Defining Value Based Agency Compensation

A few weeks ago in NYC I presented the results on a survey undertaken by the WFA on Value Based Compensation (VBC) to the COMPAG Group, which will become the basis of a white paper we are preparing on the topic. VBC is the hot topic as advertisers and procurement look for ways to improve the performance of the current spend (commission) and cost based (resources) models.

“The biggest barrier is defining value in a way
that is objective and fair to both sides”.

Value is what it is worth to the buyer and how much they are willing to pay

So how do we define value?

val·ueverb, -ued, -u·ing. Noun

1. relative worth, merit, or importance. (what is it worth to you?)
2. monetary or material worth, as in commerce or trade. (what is it’s market worth)
3. the worth of something in terms of the amount of other things for which it can be exchanged or in terms of some medium of exchange. (what is it potentially worth?)
4. equivalent worth or return in money, material, services. (what is its replacement worth?)
5. estimated or assigned worth. (what do you think it is worth?)

There are two basic forms of Value Based Compensation:

1. Output based value models
2. Outcome based value models

So what is the difference between these two models?

Output based value models

The output based value model is a fundamental shift from the cost based input model with its focus on resources and their associated costs. Instead the focus is on the deliverable outputs required by the marketer and produced by the agency.

Instead of interrogating the cost of the service provided, the marketer sets a “price” that is based on the value of the service or output. This price is the value of that service or output to the advertiser and is often based on a number of considerations including:

  1. Historical cost or price – requires clear understanding of the price paid previously
  2. Strategic importance – strategic or tactical
  3. Brand or business objectives – the potential value to the business
  4. Geographic use – major market, minor market, growth market, multiple markets

The marketer sets the price as the value of the service or outcome and then agrees this price with the agency. The model goes beyond fixed fee compensation models, as the cost of resource is a foundation to setting value but is not the ultimate driver of defining the value of the output to the marketer.

Outcome based value models

All of the above models can accommodate a performance based compensation component. This is where the agency is either:

  1. Provided a bonus on top of their base compensation and profit margin for achieving a pre-agreed set of objectives
  2. Sacrifices a portion of their base compensation, to receive a bonus higher than the profit margin for achieving a pre-agreed set of objectives
  3. Earns their profit margin on achieving a pre-agreed set of objectives

These pre-agreed sets of objectives or metrics usually fall into one of three categories:

  1. Soft – Relates to the evaluation of agency functional areas: account services, creative and media in terms of: performance, service, relationship, cost efficiencies, etc.
  2. Medium – Relates typically to marketing and advertising metrics: product awareness, ad awareness measures, consumer measures, attitude ratings, persuasion, purchase intent, awards, brand equity, image, effectiveness awards, etc.
  3. Hard – Typically include business and financial objectives: sales, traffic, profit, market share, volume growth, etc.

This model is where the agency is compensated partially or totally based on the agreed outcomes, which can be from one or all of the above categories of criteria. But usually has a focus on the financial value created and therefore the criteria focus is the hard business and financial metrics.

These two models go hand in hand and in most cases we have implemented a version that has elements of both. A pricing model for the value of the outputs and a performance component for the value of the outcome. The mix of the two depends on the circumstances of the brand. It could be all pricing based or all performance based but usually somewhere in between. The way to determine this I will discuss in a later post.

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About Darren Woolley

Darren is called a Pitch Doctor, Negotiator, Problem Solver, Founder & Global CEO of TrinityP3 - Strategic Marketing Management Consultants and a founding member of the Marketing FIRST Forum. He is also an Ex-scientist, Ex-Creative Director and a father of three. And in his spare time he sleeps. Darren's Bio Here Email: darren@trinityp3.com
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