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Creating Value - Issue 5

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The "Creating Value" series from Ignition Consulting Group explores how advertising agencies and other professional services firms can innovate in pricing and compensation.

The "Creating Value" series from Ignition Consulting Group explores how advertising agencies and other professional services firms can innovate in pricing and compensation.

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Creating Value - Issue 5 Creating Value - Issue 5 Presentation Transcript

  • Issue 5: 1Q 2008 creatingVALUE Creativity in Agency Compensation 1st Quarter 2008 Issue 5
  •   Issue 5: 1Q 2008 1 2 3 u Section 1 Where agency profits come from Risk as a positive concept - pg 3 Agencies and risk avoidance - pg 4 The power of belief - pg 5 u Section 2 How agencies create value The bottom line of agency value - pg 6 A company’s most valuable partner - pg 7 The role of agencies in pricing power - pg 8 Agencies make money instead of cost money - pg 9 Agencies as powerful brands themselves - pg 9 All agencies are not created equal - pg 11 u Section 3 Creativity in compensation Different approaches to value - pg 13 Not the quantity of time, but the quality of time - pg 16 u Section 4 Confidence leads to value Just say no - pg 17 No time for monkey business - pg 18              Creating Value is a quarterly exploration of the ways marketing communications firms are transforming themselves to become more valuable and competitive in the new multi-channel, media-neutral marketing environment. In This Issue Published by Ignition Consulting Group, Inc. Copyright 2008, all rights reserved. By subscription only at www.ignitiongroup.com/creatingvalue creatingVALUE
  • creatingVALUE   Issue 5: 1Q 2008 As the story is told, ad legend Jay Chiat and one of his partners are meeting with a new client over lunch. Halfway through their lunchtime conversation, Jay Chiat jots a quick note on his napkin and quickly tucks the napkin away in his coat pocket. His partner notices but the client doesn’t. Later, on the drive back to the agency, Jay’s partner asks,“What’s the deal with the note on the napkin, and why were you so quick to get it out of sight?” Jay replies,“It’s the idea that’s going to make this client’s brand famous.” Jay’s associate asks,“Well then why didn’t you share it with the client?” Jay answers, “Because if we told them about it now, they wouldn’t think it’s worth anything. We have to wait until we’ve logged a few hundred hours so the client will feel our fee is justified.” Whether this story is fact or legend, the same dynamics come into play in countless agency-client relationships where time, hours, and activities form the basis of a compensation agreement. Needless to say, these dynamics benefit neither party. Where agency profits come from Consider the deceptively simply question,“Where do profits come from?” When you pose this question to a group of agency professionals, the answers will typically include such things as clients, hours worked, and even efficiency. But the real answer to this question is that profits come from risk. Just being in business – paying salaries, rent and the light bill – is a risk. Sure, innovating is a risk. But so is coming to work and doing things the same way every day. The fact is every day in business is a risk of some kind, so why not choose your risk instead of letting it be chosen for you? Risk as a positive concept The word“risk”doesn’t always have to be negative. Risk is actually an economic positive. If you eliminated risk, you would eliminate profits. The point is to be conscious of the type of risk you’re taking, and to choose the kind of risk that has the most potential of paying dividends – in other words, profits. The biggest profit drain in your firm is not risk, but the cost of not taking a risk. Of course, the cost of lost opportunity is never tracked or measured, and certainly never shows up on an income statement. Investing in new agency disciplines that will take the agency successfully into the future is certainly a risk, but it’s the type of risk that produces future profits. Likewise, changing the agency’s pricing and compensation approach is a risk, but it has the potential to be an“economic positive”that will spur profits. Creativity in Agency Compensation
  • creatingVALUE   Issue 5: 1Q 2008 p “Even though you can calculate what a cost is, it doesn’t mean that you know what a cost ought to be.” - Henry Ford Agencies and risk avoidance Most agency principals will go to great lengths to avoid what they see as risk. While it’s basic human nature to avoid risk and uncertainty, the forms of risk-avoidance at agencies are primarily: Sticking to traditional organizational structures Using industrial-age efficiency metrics and cost accounting methods Tracking efficiency instead of effectiveness Focusing on activities and costs rather than results and value Legacy performance measurement and reward systems Cost-plus pricing       The power of belief In business, as in life, we are guided not by what we think, but what we believe. And as long as agencies believe they’re selling FTEs instead of IC (intellectual capital), they will continue to undervalue – and underprice – their services. Do you buy this argument? If so, change the way you price your services. As the saying goes,“To know and not to do is really not to know.”2 80% of the world’s wealth is in the form of intellectual capital, not oil or land. The richest companies in the world are those with very few physical assets (like Microsoft and Google) but tremendous non-tangible assets in the form of IC. The purpose of an agency is to create wealth for its clients, and wealth is created primarily through intellectual capital. Everything an agency does is – or should be – the means to that end. Ultimately, the worst offender on this list is the last one – cost-plus pricing – because it so directly affects the firm’s ability to invest in its future. It also affects the agency’s ability and willingness to invest in its clients. A recent survey by the CMO Council shows that clients are very concerned about“lack of innovation”and“no value-added thinking”from their agencies. To their credit, clients also realize that“the way companies have structured their agency relationships is not drawing out of agencies what they want,” according to Deloitte Consulting, who conducted the study.1 Where agency profits come from
  • creatingVALUE   Issue 5: 1Q 2008 How agencies create value Answering the question“What are you really selling?” is at the heart of the compensation question. Agencies are pretty good at helping their clients answer this question by using innovative brand planning techniques. For example, jet engine manufacturers aren’t really selling jet engines, they’re selling flying time. Cement companies don’t sell cement; they sell on-time delivery. The bottom line of agency value What would agencies learn if they applied this same question and same approach to their own business? Let’s take a shortcut past the obvious answers (such as brand awareness, brand preference, etc.) and instead ask: Q: How do agencies create value? A: By helping to create brands. Q: What’s the value of a brand? A: A brand commands a higher price than a commodity. Q: What’s the value of a higher price? A: Higher profits for the company that markets the brand. The promise,“We help companies make more money”may sound like a shop-worn phrase, but in reality it is the essential end-benefit that agencies deliver. Agencies quite literally help their clients earn higher profits by helping to create brands that command a higher price. No other professional service provider can make this claim as strongly as advertising agencies; not law firms and certainly not accounting firms. A company’s most valuable partner Agencies greatly undervalue the contribution they make to their client’s success, because nothing affects a client’s success more than helping to maintain the pricing integrity of their brand. A study by McKinsey shows that reducing costs (such as marketing expenditures) only marginally improves a company’s profits, whereas increasing the brand’s price dramatically improves profits. A 5% improvement in price can result in as much as a 50% improvement in profits. The investment companies make in marketing and advertising has as its ultimate objective to build the overall strength of the brand and thereby decrease customer’s price sensitivity. In fact, it could be argued that the default purpose of marketing is not to increase sales but rather to increase profits. CMOs and their agencies should not be evaluated based on their ability to sell more product, but rather their ability to reduce price sensitivity to the brand through powerful brand differentiation.
  • creatingVALUE   Issue 5: 1Q 2008 The role of agencies and advertising in pricing power Project Apollo, the joint venture of AC Neilson and Arbitron, is breaking new ground in establishing the value of advertising. Their data is based on minute-by-minute behavior of 11,000 consumers equipped with“Portable People Meters.” The study is by major advertisers with a combined $6.8 billion in ad spending, including P&G, Unilever, and Pfizer. Here’s the first major finding from the study, released just a few months ago: “Advertising reduces sensitivity to price differences, particularly when consumers are frequent buyers in a category. Even one or two exposures to ads for the brand produce reduction in price sensitivity.” An authoritative study published this past year in the Harvard Business Review confirms that “even campaigns that don’t do much to boost sales can increase margins by differentiating brands and thus allowing companies to raise prices.” They cite the experience of Victoria’s Secret, who has conducted a number of advertising tests that have shown that while advertising may not always increase short-term sales enough to justify the cost, they have linked increases in advertising to their ability to charge higher prices over the long term. 3 This means agencies can be creating incredible value for their clients even if sales don’t go up. Sales are not the key metric; profits are. Profit is driven mostly by price. Price is driven mostly by brand perception. Brand perception is driven mostly by what agencies do. Agencies make money instead of cost money This is an immensely important concept for agencies to understand and embrace. Other advisors can save the client money (in lawsuits, on taxes) but it’s primarily their agency that makes them money. So why are agency contracts being negotiated by procurement agents – the same people that buy pencils and paper clips for the company – whereas law and accounting firm relationships are negotiated in the C-suite? Even using the flawed hourly rate approach, lawyers and accountants charge hourly rates of 4 to 6 times salary cost versus 2 to 3 times for agencies. Agencies as powerful brands themselves An exceptional agency is worth an exceptional fee, yet agency contracts are established on the basis of industry-standard hourly rates, as if agencies themselves are commodities instead of value- creating business partners that vary in skill as widely as golfers. Brenton Group founder Tim Brenton tells agencies that“Labor- based systems exist to commoditize your deliverable.” He believes that as long as agencies give away their cost information, they are participating in a one-sided process where the client holds all the power and plays one agency against the other. 4 How agencies create value
  • creatingVALUE 10 11 Issue 5: 1Q 2008 In this sense, agencies are behaving not as professional knowledge firms but rather regulated utilities, where income and profits are literally dictated to them. t When agencies base their compensation on costs instead of value, they allow their clients to determine how much profit they make. This is the model of a regulated utility, not a professional knowledge firm. How much does a Coke cost? Twelve ounces of the very same sugary-water costs 20 cents at Costco, $1.00 at a vending machine, and $2.00 at a restaurant. When agencies charge standard hourly rates, they are ignoring the fact that value – the basis of price – is completely contextual, and should therefore be different at different times under different circumstances for different clients. All agencies are not created equal As former Anomaly CFO Sal LaGreca preaches, all agencies are not created equal. It’s not the hours; it’s the value of the idea. When it comes to compensation, the Anomaly approach is to“Embrace any mechanism that rewards the differentiation between the quality of ideas.” In new business situations, Crispin Porter + Bogusky president Jeff Hicks says“We’re not in the business of selling time – we sell momentum for your business.” If pressed on their timesheet-less approach, his response is“Do you want to haggle over hours, time, and costs, or do you want the ideas that will give momentum to your brand?”5 Like actors, agencies should be paid based on their talent, not their costs. Cate Blanchett doesn’t get paid for a movie based on her timesheets, but rather her box office draw (which ranks her as number 13 among the hundreds of Hollywood actresses.) In the world of hourly-based compensation, the slower and dumber you are, the more you get paid. It’s like Alice in Wonderland, where nothing makes sense and everything is the opposite of what it should be. If the agency improves in efficiency, the agency should benefit, not the client. If the agency makes investments in technology that speed up delivery, again it’s the agency that should benefit. All of this is backwards in a time-based environment. How agencies create value
  • creatingVALUE 12 13 Issue 5: 1Q 2008 Agencies and the prisoner’s dilemma Game theorists have created a scenario called“the prisoner’s dilemma.” In it, two prisoners accused of the same crime find themselves in separates cells unable to communicate. Their jailers try to persuade them to implicate one another. If neither goes along with the guards, they will both receive a sentence of just one year. If one accepts the deal and the other keeps quiet, then the turncoat goes free while the patsy gets ten years. If the first prisoner is planning to keep quiet, then the second has an incentive to denounce him, and so get off scot-free rather than spend a year in prison. If the first prisoner were planning to betray the second, then the second would still be better off pointing the finger, and so receive a five-year sentence instead of a ten-year one. In other words, a self-interested person would always betray his fellow prisoner. Yet that leaves them both moldering in jail for five years when they could have cut their sentences to a year if they had both kept quiet. A bit of a brain twister for sure, but analogous to the situation the advertising agency business finds itself in when agencies are asked by prospective clients to disclose their costs. They’re all better off keeping quiet. 6 q Creativity in compensation Marketing professionals are taught the four P’s: product, place, promotion, and price. Agencies usually apply tremendous creativity to product, place, and promotion, but hardly ever to price. And since price is the only one of the four P’s that actually makes money instead of costing money, the irony is even more pronounced. Of course value-based compensation takes many forms. One of its more sophisticated forms is outcome-based compensation, which is at the far end of the value pricing spectrum. At the near end of the spectrum are other forms of creative compensation that have their roots in value instead of costs. Different approaches to value For example, New York-based Anomaly crafted a creative compensation agreement with its client Aliph, maker of the Bluetooth headset known as the Jawbone. The firm earns a royalty for every headset sold, plus has a stake in Aliph. JWT created and produced a series of two-minute advertainment episodes called“Lovebites,”which it licenses to its client Unilever. In other words, instead of assuming the traditional “work for hire”role, the agency took steps to retain ownership of its intellectual property and earns recurring rather than one-time revenues. How agencies create value
  • creatingVALUE 14 15 Issue 5: 1Q 2008 Communications planning firm Naked has a“Naked Ventures” unit that develops and licenses its own content, music, and other intellectual property. Most importantly, Naked takes pains to sell and price what it does as outputs rather than services. Their goal is to build and brand a value-added product and price it based on value instead of hours. Examples of this are the “Naked Strip Tease”(an audit product),“Naked Vulture”(a research product), and“Naked Tool Shed”(a communications planning tool). The Brooklyn Brothers went beyond the traditional cost-based model to propose 20% ownership and a sales royalty for its work for a bottled coconut water called Oco. The new social networking website Couplets.com hired New York-based Sugartown Creative on the basis of a percentage of membership and advertising revenue generated by the site. Among the many pricing and compensation experiments tried by Crispin Porter + Bogusky, one notable example was having enough faith in a new client (and enough confidence in their own abilities) to accept a minority stake in Method, the successful maker of eco-friendly detergents. Red Ball Tiger, which calls itself a“production agency”(because it both writes and produces commercials for clients) is compensated based not on costs or time, but rather what they call “Return on Involvement.” In his blog“Digital Mind Change”principal Greg Wilson describes their innovative compensation model this way: “What if advertisers paid their agency for the concepting of the commercial based on how well it actually worked in the search marketplace? In other words, based on how long those who started to watch actually watched. It’s difficult to argue with the fact that the longer a viewer watches a spot, the more value that spot has for the advertiser. Otherwise, why wouldn’t they have just made a shorter spot? So, why not pay the agency on that basis? The longer people watch, the more money the agency makes for creating the spot. Right now, advertisers are paying their agency based on how long it took to make the spot. They now have the option to pay them for how long people watch the spot. In other words, instead of paying for effort, they will be able to pay for outcome.” Creativity in compensation
  • creatingVALUE 16 17 Issue 5: 1Q 2008 Not the quantity of time, but the quality of time It surprises a lot of industry professionals to learn that the world’s largest marketer – Procter & Gamble – engages in a form of value- based compensation with its lead agencies by tying their pay directly to the sales performance of the brand. Johnson & Johnson has a similar arrangement with Deutsch for the agency’s work on the Tylenol brand. General Mills has a new performance-based compensation arrangement not only with its lead agencies, but its specialist agencies (digital, multicultural) as well. Austin-based GSD&M crafted an outcome-based client called World Market. The premise of all these agreements, of course, is that agencies shouldn’t be rewarded for inputs but rather outputs. The quality of time rather than the quantity of time. So believes the energetic founder of the firm Ideocracy, Ted D’Cruz- Young, who says“I trade on ideas. I don’t work on fees. I prepare things and I’ll go into a company and say,‘Here’s what you should do.’ And I’ll put it in front of them and say,‘Here’s what I’ll sell it for.’ Don’t go asking me how much time I spent on it because it’s none of your ______ business.” 7 If you doubt that a change in agency compensation is on the horizon, consider that the president of the Association of National Advertisers, Bob Liodice, included the following in his list of “Top 10 Trends”for 2008: Getting Compensation Right: Agencies and clients will work together to create mutually fair value-and incentive-based approaches. Markets will pay well for great ideas, fabulous brand stewardship, and superb media management. The key is to get expectations right between agencies and clients. Its’time.” Confidence leads to value How much confidence do you have that you’re selling something of great value? If you believe you’re selling a person’s time or activities, then you’re probably equating the value of what you sell with that person’s hourly rate. But if you believe what you’re selling is powerful ideas capable of creating tremendous wealth for your clients, then you might consider the value much differently. Just say no Some agencies understand and accept this concept better than others. Recently a AAAA member agency sent this response to a new business prospect: We received your RFP dated today. The terms of the RFP are not acceptable to us and therefore we will not be responding. The following terms of the RFP do not conform to our standards or our industry’s standards: You have asked for speculative creative work without offering any compensation. You have stated that you would own any work that was submitted even though you would not pay consideration for the work product. The outcome of the process may be to not choose an agency or to retain as many agencies as you wish – making it difficult for us to evaluate the level of investment we would be willing to attribute to this review.    Creativity in compensation
  • creatingVALUE 18 19 Issue 5: 1Q 2008 You have not provided an anticipated budget that you would ask an agency to work within. The timing of the RFP is not reasonable – speculative work for a major brand in 8 days. We would not agree to work on a cost-plus basis for the majority of our work product. We believe that our marketing strategies in the category are significantly more valuable than those used in your example. If you choose to reevaluate your RFP process that is more in keeping with the protocols of both the American Association of Advertising Agencies and the Association of National Advertisers, we would be please to revisit our participation in your review. Thank you for considering us to be among a group of qualified marketing partners that you would consider.   No time for monkey business Last year Chicago-based Cramer Krasselt produced and placed in the Super Bowl the well-know monkey campaign for their then- client CareerBuilder.com. When the ads failed to win the“best-like” accolades, CareerBuilder announced they would be putting their business into review. C-K’s response was to promptly resign the business. Not only was the client shocked, but the move took the entire industry by surprise, since most agencies react to situations like this by investing tremendous amounts of money and emotional energy defending a piece of business they have little chance of retaining. But C-K’s move wasn’t based on the low odds of retaining the business; it was based on their sense of integrity and self worth. It earned them the praise of industry observers worldwide. Resigning CareerBuilder enhanced the agency’s reputation, and is widely believed to be one of the factors that played into Porche effectively handing Cramer-Krasselt their business without a review. Abundance mentality: Stephen Covey preaches that if you want to make minor, incremental changes and improvements, work on practices. But if you want to make significant, quantum improvement, work on paradigms. Is your paradigm one of abundance or one of scarcity? Do you believe that agency compensation is a zero sum game, where agency and client are competing for slices of the pie, or do you believe that it’s about making a bigger pie? Confidence leads to value
  • creatingVALUE 20 21 Issue 5: 1Q 2008 The solution is you The change needed in our industry will not come from an association or from a published list of guidelines. It will come from individual agencies that have the foresight to change the dialog and completely change the way they price and value their services. As Ghandi said,“The change you desire in the world begins with you.” So far, only a handful of agencies across the world have adopted this new way of thinking and working. These are the agencies that have virtually thrown timesheets out the window, abolished hourly rates, torn up their rate cards, and instead focus on creating value for their clients. A parting thought The reaction of many agencies to this line of thinking is,“This is all well and good in theory, but in the real world …”This implies that the firms that have made the switch to value-based compensation are not in the real world, but perhaps another planet like Mars. Recently a professional knowledge firm in Knoxville, Tennessee made the transformation. Upon learning about this, other firms were heard to say: Knoxville is a small market and our firm is in a larger market where this would not work.  Knoxville is a big market and our firm is in a small, tight-knit market where this would not work. I can see how they could do it for current customers, but our new customers expect to be billed by the hour. I can see how they could do it for new customers, but our current customers expect to be billed by the hour. They are a smaller, more nimble company than we are, so this would not work for us. They are a larger company with more resources than we have, so this would not work for us. Etc., etc., etc. You get the point. The only way out of the compensation dilemma is through. The only question for your firm is when.     
  • creatingVALUE 22 23 Issue 5: 1Q 2008 Footnotes 1 Study released by the CMO Council, as quoted in Adweek, January 14, 2008. 2 As quoted in The 8th Habit by Stephen Covey, Free Press, 2004. 3 From“If Brands Are Built over Years, Why Are They Managed over Quarters?”by Leonard Lodish and Carl Mela, Harvard Business Review, July-August 2007. 4 From“Team-Based, Value-Oriented Client Compensation Solutions,”as presented at AAAA Finance Conference, New York, 2007. 5 As quoted in a presentation given at the AAAA Management Conference, Scottsdale, Arizona, 2006. 6 As quoted in The Economist, September 29, 2007. 7 From interview in Adweek, October 15, 2007 Creating Value is edited for senior professionals in the marketing communications business. All content is copyrighted by Ignition Consulting Group, Inc. and may not be reproduced or retransmitted without express permission. Creating Value is available by paid subscription only, and is distributed as a downloadable PDF. To subscribe, visit www.ignitiongroup.com/creatingvalue. Creating Value is published by Ignition Consulting Group, Inc., a consultancy devoted to helping marketing organizations create and capture more value. For more information about Ignition, visit www.ignitiongroup.com, e-mail info@ignitiongroup.com, or call 801.582.7297.