“It was the best of times, it was the worst of times…” – Opening line of A Tale of Two Cities
Billing in advertising agencies used to be relatively easy. We lived on a 15 percent media commission and a 100 percent or greater (1 x 3 was not beyond the realm of reasonable practice) mark-up of services rendered. Current billing practices are in flux as we move from commissionable media to noncommissionable media and from traditional outbound marketing to inbound marketing as the dominant paradigm in the industry.
What are some of the most widely used agency billing practices today? The easy answer is – “it depends”. It depends on what type of agency you’re working with (full service, specialty, etc.) and the media choices employed. The only common factor across agencies and media is that the commission model (described in the opening paragraph) utilized for 100 years or more is no longer viable from both an agency and client perspective. The beginning of the end of the traditional agency compensation model is attributable to the emergence of the internet, the proliferation of personal computers and the increasingly fragmented television market. All happened simultaneously around 1994. Agency compensation began to shift from commission-based to fee-based soon after and refinement of the new agency compensation structure continues.
In general, agency compensation models fall under one of three dominant paradigms: behavior-based, outcome-based or hybrid compensation models. Behavior-based compensation models are more commonly known as fee-based models. Outcome-based compensation models are more commonly known as either incentive-based or pay-for-performance models. And hybrid compensation models provide agencies with the ability to structure compensation utilizing both the behavior-based and outcome-based approaches.
Behavior-Based Compensation Models:
Fee-based compensation models indicate a movement towards billing clients in the manner that other professional services use: fees based upon time, effort, expertise, etc. In this regards, billing is approached in a similar manner as public relations firms and law firms. In my opinion, large agency advertising billing is adopting the structure of public relations firms, including the “retainer” or agency fee. Options under the fee-based compensation model include fixed (project-based), hourly and cost plus billing. Fixed billing charges one price for a project or service. The downside for the agency is that disproportionate amounts of time can be spent on similar projects (think “customer-from-hell”). Hourly billing is more accurate from the agency perspective, but can be considered too expensive by the client. Cost plus billing offers a tie to the past in that the cost of the time, materials, media, etc. are summed and a desired agency profit margin is added as negotiated with the client (typically based on the client’s perception of the expertise, reputation and or perceived value-added of the agency).
Outcome-Based Compensation Models:
Compensation under incentive-based systems allows for pay-for-performance. The key to managing pay-for-performance is having a mutually acceptable, reliable, accurate and independent source of metrics available for measuring advertising performance. Inbound marketing by its very nature provides an opportunity for incorporating incentive-based compensation into the agency-client relationship. The key question thus becomes “who is responsible for the cost of under-performing campaigns”? From an agency perspective, the client should pay for all costs associated with the campaign including media placement. The client perspective, as one might imagine, is the converse. To be fair, incentive-based agency compensation has to be based on a cost-plus model (the hybrid compensation model).
Hybrid Compensation Models:
Hybrid compensation models combine aspects of both fee-based and incentive-based models. As described above, one of the most commonly used hybrid compensation models is a cost-plus model where the “plus” is a pay-for-performance agreement. The difficulty becomes one of monitoring performance based upon mutual agreement, trust and transparency. In my opinion, the hybrid compensation model has the best chance of emerging as the dominant agency compensation model.
Interesting Specialty Models:
But what if your agency specializes in pay-per-click (PPC) advertising placement and management – how do you bill for those services? I believe that the hybrid compensation model remains the best approach, but other innovative models are being utilized including the ala cart model (pick the services that you want based upon the monthly price that you’re willing to pay) and the three-tiered model (base/percent/ceiling). The three-tiered model sets a low end ala cart foundation (e.g, a minimum buy-in of $2000 per month in PPC campaigns using x keywords across y search engines pointing to z unique landing pages), an acceptable percent of total advertising dollars spent in the middle (agency fee) once monthly PPC expenditures reach some negotiated total dollar volume, and a maximum ceiling for large volume accounts (e.g., maximum charge of $10,000 per month to perform premium PPC services). The three-tiered PPC model provides PPC agencies with a secure base and clients with a ceiling limit for monthly expenditures.
From an agency perspective, it is the best of times. Never before in our history have we had access to such targeted media and unique, measurable, ways to reach consumers. And yet it’s the worst of times because billing and compensation practices have become increasingly complex and contentious.
In your opinion, what will become the dominant agency compensation model of the future?