Feeling the squeeze

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Only two years ago, old-line advertisers and archrivals Procter & Gamble Co. and Unilever stood as the biggest remaining pillars of commission-based agency compensation. Today, both have walked away from commissions, replacing them with incentives or fees.

"The 15% commission is a long gone standard that is frankly out of step with [new integrated marketing] issues," said Brad Brinegar, CEO of Bcom3 Group's Leo Burnett USA, a P&G agency. "A lot of the value we offer is in strategic thinking, and how to pay for that is very different from traditional media spending."

Yet, far from ending compensation tinkering, the death of the standard may have accelerated it. The most recent Association of National Advertisers compensation survey, released last month, found a record 49% of advertisers made significant changes in compensation plans in the past three years, while 21% plan more changes soon. At 76%, the percent of advertisers satisfied with agency pay plans is the lowest in at least six years.

This year's economic downturn only increases attention on agency compensation. "Price pressures have dialed up as a result of the economy, but it's also just the new way of doing business, getting more productivity out of the agency and finding ways to do it at lower prices," Mr. Brinegar said.

With so many flavors of compensation available, most marketers guard the details of their agency pay as if it were the recipe for the secret sauce. Wal-Mart stores has "a strategy we developed ourselves," said a marketing executive. "It's very motivating" for the agency, he said, he considers it proprietary and would give no details.

Pay schemes have grown so varied that agency executives said it's rare for any two clients to get the same deal. In turn, since no one really knows the deal the next client has received, consultants say concern is growing about fairness. And while ditching commissions appears to have paved the way for more varied marketing approaches, as intended, pay for the specialty marketing services shops executing those approaches is becoming a bigger issue.

GREATER SCRUTINY EXPECTED

"The more traditional full-service agencies have received far more advertiser scrutiny than the specialty agencies [regarding compensation]," said David Beals, president-CEO of Jones Lundin Beals, the Chicago-based consulting firm that conducted the trends in agency compensation survey for the ANA. "Now that the holding companies are glomming onto all those [specialty shops], they're going to come under that same umbrella and over time going to come under the same scrutiny the traditional agencies have."

Specialty shops have gotten less attention for several reasons, ranging from lower overall costs, more transparent results from direct-mail or promotion and the headlong rush to sign up interactive shops with little regard to cost in the late 1990s.

With holding companies generally making better margins off specialty services than they do off their regular agencies, however, Mr. Beals expects more clients to try getting some of that money back for themselves, possibly looking to DaimlerChrysler's move last year to consolidate both general and specialty work with Omnicom Group as a model.

The squeeze is already being felt in some quarters. While P&G last year implemented a massive change in its compensation structure from one based entirely on media commissions to one based entirely on sales-based incentives, a quieter compensation struggle has been raging between the marketer and its Hispanic agencies.

Following relocation of its Hispanic marketing unit to San Juan, Puerto Rico, in 1999, P&G began comparing fees it was receiving from its Puerto Rico-based marketing services shops, including Grey Global Group's Wing Latino unit, with those of its Hispanic shops based in the states, including Bcom3 Group's Bromley Communications, Austin, Texas, and Lapiz, Chicago; Arnold Worldwide Partners' JMCP Publicidad Euro RSCG, New York; and Publicis Groupe's Conill Advertising, New York.

According to executives familiar with the situation, P&G began pressuring the stateside units to offer fees more in line with shops in Puerto Rico, where the cost of doing business is lower. In a shock for a company renowned for generally longlasting and stable general agency relationships, executives of three stateside P&G Hispanic shops were so exasperated that they discussed resigning their accounts en masse, according to the executives. They never actually took the step and their parent agencies, all P&G roster shops, would have been unlikely to ever condone such a threat.

"It's very hard for anyone in the Hispanic marketing business to make money with Procter & Gamble," said an agency executive, adding that the Hispanic agencies and P&G have discussed their problems, though pricing pressures remain. The executive blamed tensions on expectations from P&G headquarters rather than executives in the Puerto Rico-based Multicultural Business Develop-ment Organization.

"With every agency we work with, we want a competitive price for the services we're asking for, but we want a win-win, principle-based relationship" said Bob Wehling, P&G's global marketing officer. "As we've heated up our Hispanic activity with the formation of the multicultural marketing group, I think they've been feeling their way into a lot of their agency relationships. ... Nothing has escalated to my level. No agency has come to me and said we've got an issue with the way we're being treated."

P&G isn't the only comapny looking to get more for its money from specialty marketing services. Morgan Anderson Consulting, New York, is working on two reviews aimed strictly at consolidating marketing services shops for large clients.

Larger marketers, which used to allow individual brands or business units to manage their own marketing services shops, increasingly are managing those relationships centrally, said Arthur Anderson, a principal with the firm. Central management often means consolidation and negotiation of more favorable compensation arrangements.

"It's driven in part because clients are spending more money [on the marketing services shops]," said Mr. Anderson. "But also it's just part of the whole procurement culture that you see in many large marketing organizations, where purchasing [departments] are involved in these decisions along with marketing. Purchasing and sourcing [people] approach things differently than marketing people. They look at economies of scale, accountability, pay for performance in a different way than marketing."

Mr. Beals expects DaimlerChrysler's deal last year with Omnicom, combining both general agency services from DDB Worldwide and BBDO World-wide along with other marketing services, to become a model for future consolidations of general and specialty work. "What essentially happened is that Omnicom agreed to a very favorable margin for one client," he said. "As people start to exercise their options like DaimlerChrysler, it's not going to take much time for people who aren't getting those deals to scratch their heads and say `Hey, wait a minute. If it's good enough for DaimlerChrysler, it's good enough for me."

Clients, though, have long been rankled by the suspicion that others are getting better deals, Mr. Anderson said. Strangely, however, his own analysis indicates that smaller accounts traditionally have gotten the best deals, from the standpoint of offering agencies lower profit margins than the large accounts. "It's very certain to us in the work we do that certain clients of an agency provide a disproportionate amount of the profit," he said. "And most clients don't like this. They want to pay their fair share."

Small accounts, along with a handful of longtime advertisers who have stuck with commissions either from inertia or for administrative simplicity, are among the last remaining guardians of the once-standard 15% commission, Mr. Anderson said. But while that may not seem as good a deal as the fee- and performance-based packages given to big clients, it's often a very good deal given agency economics.

It may take nearly as much creative, production and media planning and buying time for a $10 million account as for a $100 million one, he said, making the larger account far more lucrative. Were deals done strictly based on profit margins, small advertisers might pay commissions of 18% to 20% or more, Mr. Anderson said.

Why are agencies willing to subsidize smaller accounts with profits from larger ones? In some cases, agencies may see potential for growth or need a small but high-profile account in a business where they want more exposure.

The experience of one $10 million dot-com advertiser last year shows how even a small client can negotiate a fee- and performance-based system and get a very good deal under the right circumstances.

ROOM TO BARGAIN

The client, which wanted its name and that of the agencies withheld because of contractual obligations, received basic compensation guidelines from each of three finalists in a review, with at least two open to some kind of equity-based compensation. Negotiations didn't start in earnest until the agency was chosen. The agency, having just lost two dot-com accounts, was eager to land another at a time when dot-coms were still highly sought-after.

The agency proposed a labor-based monthly retainer using the estimated number of creative executions and revisions for a $10 million account with TV, print and outdoor ads, assigning percentages of time ranging from about 10% of the salary for copywriters to 1% to 2% of the salary of its CEO. The client's chief operating officer was aiming for a deal equivalent to a 10% to 15% media commission and ultimately got one he estimates at 10% to 12% of billings in cash plus performance incentives paid entirely in the form of equity in the startup business.

The deal ultimately was labor-based, with a monthly retainer of $100,000 in cash combined with equity-based performance incentives based on consumer response and media buying efficiency that could bring the total retainer to $160,000 to $170,000. "I'm not sure any agency would agree to a deal like that today," the client executive admitted.

Indeed, while his dot-com remains in business though still unprofitable, the broader dot-com bust left many agencies holding equity stakes that have become worthless.

The suspicion that agencies are using their business to subsidize unprofitable pursuits of new business has left a bad taste in some advertisers' mouths and fueled demands for more disclosure of agency financial information, Mr. Anderson said. Yet, if anything, agency financial disclosure is on the decline rather than on the rise.

In the most recent ANA survey, the percent of advertisers that said they get access to financial information regarding the profitability of their accounts fell to 53%, down from 59% three years earlier. The percent of clients that said they were allowed to audit agency financial records fell to 48% from 66% three years earlier.

"Many agencies don't like providing transparency or full disclosure to their large clients, because the cat's out of the bag then," Mr. Anderson said. "I've found it's an interesting law of agency compensation that the higher the profit margin an agency has on a client's account, the less they like giving full disclosure, and the lower the profit margin or loss they have on another client's account, they embrace full disclosure."

Reluctance to disclose financial details is particularly troublesome, he said, given the growth of performance-based incentives, which, according to the ANA survey, are now included in a record 35% of plans, up from only 13% in 1991. Clients need to know the break-even point for their accounts before they can establish meaningful incentives, Mr. Anderson said. "If you set the base too low, [the agency] could lose money [even with the incentive]. If you set it too high, they could be making a large profit already, so they're not motivated to make more."

One agency executive said that while most agencies are perfectly willing to provide full disclosure and audits related to profitability of an individual client's account and the overall agency that client efforts to delve intothe intricate details of agency financial performance, including disclosure of individual salaries, is inappropriate. "I don't know that anyone is going to McKinsey & Co. or major law firms and asking them for this kind of information on a client by client basis," he said.

For all the discussion about motivating agency performance, compensation discussions still hinge on saving or making money. Among clients who were considering significant changes in compensation structure last year, according to the ANA survey, 68% said their intention was improving agency performance, while 50% also listed cutting costs as a goal. That means at least 18% hoped to do both. "That should be pretty tough," Mr. Beals said, laughing.

Realistically, almost any major change in compensation structure ends up wringing out the agencies, said a former executive for a P&G agency, who added: "I think everyone ended being squeezed a little" in P&G's shift from commissions to sales-based incentives.

P&G's Mr. Wehling said last year, however, the goal was to make the transition revenue-neutral, so the percentage of sales agencies now receive in year one of the new system was roughly equivalent to the average annual revenue generated by media commission on the brands they handled during each of the prior three years.

Given P&G's sluggish sales this year, its agencies haven't exactly had a windfall. Through the first three quarters of P&G's current fiscal year, which ends June 30, the company's sales were down 2% to $29.7 billion. Yet sales-based compensation turned out better than media commissions would have, since P&G's measured media spending in the U.S. fell 12.6% in 2000 to $1.53 billion, according to Taylor Nelson Sofres' CMR, as P&G shifted some spending to interactive, lower-cost media, direct-mail and co-marketing approaches.

P&G's goal in changing compensation wasn't to cut costs, Mr. Wehling said. The goal was to increase sales and support agencies in developing more comprehensive marketing plans that focus less exclusively on TV advertising and more on a broad array of reaching consumers.

While sales clearly haven't increased, the impact of agency compensation on the current year's results are impossible to gauge. But the new compensation system has helped broaden P&G's marketing mix by encouraging agencies to turn to other marketing services earlier in the process, said one P&G agency executive.

But as the work of other marketing services agencies becomes a bigger part of the media mix--and marketing budget--that in turn leads some P&G marketing executives to question the compensation, he said, since general services agencies continue to receive the same cut of sales even as their work may be contributing less to the brand's sales.

"I don't think the results are in on that P&G model," Mr. Anderson said. "I haven't seen anyone else adopt it."

More broadly, it's not clear that any of the constant churn of compensation plans has really made much difference.

Jim Dougherty, recently retired agency analyst for Prudential Securities, recalls conversations in the past year with financial executives of the Interpublic Group of Cos. and Omnicom as they described the countless compensation plans used by their agencies. When he asked both to supply total media billings for their holding companies, their total revenue in each case came to 14%.

"Despite all the variation, it all still shakes back fairly close to that [15%] number," Mr. Dougherty said. "That's the economic reality. It's about as low as [agencies] can go to have a reasonable profit and it's about as high as it can go given that there are other agencies out there."

Mr. Beals acknowledged that many clients and agencies still use the 15% standard as a starting point for figuring labor- and performance-based plans. But he said holding companies today aim more for profit margins, striving for 20% to 25% and generally getting 15% to 18%.

It's also unclear how much protection the new generation affords agencies from the vagaries of client media budget cuts. "If a client comes in in real trouble in terms of making their numbers and they need to cut their budget, and cut what they're spending with their agencies, they're going to ask [the agencies] to cut their fees, too," Mr. Dougherty said. "And there's no agency I know of that's not going to do that, whether the contract is written to fee or straight commission."

Mr. Beals acknowledged that labor-based commission is still subject to renegotiation in most cases, but says the fee system at least gives agencies more choice. "The agency can at least engage the client in a discussion of what services can be cut back," he said. "With commissions, there's no discussion."

Contributing: Kate MacArthur, Alice Z. Cuneo, Jean Halliday

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