The limitations of input cost over output and outcome value for advertising agencies

The limitations of input cost over output and outcome value for advertising agencies

Talking with a media agency today, they were sharing the struggle they had with a client getting a fair fee. They won a pitch based on their excellent credentials in creating econometric models for their clients to inform media mix modelling and attribution models.

Yet, when it came to the agency fee model, the agency had suggested a results-based model that rewarded growth, but the client was more interested in the traditional cost-based model and was even using an effective media commission benchmark to assess the appropriate fee level.

This is the issue with the input cost model so popular across the industry. It makes the application of more effective agency fee models difficult to implement while advertisers cling to outdated models and benchmarks.

Effective media commission

This is a remnant of the traditional media commission model. Back in those days, the media commission was 10% (and effective 11.1% mark-up) and often ad a service fee was applied on top. While media commissions are relatively unheard of today, the effective media commission model is calculated by representing the proposed agency fee as a percentage of the total media spend as a percentage.

This means an agency fee of $500,000 on a media investment of $10 million media spend is a 5 per cent effective media commission. This figure, the effective media commission percentage, acts as the benchmark in quite a ham-fisted and clumsy way. This is because it provides no nuance into the media mix, the channels, the client complexity, programmatic spending or any number of factors that impact media agency fees.

Traditional input-based fees

Mind you, the traditional input-based fee model is only slightly more accurate in setting agency fees. Agencies can develop a resource plan to meet your budget, but will it be the right level and mix of capabilities and seniority to deliver the results you need? That is the big question that few can answer with any certainty.

Besides, even if you have the agency team assembled, the value is not in the cost of the team, the value exists in what they can do (output) and what they can achieve (outcome). Yet the retainer cost or agency fee is in no way linked to either of these in this approach.

Paying for growth

It is interesting that the advertising industry has been talking up performance and the importance of their key differentiator, creativity, as an essential ingredient in delivering growth. Marketing and advertising led growth has become the catch cry for the industry, right up to the negotiations on agency fees and then all parties revert to the traditional cost model for agency fees.

But if there is any truth to the fact that agencies and their work contributes to growth, then why wouldn’t advertisers want to pay their agency based on the growth results they contribute to? Part of the reason is that marketing budgets are not growth budgets. The marketing budget is set as a business expense and is finite. If it was a growth cost, it would more likely be linked to the cost of goods sold (COGS) and be a variable based on sales.

Also, marketers struggle with measuring and attributing the percentage the media and creative advertising have on these sales results and growth. Even with the complexity and comprehensiveness of marketing mix models and the data and analytics that underpin these, marketing is still unsure what proportion of the result is the agency’s contribution.

Finally, there is then the complexity of immediate and longer-term growth. Many in the industry want to include longer-term results from marketing investments today. But unfortunately, the financial system struggles with this concept as it struggles with the lifetime value of customers. This limits consideration of rewarding agencies based on growth to the results delivered today.

Outputs and outcomes equate to value

Okay, so it can be a challenge finding an advertiser who can not only measure and attribute growth outcomes to the agency but also has the flexibility in their budget to pay for the results when they are delivered.

It is crazy the number of times we have been called in to adjudicate on a performance payment model gone wrong. Usually because the results have been well above expectation and the client is unable to pay the agency within their budget allocation. Suddenly the result is less about the agency contribution and more due to other factors.

But when we have implemented a performance-based model based on outcomes, where there is a direct correlation, such as direct response and e-commerce, it is amazing the results the agency can deliver.

But if for whatever reason you cannot pay based on outcomes, then it is better to pay on outputs, rather than the costs of inputs. This means instead of paying the agency for the number of hours worked, you pay for what the agency delivers. This can be tangible, like advertising, and intangible, such as strategy, and big ideas.

But this is not simply project-fees, because the opportunity here is to relate the value of the fee paid for the output to the strategic and financial value of the work. The best example of this was we developed and implemented a value-based pricing model for a CPG client who was marketing a range of brands. Some brands were financial more valuable to the company than others and some were more strategically important than others. And the brand marketing budgets reflected these differences.

But the agency that worked across all the brands charged the same for like-for-like outputs. The fee for a television commercial was effectively the same for a high-value brand as a low-value brand because the agency cost was the same.

What if the agency fee for what they produced was linked to the value of the work? What if the financial and strategic value of the agency output defined the agency fee for the service? Now the agency would be paid for the value of their outputs and not the cost of the people.

What is needed

What is needed is a more flexible approach to paying agencies. Rather than approaching agency fees as simply a way to pay for services, turn the approach into a reward to encourage performance or to recognise value, rather than simply considering it a cost.

The first step is to categorise the work the agency does by type and value: Is it low or high value to the brand and the business? Can the results of the work be measured and accounted?

By aligning the agency fee type to the work being done, you can incentive the agency for the work that is directly attributable to the results delivered, variable price the work against the value it represents, and only pay a traditional cost-based fee on the work that is really of low value. In this way.

While you may be dealing with one agency, it is amazing how across the breadth of those agency services there is a fee model to encourage higher performance, without putting all your eggs in the one basket. And we have the experience to show you how.