Retainers are still the most common form of remuneration for advertising agencies in the major markets. These retainers are based on resources multiplied by direct salary costs by overhead factor and then multiplied by profit margin.
But how do you value your remuneration / compensation model?
Value has many definitions.
But basically value can be defined as V = Q / $ which is VALUE is QUALITY and/or QUANTITY divided by COST.
So lets look at 3 different types of agency remuneration and how value is calculated:
1. Retainer / payment based on resource alone
This is the most common and is effectively the outsourced agency resource.
2. Retainer / payment based on outputs or deliverables
This model, reportedly used by Coca-Cola, values advertising like a manufacturing process.
3. Retainer / payments based on outcomes or results
This model, increasingly applied in some shape of form to varying success, links value created to cost of advertising to provide accountability.
In each each case we will look at the model, the value calculation and the strengths and weaknesses.
1. Retainer / payment based on resource alone
The model: This is outsourcing at its worst. Basically the marketer pays a fee or retainer for a quantum of resources (people). There is no direct correlation (relationship) between the number of people and the amount paid in the retainer or fees.
Value: The only calculation of value is the number and experience of the people and their cost.
Strengths: Often this works in the favour of one or other parties (agency or marketer) as it can be difficult to quantify. With the increasing involvement of procurement it is usually financially in the favour of the marketer at the expense of quality people working on their business (False economy)
Weaknesses: If you try and review the value of the model there is usually huge disagreement largely based on subjective opinion in regards to the huge amount of variables:
a. The number of staff – FTEs – who is in and who is out and how much time is required and why?
b. The number of hours that constitutes full time equivalence – FTEs – are public holidays, sick leave and annual leave counted?
c. The experience and quality of the staff – a tough one.
d. Their salary rate – industry? or actual? – both with traps for unwary players
e. The overhead multiple – inclusions and exclusions and level?
f. Indirect salary costs – Is the agency CEO / Managing Director a head count or an overhead?
g. The profit margin – how much is too much and how little is too much?
No wonder agency remuneration / compensation becomes a confusing discussion of contradiction under this model. (Note to self – if the discussion does become confusing and difficult it is probably because you have this model)
Also, as you are effectively outsourcing, cut your budget / spend and the agency will probably ask you who they should cut from the team.
2. Retainer / payment based on outputs or deliverables
The model: As Coke realised, paying for the inputs (people) and their costs (salaries, overhead and profit) does not equal a sound basis for value. Therefore if you think of advertising (including media) as a manufacturing process (say making bottles of carbonated flavoured and sweetened water?) then instead of paying for inputs, you pay for outputs.
Value: In this case you can calculate the value as the outputs divided by the cost. Therefore if a TV campaign cost you $500K in agency fees and now if costs you $400K in agency fees you have got a 20% improvement in value. Of that website cost $750,000 for 20 html pages then this is $37,500 per page. Now if another website costs you $2 million for 120 pages that is $16,666.66 which is almost double the value.
Strengths: it is certainly easier to define and measure the outputs of an advertising agency (including media, pr, digital, direct marketing etc) and then measure the “value” of these outputs. It also allows you to simply adjust the fee for the agency based on the increase and decrease in your requirements. Sort of like speeding up or slowing down the advertising production line to suit demand.
Weaknesses: Of course measuring the quality of these outputs is still subjective. And without a measure of quality (read effectiveness) is it really a measure of value?
3. Retainer / payments based on outcomes or results
The model: This is often seen as performance based remuneration or payment by results. PBR. The trouble is that it is often ineffective and fails because it is applied in a half-hearted manner. Usually the carrot (payment to the agency) is too small to drive behaviour and alignment to results or the stick (loss of revenue) is too high and is a deterrent.
The other problem is that in trying to make the process accountable, the measures become too complex and often too expensive to measure and calculate and therefore again fails in driving and rewarding the behaviour and alignment to results.
Value: Assuming the advertising is delivered at cost using the first two models above, this means that the profit is paid to the agency is the marketer achieves or betters the results required.
If the marketers objective was growth (sales, revenue or profit) then it becomes part of a return on investment calculation representing real financial value.
Strengths: If the carrot is big enough it can provide a link between the agency cost and the financial results achieved, however tenuous. The upside being if the marketer makes profit the agency makes profit.
Weaknesses: There are so many ways people get this wrong.
The agencies will say they do not control all variables that impact on profit so why should their profit be at risk.
Procurement will say that while their profit is at risk, the up side for them can be no more than they made when it was not at risk.
Marketers will say that it is difficult (if not near impossible) to get a direct correlation between the agency activities and the sales results. (Excluding direct response an online transactions)
But in summary, if you want to achieve a value based remuneration model, agency remuneration needs to move from a cost base / input model to a value-based output model. And the steps along the way are somewhere in between.
In the words of Jim Rohn “You don’t get paid for the hour. You get paid for the value you bring to the hour.”
