Risk vs reward in value and performance based agency compensation

This post is by Darren Woolley, Founder of TrinityP3With his background as analytical scientist and creative problem solver, Darren brings unique insights and learnings to the marketing process. He is considered a global thought leader on agency remuneration, search and selection and relationship optimisation.

The current resource based model is low risk for both agencies and advertisers, which is possibly why it is so increasingly popular. The marketer knows what they are paying and knows what resources they are supposedly getting for their fees and retainers. The agency is guaranteed to recover their salary costs and overheads and make an agreed margin on these costs.

Everything is calculated and determined and there is minimal risk for both parties.

But here is the problem. Like most businesses, agencies need to demonstrate growth to their shareholders and for publicly listed companies this is a quarterly requirement. If I am going to increase my revenue and profit it is through selling more resources for more money to my clients, who increasingly are looking for more cost effective ways of having their advertising requirements delivered.

Risk or RewardThis is why more people are considering value and performance based compensation models. But to make this work effectively you need to understand the role that risk and reward plays in the equation.

Rewards

Being optimistic Type A personalities, most in marketing and advertising are looking for the upside when considering performance incentives, bonuses and rewards. On the other side we have the more pragmatic procurement team who are looking for ways to reduce the cost and so you get reward models that are all stick and no carrot.

The typical model we have seen is where the agency sacrifices 10% of their profit for the chance to earn 15% back.

I often ask marketers if they would do this with their own salaries and the answer is always an emphatic NO! So I am baffled as to why anyone thought this was a winning idea.

For rewards to be motivators they need to be substantial.

First, this percentage is often only calculated on the retainer, which is usually slightly less than half of the total revenue the agency will take from the advertiser.

Second, in some cases the 15% is less than the revenue the agency makes on a really good production project and so is not a major incentive.

And third, if the criteria are set badly the agency can usually at best make back what they would have been paid anyway, and yet they will have to work a whole lot harder to do it. So where is the incentive?

If you are going enter into a reward model to drive performance then it has to be worthwhile.

Risks

This is the next big sticking point, which is the risk associated with any reward model. It comes down to the criteria against which the agency will be evaluated.

Criteria type Example Risk Profile
Criteria that the agency can directly control Relationship Low risk
Criteria the agency can influence Media costs Low – Medium risk
Criteria where the agency has little influence Brand tracking Medium risk
Criteria where the agency has no influence Sales / Profit High risk

The less control or influence the agency has the higher the perceived risk.

But in a complex system such as a market place it is strange to be considering risk as in many ways no one involved has control. When you consider that issues such as the economy, the weather, product supply, competitive activity and distribution are often outside of the control of the marketing team, let alone the agencies, it is strange to be considering control. But for the agency, entering into a reward-based model has associated risks.

It is natural for the agency to want to minimise the risks and maximise the rewards. This is simply them reacting in a natural human way, which is to not want to risk what they already have, which is the current compensation model.

Risk & Reward

When you bring these two together it is important to balance both the risk and the reward. As the risk for the agency increases the reward for the agency should also increase. It is striking a balance that is important and both the agency and the advertiser need to be open and honest in what they value and what risks they are willing to take.

Because of this relationship of increasing risk being balanced by increasing reward, we find that the metrics used for the agency will move from agency performance measures to brand and financial performance measures. The reason being that the increased reward must be justified by a financial improvement for the brand and the business.

Many will try and mitigate the increased risk by having a spread of measures across a range of risk profiles. This is a logical approach, but care must be taken that the rewards within that approach match the risks. Too often the low risk criteria end up with similar levels of rewards to the high risk making them a much more desirable focus for the agency and one they will default to, especially if they are able to directly control or impact the results.

The role of trust

Because you are asking the agency to move from a low risk proposition to a potentially high risk model it naturally requires a level of trust between each of the parties. In the past many agencies have been burnt by the traditional procurement model described above which was all risk and little reward for the agency as the primary reason for the implementation was to reduce the agency fee.

One way of building trust is to transition over time from a low risk model to a higher risk model. That is to have a low risk and low reward model implemented initially and then each year increase the risk profile and the reward level for the agency.

This approach fits with the agency desire to have a mechanism for increasing their own financial performance and with time they are able to see how the risk and reward model works.

Some try to implement the model at the time of selecting a new agency. This is definitely possible as a way to establish a new relationship based on rewarding performance. But the risk factor is still a concern for agencies. Again we would recommend tabling a model that commences with a lower risk and lower reward model initially with a transparent view of increasing the agencies risk profile and reward size over time.

The danger of forcing the agency into accepting a high-risk model is that if the model under delivers to their revenue expectations it can significantly damage the relationship between the agency and the advertiser.

Getting the balance right

Often the process requires an independent third party to get the balance right by:

  1. Creating a model that meets the performance needs of the advertiser and also satisfies the risk comfort level for the agency.
  2. Acting as a voice of reason in bringing both parties to a common ground.
  3. Monitoring the metrics and ensuring the agency is both held to account and rewarded as necessary.

While we can facilitate the process and assist in developing an  environment of trust, the one thing we cannot do is to build the trust itself. This takes the two parties working together with open and honest communication, integrity and goodwill.

What are your thoughts?

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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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