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Paying the ad agency
Roderick White
Warc Best Practice
February 2007
 
 
Paying the ad agency
Roderick White
Traditionally, advertising agencies were paid a commission by the media on the value...
has published a series of surveys (2).
The main approaches now in use
1. Fees: there are a number of ways of formulating f...
that it would be based more on growth in brand equity (however measured) than on specific sales or share targets. This
was...
3. G Beckett: Pricing for growth. Admap 450, May 2004.
4. J Lace: Diving for pearls. ESOMAR, September 2002.
 
General ana...
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Paying the ad_agency

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Paying the ad_agency

  1. 1.   Paying the ad agency Roderick White Warc Best Practice February 2007  
  2. 2.   Paying the ad agency Roderick White Traditionally, advertising agencies were paid a commission by the media on the value of the ads they placed for their clients. This commission was 15% of the gross (commission-inclusive) cost, or 17.65% of the net cost. A few individual media paid less than this, and it was the custom to increase the rate to 20% for international business. The system had the apparent merit of simplicity and transparency, and as agencies became progressively more involved in the physical production of the advertisements, they successfully extended the process to cover production costs, too, on the same basis. When commercial TV became widespread, the economics of agency operations changed dramatically. Where it had been the case that a press campaign required several ads, each of which cost relatively little to produce, and which individually had quite small media money put behind them, a TV commercial might cost substantial sums to produce (at 2005 prices, an average commercial might cost $380,000 in the US), and could be backed by very substantial media expenditure. It became extremely easy for an agency that could push its clients into TV to earn large commissions and a greatly enhanced profit margin. This, it has been suggested, acted as a force to distort agency media recommendations (7, 9). Pressure on commissions After a time, advertisers began to recognise this situation, and started to insist on reduced commissions. At the same time, the process of ‘unbundling’ both media planning and buying into specialist agencies began to develop, so that it became necessary for agencies and advertisers to price media and creative operations separately. What had been a monolithic 15% commission to a full-service agency became (broadly) 1.5-4% for the media specialist and perhaps 7-9% for the creative agency (14). Aggressive negotiators among advertisers could obtain an advertising service for as little as 7-8% in total, and 12% became quite normal. Many agency contracts allowed for commission on a sliding scale - the higher the aggregate spend, the lower the rate of commission, and unilateral reductions by client companies became more widespread (5, 18, 20), with the media sometimes joining in (19). Agencies’ reaction to this was to try to change the rules, in order to protect their revenues and margins. Over the last 25 years or so, a number of different models of how to pay the agency have evolved. A good overview of the various methods used in the UK and their pros and cons is published by ISBA (1). In the US, the ANA    Title: Paying the ad agency    Author(s): Roderick White    Source: Warc Best Practice    Issue: February 2007   Downloaded from warc.com     2
  3. 3. has published a series of surveys (2). The main approaches now in use 1. Fees: there are a number of ways of formulating fee payment systems, some including incentives or payment by results elements. Most fee systems are based effectively on time, as are those of many other professional services. For large operations, it is by now quite standard practice for advertiser and agency to agree a basis for charging the work of each significant member of the agency team, and on this basis to negotiate an annual fee, usually subject to regular review. However, it has been widely observed that this mechanism may encourage the agency to waste, not save, time (3), nor does it reflect the actual time that may be required to solve a particularly difficult problem (8). A more modern approach is to assess fees on the basis of the value provided by the agency - a rather broader approach than a (rare) refinement, which is to set a fee specifically for achieving a creative solution to the advertiser’s problem (13). This approach is, in fact a ‘hybrid’, since it usually includes a ‘base’ fee to cover the agency’s costs of servicing the account, with the creative fee as, in effect, a preagreed ‘bonus’ or reward. A number of mostly smaller agencies operate a fixed-cost, menu-driven fee structure, with prices fixed for different types of task. This has been refined in great depth by one small UK agency (12). 2. Commission: fixed, usually below 15%, or variable. Variable commissions typically operate in steps, depending on the size of the budget, with successive tranches over a base level attracting lower rates of commission. Pure commission systems are disappearing rapidly from the marketplace (7), in spite of their simplicity and transparency (8). Even media is beginning to move away from commissions (7, 10). 3. Incentives and payment by results (PBR): a growing number of advertisers are building incentives into their agency agreements (11). These typically provide for an extra fee (or an increase in commission) when agreed targets are achieved. The basis for these incentives varies widely, and each has its pros and cons. l Sales/share (etc.) targets: this reflects the ultimate objective of the advertising, but the targets need to be set realistically - where a brand’s marketing objective is to maintain share, it is unrealistic to reward the agency only if the share increases. Further, advertising - or all the various parts of the communication mix within the agency’s remit - is not the only force affecting the market. The agency would be (justifiably) displeased and demotivated if targets were missed because of a price change only announced halfway through the campaign period. l Client-agency evaluation: well-run agency relationships usually include regular reviews of the agency’s performance on a variety of criteria. These are used by the client both to monitor the individual agency’s contribution to the business and to provide more or less objective comparison with other agencies used, or between international offices in the agency network. While these typically involve ‘soft’ measures, a well-designed scheme enables both client and agency management to develop the relationship, and the scores on these evaluations can be - and are - used as the basis for PBR schemes. The process is vulnerable to possible distortion if individual relationships go awry in the short term, and the periodic nature of the assessment means that the agency risks being ‘only as good as its last ad’. Agency evaluations seem particularly common in international operations (6). l Brand prosperity: Procter & Gamble in late 1999 announced that it proposed to remunerate its agencies on the basis of ‘sharing in the success of its brands’ (17). It was unclear precisely how the proposed scheme would work, but it seemed   Downloaded from warc.com     3
  4. 4. that it would be based more on growth in brand equity (however measured) than on specific sales or share targets. This was an early example of the development of so-called ‘value-based’ incentive schemes (3), and has since been widely imitated. A more general criticism of PBR schemes is that they are, almost inevitably, relatively short term in nature, while effective brand building may take (and last) for years (14). Key to the success of these schemes is that they are sufficiently large, as a proportion of the agency’s potential income, to be motivating, but not too large to lead to potential damage to the agency’s financial stability (4). 4. Hybrid schemes: with 40% of US advertisers already using PBR as an element in their agency remuneration by 2004, according to the ANA (2), many systems are automatically ‘hybrid’. Traditionally, the main hybrid format was a mix of fee and commission - for example, where an agency is working on a new product launch, which may require many months’ work before an ad appears. In this case it is common to pay fees for the development period, and then to switch to commission once the brand is being advertised. More recently, advertisers and their agencies have negotiated remuneration packages that consist of a base level of fees plus a variable bonus related to the achievement of specific targets - specifically, fee + PBR. In addition to charging for the main business of planning, creating and executing advertisements for their clients, agencies have begun to try to develop ways to circumvent the quite severe squeeze on their margins that has occurred during the past 20 years (4). These fall into two main categories. 1. Charging for elements of their service that were previously ‘given away’, within the 15% commission. This applies especially to elements of the planning process: increasingly, agencies are packaging analysis processes and selling them as ‘brand audit’, or the like. 2. Negotiating additional payments for creative ideas: an extension of the system described by Rainey (13), by which a successful idea is charged for in each new medium or market in which it is used - in effect, a sort of creative ‘royalty’, since fee systems tend not to reward the very best ideas adequately (3, 7). One final note: as client purchasing managers (procurement departments) have increasingly become involved in agency relationships (15), a spotlight has been shone on the lack of transparency in the ways in which agencies traditionally have costed and charged for various aspects of production (3, 4). For some agencies, discounts from production houses and studios have been a disproportionate part of revenue, and proper understanding and control of production processes has become an area of substantial cost saving for some large advertisers. In the last resort, the agency has to be able to make a profit on a properly run piece of business, and the advertiser need to recognise that. As Phillips (8) points out, the key to a successful remuneration agreement is mutual trust and partnership, entered, ideally, for the long term (16). Core reading 1. *Paying for Advertising IV, ISBA/ARC, London, 2006. 2. *Trends in agency compensation, 13th edn, ANA, New York, 2004.   Downloaded from warc.com     4
  5. 5. 3. G Beckett: Pricing for growth. Admap 450, May 2004. 4. J Lace: Diving for pearls. ESOMAR, September 2002.   General analyses 5. G Duncan and J Lace: Agency remuneration: time for a new paradigm? Admap, October 1998. 6. J Lace: Global agreements: a new solution to an old problem. Admap 429, June 2002. 7. J Lace: Is remuneration the real stumbling block to IMC? Admap 442, September 2003. 8. N Phillips: The ethics of agency remuneration. Admap, October 2000. 9. Alan Smith: Distortion by commission. Admap, June 1997.   PBR and other systems 10. M Cross: Calling time on the commission system. Admap 444, November 2003. 11. J M Lace: Payment-by-results. Is there a pot of gold at the end of the rainbow? International Journal of Advertising 19, 2, 2000. 12. J Orsmond: Fixed-cost working: a better way to pay for agency services. Admap, October 1998. 13. M T Rainey: The ‘ideas’ idea: an alternative view on agency compensation. Admap, October 1998. 14. J Surguy: Incentivising agency performance. Admap 417, May 2001.   Procurement 15. A Melsom: Marketing and procurement - a curious blend of art and science. Market Leader 25, Summer 2004.   Case history  16. D Calhoon and E Decker: How to develop a productive relationship with your agency. The Advertiser, January 2003.   News items 17. WARC News: P&G to pay agencies by results. 1 September 1999. 18. WARC News: GM squeezes up to 10% fee cut from agencies. 10 December 2001. 19. WARC News: Google to withdraw commission from UK ad agencies. 5 October 2005. 20. WARC News: General Mills changes agency payment plan. 15 June 2006.   © Copyright Warc 2007 Warc Ltd. 85 Newman Street, London, United Kingdom, W1T 3EU Tel: +44 (0)20 7467 8100, Fax: +(0)20 7467 8101 www.warc.com All rights reserved including database rights. This electronic file is for the personal use of authorised users based at the subscribing company's office location. It may not be reproduced, posted on intranets, extranets or the internet, e-mailed, archived or shared electronically either within the purchaser’s organisation or externally without express written permission from Warc.   Downloaded from warc.com     5

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