Why are you still paying production mark-ups to your agency?

With all of the recent controversy about secret media commissions, kick backs and the like, it is no wonder that many advertisers are overlooking the same behaviour happening with agency production mark-ups.

Just the other day I read a publication from a reputed local industry ‘finance guru’ who was justifying the practice of charging production mark-ups on external supplier arrangements.

Yet this practice should have gone the way of the media commission. The truth is that like media agencies, many creative agencies are continuing to apply a production mark-up, often without their clients knowing.

Agency justification

In the publication, widely distributed and promoted to agencies and agency associations across the market, it stated the charging of a production mark-up was essential to:

• reimburse the time involved to negotiate with suppliers
• provide their administration cost recovery
• compensate the value of their intellectual property and technical expertise

Of course all of these seem reasonable at face value. But then when you dig a little deeper, isn’t this the reason why a marketer engages an agency partner in the first place? And aren’t most agencies already being compensated for this in other ways already?

What does justify the production mark-up for the agency is the opportunity to increase their revenue and potentially their margin if it means they are being paid twice for the same service.

Now don’t get me wrong, these are all services provided by the agency and the value of these services should be paid to the agency based on the agreed method of compensation.

However, to remunerate them via a production mark-up is essentially flawed in my opinion. This is especially the case where these costs are already either retained or estimated as part of the production estimate anyway, which could effectively lead to the marketer double paying for some services.

Lacking transparency

The problem with agency production mark-ups, much like the recent controversy on media agency kickbacks, is that they can be difficult to identify.

In the industry publication I read, it mentioned that it was common practice within the industry for an agency not to disclose any mark-ups or margins on 3^rd party charges, which totally undermines the concept of a transparent relationship.

If the agency is not disclosing the addition of a production mark-up then it can be very difficult to identify the practice unless you know what to look for in the agency estimates and invoices. Of course you could undertake a full financial audit of your agency, but if they are not doing it, it could be a complete waste of time and effort, and a flag to the agency that you do not trust them.

But have you and the agency agreed on whether they can add a production mark-up or not?

Are you paying twice?

The publication I was handed, indicates that this is common industry practice, inferring that if an advertiser’s contract does not specifically exclude the practice, then it is reasonable for the agency to apply the mark-up as industry practice.

Even if your contract does exclude the practice, we have seen agencies apply the mark-up. In one case an agency appointed following a pitch managed by us, and having signed a contract excluding the practice, then proceeded to hide the mark-ups in the estimates.

Only because the client felt the production costs were high and asked us to take a look were we able to confront the agency on the breach of contract. Even then the agency was incredulous that the practice was disallowed by the contract they had agreed to and signed.

The reason the practice had been disallowed in the contract was because the agency was already allowed to charge for the production hours required to manage the production process. The resources required (their hours and expertise) was allowed for in the estimates and paid for in the fee and some were paid for in the retainer.

Therefore the production mark-up applied by the agency was simply to increase revenue and margin.

Increases mistrust

If the production fee is being added by the agency to simply increase the margin, then it is most likely that the agency will select the more expensive production options or the most expensive production supplier.

The more expensive the production cost, the larger the mark-up and therefore the more margin the agency makes as a percentage of the total production cost.

We recently reviewed the financial performance across the roster of a major advertiser. Even though they had a print management agreement in place, almost all of the numerous agencies on the roster were placing print themselves, the majority adding up to a 25% mark-up to these costs for production management.

The clients were unaware of the production mark-up. Likewise they were surprised that 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 wasted.

At a time when marketers are trying to achieve more with less this caused a huge level of distrust between the various agencies and their marketer clients. Possibly the agencies can justify this based on the millions they made on the transaction.

It is fundamentally unfair

If the purpose of the agency fee is to compensate them for the cost of the resources used to deliver the outcomes, then the production mark-up fails to deliver the desired outcome. If the time and effort required to manage the production process were directly proportional to the total cost of the production process then this would work well.

But the fact is, the more costly the production, the relatively lower the cost of the management of that production. Therefore agencies become unfairly compensated the higher the total cost of the production. This provides an incentive to inflate the cost of the production, as they will make more revenue compared to the cost and therefore a higher margin.

This is why the vast majority of advertisers have moved away from the production mark-up. It is just a pity the agencies and their financial advisers have not stayed abreast with their customers.

Production mark-ups are flawed

It is for these reasons I believe the agency production mark-up methodology is flawed:

• A mark-up is essentially a percentage of the base cost to cover salary, overhead and profit that remunerates the agency in a way that may not be reflective of the scope of work at hand. I recently reviewed a large automotive client, who was using their agency to avoid placing a large number of external suppliers into their financial system. However, the spend was relatively high on a few key major spend projects, and therefore the mark-up grossly exceeded the resourcing required to effectively service the marketer’s requirements.
• There is no guarantee on the level of resources from a capability and experience perspective. Unfortunately this is something we often encounter, with some agencies often placing junior to mid resources on the account, to maximise their ability to generate profit. Unfortunately great creative can often be let down by poor execution.
• A mark-up that rewards the agency based on spend, generally doesn’t support the efficient use of the marketer’s budgets. It’s is generally a KPI of most agencies for account management to try and maximise revenue opportunities, wherever possible. However, when agency remuneration is generated by spend, it’s against the agencies best interest to negotiate the best deal possible, which would potentially reduce the agency remuneration for the project.

Sustainable and transparent

The TrinityP3 ethos completely supports fair and equitable financial relationships, which ultimately require trust and transparency to succeed. In my opinion, agreeing resource levels up front and paying for resources based on a pre-agreed rate card (with margin), or even better on a value-based model, is a better system to remunerate your agency, than a production mark-up.

Agreeing a production estimate or value up front to remunerate the agency allows for a transparent recovery of its costs, and the ability to tailor the estimate or value based on the actual task at hand.

I think this model is fairer and more equitable to both parties, and therefore all production should be passed on a net cost in any transparent contractual relationship.

It is disappointing that agencies and their consultants and advisers do not also support this approach.

 

To find our how TrinityP3 Marketing Management Consultants can help you further with this, click here.