Pay-for-Performance Starts to Gain Steam

Sophisticated Measurement Tools Help Model Become Reality at Media Shops Such as Interpublic's UM

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Last year, Interpublic Group of Cos.' media agency, UM, hired consulting giant McKinsey to analyze how other industries are compensated. The objective was to change the antiquated agency-fee model to a riskier but more profitable pay-for-performance one. What resulted was a revamped system that more closely aligns the firm's goals with those of clients. It is tied to key indicators such as sales or market share.

Pay-for-performance is like an urban legend of media buying and planning. But with increasingly sophisticated measurement and planning tools, the concept is morphing into a reality that could in some cases replace the traditional fee model, under which shops make slim margins from a percentage of often low-balled budgets.

UM has experimented with pay-for-performance with clients for the past few years. After having some success with the model, UM has become more aggressive with it.

Half of the firm's clients, which include Chrysler, are engaged in compensation in which at least 20% to 75% of each media-buying contract is earned through pay-for-performance, according to Guy Beach, chief operating officer. Most of the remainder typically goes to cover costs.

This model does not adhere to traditional performance compensation, said Jacki Kelley, UM's CEO. In that formula, agencies typically received a standard commission and a 10% to 20% bonus based on a client's qualitative evaluation. The new approach is rooted more in quantitative benchmarks than in such evaluations.

Ms. Kelley, who before joining UM in 2009 was exec VP-media sales at Martha Stewart Living Omnimedia, said the agency will make more money with pay-for-performance.

Jacki Kelley, CEO of UM
Jacki Kelley, CEO of UM

"The current model is not sustainable when you think about the level of analytics and investment that needs to be made to deliver what clients want," Ms. Kelley said.

But the system also represents challenges for UM. As it looks to implement pay-for-performance agency-wide, the firm is asking senior employees about accepting "slightly reduced" base salaries. Though the idea is just being tested, the result would be that they would take on personal risk but be more invested, with the potential to earn extra if the team meets goals.

"The result of being tied to performance and having skin in the game -- we want the managing directors to share in that for the purpose of total alignment," said Ms. Kelley.

For all the talk about these structures, they have not been broadly adopted. A 2010 study by the Association of National Advertisers found that pay-for-performance accounted for less than 1% of compensation agreements. Reporting on the study, Ad Age said that performance incentives had dropped slightly but that fee-based models (which during the 1990s replaced commissions as the main compensation method) had soared to an all-time high of 75%, vs. 63% in 2006, when the previous study was conducted.

David Beals, president-CEO of consultancy Jones Lundin Beals, said those numbers still hold but that he has noticed a push for such pay models during media-agency reviews.

"I've been in situations where agencies proposed zero compensation, defining it as getting compensated to cover costs without earning a margin unless you deliver," Mr. Beals said.

He attributes the shift to heightened pressure on marketers -- which are increasingly involving procurement departments in negotiations -- to cut expenses globally. Often, Mr. Beals noted, agencies' pay-for-performance proposals will tout the savings for marketers.

According to Chrysler, value and savings were key factors in its discussions with UM about a performance-based plan. But aside from fixed costs, the marketer compensates its agency largely through variable compensation dependent on results or key performance indicators (KPIs).

"It's working," said Susan Thomson, head of media at Chrysler Group, adding that investment in the model contributed to a 26% sales gain in 2011. "It ties them to some objectives that we're held accountable to, such as sales, share, brand perception -- those types of metrics that our management team looks to us to increase year-over-year," she said.

For example, a firm such as UM might track the effect of a media plan by linking it to a KPI such as test drives, which can be converted to sales or market share. And the ability to optimize media plans through digital tools and channels enables the team to meet KPIs.

Ira Hernowitz, senior VP-marketing at Hasbro, said that when the company brought on Initiative last spring, it wasn't just to make more-efficient ad buys but to achieve better performance.

"One thing we talked about was that it was easy to ask agencies about how well they buy media," Mr. Hernowitz said. "That's tactical. What we were looking for was a partner who would ultimately do well when we do well."

Such partnerships are made possible by sophisticated tracking tools and a complex media environment that lets agencies go beyond securing costs-per-thousand, Mr. Hernowitz said.

"Toy industry [marketing] was 95% TV, and now, with the digital world, it's expanding," said Mr. Hernowitz. "The landscape of TV and the landscape of entertainment is changing so much that we ask our partners to be strategic and make difficult decisions."

While more agencies experiment with evolving pay models, most industry executives remain skeptical and believe a wholesale shift to pay-for-performance is a long way off.

"[Agencies that are part of ] public companies are limited by the fact that in a paid-for-performance agreement with a client they could be carrying all the agency starting costs with no revenue against them," said Phil Cowdell, the outgoing chairman of Mindshare North America.

Many marketers took the opportunity of the recession to renegotiate terms, and the times most likely inspired agencies' creativity in drafting compensation plans, Mr. Cowdell said. But in "the old days," an agency would resist taking a zero-margin contract for fear that it would lead to a "sinking deal."

These models are doubtlessly on everyone's radar, and their establishment depends on how much risk media agencies are willing to shoulder.

They're also a work-in-progress for marketers.

George Debolt, senior VP-media, promotions and partnership marketing at Showtime Networks, said that even with new technologies, pay-for-performance is difficult to implement without imposing uncertainty.

"If we tie performance to sales or business metrics, we don't want to unfairly [penalize] the partner if our metrics are down for some reason that 's out of their control," Mr. Debolt said. As a result, a lot of brands have paid for performance based on softer evaluations and metrics.

Moving beyond that could help bridge the marketing-procurement divide that many have complained about. With proven results, procurement is beginning to align its objectives with those of the marketing department and agencies.

Brett Colbert, chief procurement officer at MDC Partners, said that when he was global manager of procurement, advertising and market research at Anheuser-Busch InBev, the objective was defined more by the quality and value of the buy than by cost-savings.

"We invested more to get a better return," said Mr. Colbert, though he admits that assigning measures to that are still difficult. "The biggest challenge is that most clients don't have the ability to define metrics that matter and are measurable. The agencies are defining it, though."

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