Paying peanuts? – It is not the smartest advertising agency remuneration strategy

No one wants to be paying too much for their advertising. But likewise, there are downsides to paying too little.

We see it all the time, advertisers call us in because they are unhappy with the performance and service levels provided by their agency. When we benchmark the agency remuneration, we find they are hopelessly underpaid.

The cost considerations

Many retainers are calculated on a resource, overhead and margin model. This is based on determining a set of dedicated agency resources, taking the direct salary cost of these resources and multiplying this by an overhead factor.

The overhead factor is to cover the indirect salary costs such as support staff like the receptionist and accounts, plus accommodation and utility costs and business development, IT and capital expenses.

This overhead factor can vary from 60% to 120% depending on a number of factors. Then to this cost there is a profit margin of anywhere from 10% to 25%.

Of course if the salary rate is overstated then this adds to profit as the overstated cost is multiplied by the overhead factor and the profit margin. Understated, it cuts into the profit margin. Likewise with the overhead factor and the profit margin.

Paying too much

Many advertisers feel they are paying too much because they have compared their costs with what a colleague is paying. Unfortunately, with the complexity and diversity of remuneration models they are not often comparing like with like.

While overpaying the agency will make the agency senior management happy, it can lead to complacency developing between the agency and the advertiser. After all, the adage that the squeaky wheel gets the oil applies here, and if the agency is achieving a higher than average profitability from the client with little or no extra effort, they can apply less attention to this client over another who is demanding and underpaying the agency.

Paying too little

Paying too little forces the agency management to find ways to increase the profitability of the account.

Typically there are a number of ways to achieve this:

1. Reduce the calibre and number of resources working on the business. By reducing the direct cost of servicing the account you can increase the profit margin. Replacing an account director with a senior account manager can go unnoticed if they have the same title on the business card and thereby save $10K – $15K per annum. This can become self-perpetuating as the staff on the account turn over more frequently due to burn out – having to deliver the same with less.

2. Increase the charges outside the retainer agreement by increasing the number of changes made during the production process to increase production charges on each job thereby increasing the “extraction rate” for that client.

If you are underpaying the agency they will need to find a way to increase revenue and manage costs to increase profit.

Pay for the resources or the outcomes

At the end of the day what you actually want is outcomes and results, not just resources. If you just wanted the people, why not employ them directly. The overhead factor will be a lot less.

So if you want to pay for outcomes, firstly you need to define the outcomes you need for any period and the results you want these outcomes to deliver. Then you can strike a retainer or project fee for the agency to deliver the outcome and then a value based remuneration for delivering the results.

This is a value based model that pays the agency a fee for the delivery of the services and outcomes and then provides a significant and variable profit based on the achievement of results.

Getting the formula right

Some advertisers find it difficult to implement a value based model because they think of agency costs in terms of a cost for people. In the TrinityP3 model the agency is paid to deliver the services, but shares in a significant and higher profit margin if they participate in delivering higher than expected results in sales, market share growth or some other significant business measure.