When I first started my career in agency finance departments, adding a service fee markup to 3rd party production costs was de rigueur. Over time this was largely phased out as pricing structures became more sophisticated. But, the practice still persists, and with the controversy over the past decade about secret media commissions, kickbacks and the like, it is surprising that many advertisers are overlooking the same behaviour happening with agency production.
Agencies will often cite that the charging of production mark-ups is essential in order to:
- reimburse them for the time involved in negotiating with suppliers;
- recover administration costs; and
- compensate for the value of their intellectual property and technical expertise.
Of course, these are all important services for which the agency should be paid. But is marking-up 3rd party costs really the best way?
These are the arguments against it.
Lack of transparency
Sometimes the mark-up is clear and obvious (which probably means it’s part of the agreed method of remuneration – best double check your agency contract to ensure that’s the case) but often it’s hidden, buried in one of the many line items that make up most production quotes and invoices, or not disclosed at all.
This doesn’t necessarily mean the agency is doing anything nefarious; agency contracts are notoriously silent on the subject of 3rd party mark-ups, often not specifically excluding them, and the agency may simply be taking advantage of that fact, and adding additional margin quite legitimately, if perhaps not within the spirit of the partnership – and eating into your budget in the process.
Lack of objectivity
Even if the markup is disclosed it is likely that the agency will select the most expensive production option simply to maximise its margin and this is especially the case if the markup is not disclosed, or the agency is allowed to keep any referral fees or commissions from suppliers.
Some years ago, we reviewed the financial performance across the roster of a major advertiser. Even though they had a master print management agreement in place, the agencies were allowed to place print themselves, many adding up to a 25% markup to these costs for “production management” services.
The client was unaware of the production mark-up (although the agencies were not in breach of any contract) and our calculations showed that compared to the existing print management agreement, the agencies cost an additional 38% on $18 million of print expenditure. Almost $7 million was wasted.
Essentially a remuneration method that rewards the agency based only on spending, the fees “earned” by the agency from 3rd party cost mark-ups usually bears no relationship to the value derived from the services the mark-up purports to pay for.
Occasionally, a successful negotiation by the agency may save the advertiser significant production dollars, but this is rare today, and overwhelmingly 3rd party cost mark-ups result in a substantial premium being paid versus other remuneration methods for the same services.
This brings us to the major reason we believe 3rd party cost mark-ups are a flawed way to remunerate your agency – it usually results in the advertiser paying twice.
Whether your remuneration model with the agency is hours and FTE-based, output and deliverables-based, or even value and outcomes-based, invariably, production management and all the attendant services that encompass are already included in that base remuneration method. Any 3rd party cost markup (disclosed or otherwise) is usually an additional margin to the agency – possibly used to mitigate the discounted “too-good-to-be-true” rates which swayed you to sign them in the first place (a reminder that cheaper is not always better).
So, what can you do?
First of all, make sure the remuneration paid to your agency is fair, reasonable, and properly covers all the services you require from them. Agencies are less likely to take advantage of mark-up opportunities if they don’t feel they’re being taken advantage of. If you haven’t reviewed your remuneration arrangement in some time (or ever) now is maybe the time to do so.
Secondly, shore up your contract. If you don’t already, ensure the treatment of cost mark-ups, commissions, and referral fees when agencies are dealing with 3rd party suppliers either on your behalf or as principal in their own right, is explicitly spelt out.
Clear communication of expectations and agreeing on all this upfront is fairer and more equitable to both parties and should allow production costs to be passed on at net cost in a transparent contractual relationship.
What’s your company’s attitude to agency production markups?
You can find out how TrinityP3 Marketing Management Consultants can help you further with your agency and production commercial arrangements here.