives etc. If the advertiser wants to make unilateral changes to the resources supporting the business, and if those resources are likely to have a material effect on the agency’s ability to deliver results, then the PBR scheme must be re-visited and modified.•  Incorporate the PBR agreement, criteria and measurement into the agency contract and ensure that advertiser’s senior management are aware and involved.•  Ensure there is top management sign-off at the advertiser and that the accumulation of upside bonus monies and their payment are ‘in the budget’. In schemes with ‘downside risk’, payment schedules should allow more frequent payment as milestones are reached through the year – protecting the agency’s cash flow consistent with performance.•  Consider using an independent, objective mediator to facilitate and manage the process. 19 marketing management consultants
  20. 20. For further information please contact… TrinityP3 Pty Ltd Sydney +612 8399 0922 Melbourne +613 9682 6800 London +44 7880 910 064 Wellington +64 21 515 650 Hong Kong +852 3589 3095 Singapore +65 6884 9149 people@trinityp3.com www.trinityp3.com 20 marketing management consultants

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