5 issues you need to overcome to make agency incentive payments work

For the past ten years we have been working with advertisers to move their agency compensation from the popular cost-based model to a value-based approach. One of the cornerstones of the value-based approach is performance or incentive-based agency compensation.

Along the way we have been confronted and have managed to successfully overcome almost all of the obstacles in the way. For some advertisers and their agencies, it is incredibly difficult to move to this mode of compensation. But for those advertisers who have achieved this, the rewards have been innumerable.

In the case of a global dairy company, we aligned the creative and media agencies to the CMO’s financial performance, which determined the size of the incentive pool. The collaboration score given by the marketing stakeholders and the other agencies in the roster determined the agencies’ share. The result was the perfect alignment of the agencies to the shared performance metrics of the CMO and his team.

In our experience the main obstacles to implementing a successful incentive or performance-based compensation are:

1. Agencies are hesitant to link compensation to performance
2. The performance criteria prove difficult to agree on
3. The scope of the incentive is too narrow
4. It proves difficult to budget the payment
5. Disputes over the payment of the incentive

The problem is that any one of these can become an insurmountable issue. But as you will see it is possible to address any and all of these issues to achieve the successful implementation of the incentive based compensation.

1. Agencies are hesitant to link compensation to performance

Often agencies will shy away from sales and profit measures because they quite rightly say they do not control all the steps and channels of the sales process such as retail, call centres and sales teams.

But then who does control all aspects of sales and marketing? When you consider the number one factor influencing sales of non-alcoholic beverages is the weather, I would welcome anyone to show me who controls all aspects of sales at Coca-Cola because then I will be able to introduce you to God.

The fact is that all parties involved make a contribution or influence the result. No one can actually control the outcome. Therefore the level of influence and the associated risk must be taken into account when calculating the upside and downside of the incentive payment.

For many of our direct response advertisers, where sales are directly tracked through the website or the call centre, we have the total agency fee incentivised and paid on leads and sales. In one case the new compensation model resulted in a 250% increase in sales with no corresponding increase in media or creative other then the additional fees paid as an incentive.

2. The performance criteria prove difficult to agree on

The first issue is to make sure the criteria is achievable. We were working with a frozen food company who proposed a sales growth bonus for the agency where they agency could achieve a 20% lift in the agency fees if the company achieved their double-digit objective. I stupidly forgot to ask how achievable this objective was, but the agency pointed out that the sales objective was the same one the company had for the past 3 years and had never achieved it.

The next issue is to avoid formulas that are far too complex. A consumer goods company had a formula that measured sixteen different performance criteria. In the contract the methodology was outlined over four pages, but in the three years of the contract the incentive was never paid as no one had the time or the ability to calculate the result.

The final issue is when the measurement process becomes more expensive than the fee itself. In this case the alcoholic beverages company undertook research to specifically attribute the contribution of the agencies’ work to the result, only to find that the cost of this research was more than double the incentive fee being paid – a great incentive for the research company.

In our experience, having the metric that the marketing team is measured against, shared with all of the key agencies, is ideal. These are usually sales and revenue focused and help align the agencies efforts to those of the marketing team.

3. The scope of the incentive is too narrow

To encourage change or incentivise performance there needs to be a carrot, and quite a sizeable carrot. Too often we see performance bonuses or incentives that are really relatively small in regards to the overall remuneration proposal.

A very popular approach from a procurement viewpoint, that would undermine the success of the incentive, was to have the agency sacrifice 5% of revenue for the opportunity to “earn” 10% back if they achieved the performance criteria. Ask yourself, if your boss offered the same deal would you jump at it? Firstly, why give up anything that is certain for the uncertain. And secondly, is 5% really much of an incentive? After tax it is more like 3%.

The Coca-Cola value-based compensation had a 30% incentive for the agencies. In some cases we have had 50% bonuses or incentives in place where the agency earns an acceptable margin on past performance and then there are stretch objectives. Of course where the agency is paid on leads or sales the upside is only limited by the number of sales.

4. It proves difficult to budget the payment

The difficulty faced by many marketers is the inability to budget for an incentive payment, especially if it is substantial amount. The problem is if the performance criteria are not met, the budgeted incentive is returned to company revenue. (Not a bad outcome for the bottom line in the circumstances) This a concern for many marketers as they worry that the allocated budget should be used for further marketing activity, rather then being lost.

This concern will often limit the size of the incentive and therefore limit the effectiveness of aligning agency performance to business success metrics. We have found the best solution is to discuss with the CFO the concept of setting up an agency incentive payment pool that is funded as a cost of good sold. In this way the incentive is therefore no longer funded from the marketing budget, but is funded from the sales outcomes achieved.

This is an interesting concept for many CFOs who identify a greater level of accountability in the approach. But even if this is not successful there are many ways of being able to fund the incentive if the success criteria are financially based.

5. Disputes over the payment of the incentive

Having overcome all of the obstacles, we have had a number of agreements fail in the first year when the marketers have reneged on the incentive payment because the results were too positive and the payment too large or the marketers felt that the contribution of the agency did not justify the payment due to the agency. In both situations the failure to pay had a catastrophic impact on the trust between the agencies and the marketing team.

Ironically we had a marketer whose sales had tripled meaning the payment to the agency had effectively doubled. Still the marketers had an increasing feeling the agency was being paid too much. They insisted on cutting the agencies incentive payments and within months the sales performance dropped to pre-incentive levels.

There was also the telco who overachieved cell handset sales to the point that the payment to the media agency was due to be paid a substantial incentive. The marketers vetoed the payment as they had convinced themselves that it was the offer and not the direct response media strategy that had driven leads and ultimately sales.

Fear and greed gets in the way of performance

Our experience has shown that the major issues that arise when implementing an incentive-based compensation can be overcome through mature and informed negotiations. When we have achieved the result, it has led to greater alignment between agencies and the marketing team, increased financial performance, with improved revenue and less waste.

However, the real issue is that many advertiser and agency relationships have become damaged through years of cost pressure and power imbalances. This means that fear and greed have become the undercurrent of many of these relationships and in this environment it is difficult to implement an incentive-based model which requires shared objectives and mutual trust.

 

To find our how TrinityP3 Marketing Management Consultants can help you further with this, click here.

First published in The Internationalist May 27, 2015