Agencies and their clients speak different languages. This is often a terrific thing. Agencies apply right-brain processes to clients' left-brain business issues, and the results can be magic. Vive la difference!
That is, until the discussion comes to fair payment and the question, "What are the agency's services worth?" Agencies want to get paid for the value of their ideas. Clients are wired to negotiate more for less over time. The stark difference threatens to undermine the profitability of agencies to such a degree that they will no longer be able to provide the inspired effort that has created the classic brands, like Tide detergent and Cheerios, and more recent successful brands, like Geico and Febreze.
At the heart of the problem lies the yin and yang of agency workload and revenue. Most agencies track their revenue increases or declines year over year, but they rarely track workload year over year, and almost never track the basic financial formula that gives a clear picture of the long-term nature of their businesses: revenue divided by workload over time.
One company that has done exactly that is the consulting firm Farmer & Company. In a longitudinal study covering two decades from 1992 through 2012 for 18 major agencies across over 100 clients, and including over 940 data points, the company found that over the last 20 years, agency workload on client business has grown on average 2.5% to 3% per year, while revenue from the same clients has decreased, on average, about 2% per year. Agencies have seen the amount of money they receive for each standard unit of work decline about 4.5% every year over the past two decades. Matching this is a decline in staffing of about the same rate. As a consequence, over 20 years agencies have doubled the output per creative per year.
While client and agency agree on purpose -- to create valued brands -- agencies have a deep aversion to regular tracking of their scope of work, and pricing, based on specific work-unit deliverables. According to Mike Farmer, CEO of Farmer & Company: "Agency heads are often suspicious of negotiating on the basis of deliverable units, thinking it will undermine the value of what they do." They fail to realize that clients are hard-wired to assess value that way, and have institutionalized the practice via procurement departments.
Advertising agencies stand out as one of the only businesses that have such an aversion to hard tracking of standardized work units. As a result, the one industry that can completely transform business performance with an idea (just ask Aflac) gets rewarded not by the amount or value of its work product, but by the number of man-hours it can bill.
A better approach
Standardization of work units, often done by categorizing the complexity of jobs from low to medium to high, will often result in a total amount of billable man-hours, but it is a far more rigorous and accurate accounting of the market value of the work done than the occasional compiling of timesheets after the fact. It starts with the work that needs to be done.
A typical agency multiple on man-hour cost is about 2.35. Management consultancy companies, which have no qualms about tracking the value of their work, regularly get a multiple of 5. Last I looked, no management consultancy ever created an Aflac duck!
Many client agency contracts do offer incentive clauses that, theoretically, pay agencies for the impact of their work, but in practice they usually just let agencies reclaim income they were already getting before their margins were driven down in the latest price negotiations with procurement departments.
It would be fair to ask why we should not expect some degree of increased work units and lower revenue as a result of the efficiency wrought by the internet revolution and by deteriorating recession economies. The reality is that advertising, unlike many other businesses, has limited economies of scale. The adage that agencies assets ride up and down in the elevator every day is no less true in 2013 than it was in the days of "Mad Men." In fact, it can be argued that the internet revolution has actually led to reverse efficiencies in the advertising business. It has transformed advertising media and production through fragmentation and proliferation, and by lowering production costs. Agencies need to develop and deliver many more ideas, of more complexity, with more executions than ever before, and with fewer people.
The real story here is less about the digital transformation or economic malaise and more about the near suicidal reluctance of many agency heads to re-conceptualize their business and the basis of its worth. If they can do this, the biggest benefit will be the ability to retain their best creative talent, rather than lose them to new-economy winners, like Google. Ironically, by religiously tracking the business as work units rather than ideas, agencies will actually get paid more for their ideas -- which is the point.