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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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  • 1. Issue 6: 2Q 2008 creatingVALUE Value is Created Outside the Agency 2nd Quarter 2008 Issue 6
  • 2.   Issue 6: 2Q 2008 1 2 3 u Section 1 Value is created outside of the agency u Section 2 Value pricing as a tool of differentiation u Section 3 Why you should fire your low-value clients u Section 4 Cost-led pricing vs. price-led costing u Section 5 The right kind of client for value-based agreements u Section 6 Why client relationships are a strategic decision u Section 7 A survey to see how well your firm is creating and capturing value 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
  • 3. creatingVALUE Differentiating the Agency Brand   Issue 6: 2Q 2008 These results make it painfully clear that agencies believe value is created inside, rather than outside, their organizations, because they’re paying close attention to internal activities and very little attention to external outcomes. Know what you’re really selling A critical step on the path to becoming a value-based agency is to start turning your attention and energies to what clients are really buying from you; business success. And as soon as you become as expert in identifying, measuring, and analyzing client business results as you are in crunching your agency’s cost accounting data, you will be infinitely more valuable to clients and prospects. Agencies want to capture more of the value they create for their clients; In other words, earn more for what they do. The first step is to understand the nature of value, including how, when, and where value is created. Looking in all the wrong places The truth is, almost all agencies are looking in the wrong place for value. Their compensation agreements are based on hours worked, FTE’s assigned, and costs incurred. Hours and costs look inside the agency, but value is created outside the agency. In other words, value is created outside your four walls. Agencies and their clients are therefore usually looking in the wrong place for the basis of pricing and compensation. In order for an agency’s compensation to be based on the value it creates, the agency needs the necessary knowledge and skills to identify and measure the drivers of a brand’s success. If you don’t understand how you create value for your clients, you’ll never succeed in being paid for it. We’re counting the wrong things A recent survey by the AAAA asked agencies“What information do you track?” Here’s what they said: Value is Created Outside of the Agency Labor hours and costs 94% Staffing plans 82% Client business results 22% Job estimates 98%
  • 4. creatingVALUE   Issue 6: 2Q 2008 Value Pricing as a Tool of Differentiation Imagine three agencies presenting to a prospective client. The client has provided both agencies with a list of guidelines for the presentation, which includes explicit instructions to outline the agency’s proposed compensation approach, including hourly rates, expected hours, and staffing plans. Agency A dutifully complies with the request and, toward the end of their presentation, shows a schedule of their hourly rates and a detailed spreadsheet indicating how many people would devote what percent of their time to the business, resulting in an estimated number of hours. Agency B does almost exactly the same thing. It is, after all, what the client asked for. When Agency C presents, here’s how they handle the question: “Unlike other agencies, we don’t believe we sell time; we sell intellectual capital and business results. In fact, we believe the traditional ways agencies charge works against the best interests of both the agency and the client. Hours and timesheets are focused on efficiency, and we don’t believe you’re buying efficiency – you’re buying effectiveness. “Because we don’t bill by the hour, we don’t have hourly rates. In fact, we don’t even have timesheets, because timesheets only serve to point us in the wrong direction. We trade the time that would have otherwise been spent on tracking our internal costs and instead invest it in tracking the external results we create from your brand. “We realize that this is quite different from the way you’re used to working with other agencies. But we believe strongly that agencies and clients need a new and different way of working together – one that aligns the economic interests of both organizations.” If you were the client, which agency is going to stand out? Which agency is truly different instead of just saying they’re different? The more ways you can be different – in relevant ways – the more you look like a premium organization and the less you look like a commodity.
  • 5. creatingVALUE   Issue 6: 2Q 2008 Expect to be surprised The CFO of a large marketing organization once told us the story of sending an RFP to three agencies. Two of the three agencies were units of large multinational agency networks. The third was a small independent agency that had established a reputation for non- traditional ways of thinking and working. Included in the RFP was a section asking for hourly rates, projected FTE’s, etc. Here’s what the client reported about his experience: “I could pretty much predict how the two large traditional agencies were going to respond; they did exactly what I asked for and did exactly what I expected, including pages and pages of spreadsheets and hours forecasts. The small independent agency responded in a different way to almost every section in the RFP. They gave none of the expected answers, and engaged in none of expected agency hyperbole. “When it came to the section on compensation, they courteously informed us that they couldn’t – and wouldn’t – quote hourly rates because they simply don’t believe in being paid by the hour. They quite convincingly made the argument that they are not in the business of selling time. We couldn’t resist awarding the assignment to this courageously different agency. Their unique approach was just too hard to resist.” Value pricing as a tool of differentiation p Differentiation ultimately means having the courage of your convictions. You preach differentiation to your clients. You urge them to make their brand unique and different in as many ways as possible. You help them muster the courage to take risks. Isn’t it worth doing the same for your own brand? Well, isn’t it? The Death of Socrates
  • 6. creatingVALUE   Issue 6: 2Q 2008 Ignition associate Ron Baker has coined what has come to be known in professional service circles as “Baker’s Law”: bad clients drive out good clients. What is a“bad client?” A bad client is a low-value client; they don’t add any value to the agency’s bottom line, professional satisfaction, or reputation: For starters, low value clients are unprofitable. There is simply no rational argument for keeping an unprofitable client. Look at most agency financials and you’ll see Pareto’s law in effect: 20% of your clients generate 80% of your income and profit. Generally speaking, about one-third of an agency’s clients actually cost the agency money. Low value clients usually run your team ragged because they’re poorly organized, have unreasonable approval processes, and make constant changes and revisions because they’re not focused enough to give the agency good input and clear direction. Low value clients often treat your team with lack of respect; thereby creating a relationship characterized by lack of collaboration, mediocre work, and strained nerves. Not every dollar is a good dollar So why are so many agencies filled with clients that fit this description? The excuse offered up by most agency principals is “they at least help cover our overhead.” They have the attitude that every dollar is a good dollar.    But some dollars actually have negative value when the result is demoralized people who leave for other jobs and a damaged agency reputation that hurts prospecting efforts for both people and clients. When less is more Our firm once worked with a 50-person agency that had a roster of 45 clients. Their profit margins were razor thin, their work was only average, and their staff was literally overwhelmed by the demands on their time. The principals of the firm made the courageous decision to part ways with the bottom third of their client list – about 15 of their smallest, most unprofitable clients. They agreed that they would resist cutting any of their key staff positions until they could judge the results of their actions. The result was a rejuvenated organization that suddenly had the time WhyYou Should Fire Your Low-Value Clients
  • 7. creatingVALUE 10 11 Issue 6: 2Q 2008 and ability to grow the business of their best clients, resulting in greatly improved profitability, staff morale, and work quality. Bigger versus better To quote another of Ron’s sayings, “Growth for the sake of growth is the ideology of a cancer cell.” The only kind of growth you should want is smart growth. Income is vanity, but profit is sanity. P.S. One brilliant way to get rid of your low value clients is to charge them the highest price. Ironically, most low value clients end up getting our lowest price, because they complain the most. Do just the opposite and your low value clients will disappear. Why you should fire your low-value clients Cost-Led Pricing vs. Price-Led Costing During the past 15 years or so, there has been a pricing revolution in business. Most large successful companies are staffed with professional pricers – people who make their living by determining the value, and therefore the price, of their company’s products and services. Here’s the way today’s professional pricer approaches his or her work: Customer > Value > Price > Cost > Product Pricing professionals know that because value is subjective, the process must start with the customer, the arbiter of value. Once they’ve answered that question, they can determine a price. Knowing what price they can charge, the company then evaluates the costs involved. If they determine they can keep their costs below the price, they produce the product. Progressive organizations like Toyota work this way. Toyota actually doesn’t even have a traditional cost accounting system. They start by determining the value of a new car to the customer, then set the price, then determine what they can afford to invest in terms of costs, then – and only then – produce the product. Now look at how most professional service firms – like advertising agencies – approach pricing: Product > Cost > Price > Value > Customer
  • 8. creatingVALUE 12 13 Issue 6: 2Q 2008 Teach it to your staff You must help everyone in your firm – from the accounting department to client service – understand this concept: there is absolutely no relationship between cost and value. None. Otherwise a rock from a diamond mine and a diamond from a diamond mine would have the same value, because the cost of extracting them was exactly the same. An 8 x 10”oil painting by Joe Schwartz and an 8 x 10”painting by Vincent Van Gogh would have exactly the same value because the cost of materials (the paint and canvas) were exactly the same. Act now or act later In a marketing world where the cost of some media (YouTube) is zero, and the time required to execute an idea (AdWords) is sometime close to zero, agencies will be forced to find another way to be compensated. Sooner rather than later, all agencies will have to learn“price-led costing”and abandon the flawed model of“cost- led pricing.” Yes, it’s backwards, both literally and figuratively. They look at the product or service to be delivered, add up the projected cost in terms of hours, and then add a mark-up for profit. That determines the price. The problem is none of this has anything to do with the value to the customer. And look where the customer is in this process: dead last. No relationship between cost and value The fact that an assignment is expected to take 53 hours of agency time bears no relationship to the value to the client. The 53 hours might result in a very ugly, very ineffective print ad. Did the cost of the time translate into value for the client? Not at all. Similarly, imagine that the agency invests 30 minutes in developing a brilliant idea that requires little to no production time (like buying some key words on Google) that earns the client tremendous success in the marketplace. Again, was the cost of time equal to the value for the client? If the world’s largest car maker can operate without a traditional cost accounting system, so can you. u Cost-led pricing vs. price-led costing
  • 9. creatingVALUE 14 15 Issue 6: 2Q 2008 Obviously, most companies fall somewhere between these two extremes. Few organizations could be considered to have marketing departments that are completely reactive, just taking orders from the sales force (although they certainly do exist). And only a handful of companies could be considered to be truly expert marketers – the P&Gs of the world. Characteristics of the right kind of client In evaluating the potential of your clients as candidates for an outcome-based compensation agreement, here are four key factors to consider: 1. Do you have a high trust level with this client? Do they seem to value what you do and treat your team with respect? Are they willing to share what is often considered to be confidential information with you? Will they be as transparent with you as they expect you to be with them? 2. Are they able and willing to focus their time and attention on a serious project that transcends the demands of the day? Do they have the patience for a process that will take some large chunks of their time, but pay rich dividends in the long term? The Right Kind of Client for Value-Based Agreements Value-based compensation in an agency-client relationship can take many forms, from simple project pricing based on perceived value to more sophisticated compensation agreements based on specific outcomes. The value-based pricing continuum therefore involves different levels of complexity. While every client should be quoted pricing based on value instead of costs, only certain kinds of clients are right for the more sophisticated forms of value-based compensation involving measured outcomes. All client organizations fall somewhere along the spectrum between: Marketing as a proactive growth driver Marketing as a reactive service provider The more a client company sees and treats marketing as a C-level activity, the more likely they are to benefit from an outcome-based approach to compensation. Project-Based Pricing Outcome-Based Agreements Client organizations where marketing is a reactive service proceder Client organizations where marketing is a proactive growth driver Level Of Complexity
  • 10. creatingVALUE 16 17 Issue 6: 2Q 2008 The right incentive to do the right thing Knowing what specific results need to be created, the agency is likely to be much more proactive and resourceful in how it approaches its work. Rather that worrying about how much time got logged to the client’s business, the team will instead be worrying about whether or not they’re accomplishing the outcomes. Alignment of interests Because the agency’s compensation is tied to value created rather than hours worked, the economic interests of agency and client are the same: the success of the brand. This fundamentally changes the way the client works with the agency. Instead of just barking out orders and requests, clients are much more inclined to ask“what do you think”. The right kind of client for value-based agreements 3. Does your client understand what makes their brand successful? In other words, can they articulate their brand’s key success drivers? Do they know why some consumers buy their brand and others don’t? Do they understand how a purchase develops – the rational and emotional aspects of the“customer journey?” 4. Finally, is your client willing to invest in their own success? Identifying and measuring the metrics of success that will serve as the basis of an outcome-based relationship will cost money the client hasn’t spent before. Are they willing to create a new line item on their marketing budget labeled“accountability”? The process of developing an outcome-based agency-client relationship is intensive but extremely rewarding for both parties. Here are just a few of the benefits you can expect: Crystal clear expectations Once an outcome-based agreement is established, there will be no guessing or second-guessing about what the agency is expected to accomplish, and what the client is expected to do in return. More leverage for the agency With skin in the game and a mission to achieve specific outcomes, the agency is in a position to be much more direct and forceful in its recommendations to the client. The client is much more likely to view the agency as a partner in the true sense of the word. Why Client Relationships Are a Strategic Decision Agency-client relationships fall into one of three types. Which type of relationship do you seek, and which type do you prefer? 1. Employer/Employee This is, unfortunately, the most typical kind of agency-client relationship. The client gives the orders, the agency executes them. The agency is an“agent”does“work for hire”. This kind of relationship almost always leads to a dissatisfied, unmotivated
  • 11. creatingVALUE 18 19 Issue 6: 2Q 2008 Why client relationships are a strategic decision agency team, where the client is roundly criticized for constantly dictating to the agency. It surprises many agencies to learn that most clients actually don’t like this kind of relationship either. They see the agency as good “doers”, but weak thinkers, who seldom take initiative and provide proactive marketing leadership and ideas. 2. Doctor/Patient This is the kind of relationship most agency professionals describe as their preferred way of working. With a higher trust factor than in the “Employer/Employee” relationship, the agency is able to diagnose and prescribe. The client values the agency as much for what it knows as what it does. The agency team usually derives much more professional satisfaction from this kind of relationship. 3. Business Partner/Business Partner This is the highest order of agency-client relationships, but it’s extremely rare. It exists only among agencies that have adopted a true“shared risk, shared reward”approach to compensation. The characteristics of a partnership transcend an attitude. The actual definition of partnership is“A legal contract entered into by two or more persons in which each agrees to furnish a part of the capital and labor for a business enterprise, and by which each shares a fixed proportion of profits and losses.” Obviously, most agency- client relationships wouldn’t qualify. If you want to be a partner with a client, the following three things must be in place: Common goals. Partners seek the same results and benefit from the accomplishment of the same goals. Most notably, their economic interests are aligned. (Compare this to most agency- client relationships in which the client’s interest are in driving the agency’s income down, not up.) Transparency. Partners share information openly and freely. All data and information related to the success of the partnership is open and available for examination. (Contrast this against traditional agency-client relationships, where the client often closely guards information about sales, profits, etc.) Risk and reward. Partners invest time, energy, expertise, and/or money knowing that the potential for both gains and losses exists. (In commonplace agency-client relationships, there is sometimes an upside for the agency in the form of a“performance bonus”but almost never a downside). Agencies must think carefully if they want a partnership with their clients. It’s a different business model than the agency industry is used to, but it can be remarkably rewarding and successful for the right kind of client.
  • 12. creatingVALUE 20 21 Issue 6: 2Q 2008 Discussing value instead of costs Armed with this menu of possible indicators, the agency is in a position to begin a new client relationship by discussing value instead of costs. They talk“scope of value”before discussing scope of work; expected outcomes before expected deliverables. Imagine the impression this creates with a prospective client. The agency is asking important, intelligent questions. In the process, they very often discover that the client organization has never really answered these questions, but it becomes immediately apparent that they should. In fact, some clients will come to view the process of identifying the metrics of success as one of the most valuable aspects of their relationship with the agency. How one agency helps its clients define success Boston-based Partner + Simons is an example of a successful independent agency that takes a value-based approach to its client relationships. To help identify the right outcomes, they have developed a comprehensive model that helps their clients think through the likely drivers of their brand’s success. Many of these metrics are what we would call“leading indicators”– the best kind, because they predict success rather than just measure it. Examples include differentiation, likeability, perceived quality, price premium, advocacy, and participation. p Mid-sized independent Partners+simons organizes their metrics of success in an interesting and logical way. Why client relationships are a strategic decision
  • 13. creatingVALUE Differentiating the Agency Brand 22 23 Issue 6: 2Q 2008 A Snapshot ofYour Agency A survey to see how well your agency is creating and capturing value If you’d like to get a quick snapshot of where your agency is in the evolution toward a value-based business approach, ask all agency associates to participate in a brief ten-question survey. You can use SurveyMonkey (www.surveymonkey.com) or one of the other popular online survey websites to both administer the questionnaire and tabulate the results. Each question should be rated on a scale of 1 to 10, where 1 means “Strongly Disagree”and 10 means“Strongly Agree”as follows: 1.We begin every new client relationship with a discussion of Scope of Value before we discuss Scope of Work. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 2. We carefully define the metrics of success at the beginning of a client relationship or major client assignment. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 3. We base our relationships on how clients define success, not how agencies define it. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 4.We have an approach that identifies the client’s leading indicators of success. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 5.We have the capability to develop an agency-client performance scorecard that can be used as the basis for a value- based compensation agreement. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 6. In discussions with clients about pricing and compensation, we focus the dialogue around outcomes instead of efforts. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 7.We apply as much creativity to client compensation as we do solving our clients’marketing problems. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 8. We trade the time we would otherwise spend reviewing, modifying, explaining and defending our fees and invest it upfront in defining what constitutes value in the first place. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree
  • 14. creatingVALUE 24 Issue 6: 2Q 2008 A snapshot of your agency 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. 9.We are a stakeholder in our clients’success by sharing in both the risks and the rewards. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree 10.We are compensated for the value of outputs instead of the cost of inputs. 0 1 2 3 4 5 6 7 8 9 10 Strongly Disagree Strongly Agree You’ll obviously want to look at the ratings for each individual question, but you should also calculate the overall aggregate score. If your firm scored an average of 7.0 or above, you can consider yourselves among the top-rated value-based agencies.