Incentives poised for growth

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The latest survey on agency compensation from the Association of National Advertisers confirms the growing dominance of fee-based methods of agency compensation and the near exclusion of commissions. Survey results point to an overwhelming preference for fees across all sizes and types of advertisers, and across all forms of marketing communications disciplines.

If most advertisers have settled on the use of fees, they certainly don't seem satisfied in terms of what they're paying. Client cost cutting, particularly during the most recent economic downturn, has left many agencies complaining that fee reductions are significantly harming agency profitability and, in turn, their ability to effectively service clients. The ANA survey suggests that agency pre-tax profits as reported to clients averaged only 12% in 2003, far below the oft-quoted 20% agency industry target. It also remains clear, as in past surveys, that while clients want their agencies to be profitable, they do not agree with agencies on what defines a reasonable profit.

The client survey also indicates that more than half of respondents receive relatively detailed cost information from their agencies (including labor, overhead and profit information) and that the procurement department is involved in negotiation and management of agency compensation with more than half of the larger advertisers (those spending over $100 million a year annually in advertising).

Yes, compensating an agency is different than buying a piece of factory hardware. But to the next agency executive who argues that "no client would ever ask for cost information from their lawyers, consultants, and other service providers," I have a simple reply: Guess again. The fact is that companies are examining costs across the board.

Beyond the general desire to manage costs, why do clients seem so interested in their agencies' costs and profits? The sad fact is that many clients do not trust their agencies when it comes to fiscal matters-and this has not changed since the days that clients first started challenging commissions.

This isn't so much an "ethical" mistrust as a perception that agencies simply don't care much about controlling costs. Clients aren't confident that agency time sheets are accurate, that the agency is exploring all ways to keep down media and production costs, that overhead charges are fair. Ironically, most agencies have taken as many cost-cutting measures as their clients, and many of them have shareholders to answer to as well. But agencies do not do a good job of proactively working with clients to explain these measures. Is there any good news on the agency compensation front? Yes. And it lies in the steady increase and growing client confidence in the use of performance incentives. If closer examination of agency costs was a natural outgrowth of the move to fees, then a focus on agency "value" would be the natural outgrowth of clients satisfying themselves that agency costs are reasonable and under control.

quality issue

The most effective marketers understand the value of a good or service is determined not only by price but by quality of performance. The most effective procurement officers understand their company contribution lies not simply in securing the lowest price, but in obtaining the best possible value. Ultimately, it is the agency's ideas that bring value to the advertiser. So it ultimately would make sense to pay the agency based on how those ideas helped move the business.

More advertisers are doing just that. Almost 40% of the ANA survey respondents indicated they are using performance incentive compensation. More than two-thirds of those that use incentives believe they have improved agency performance, and fully 95% plan to keep using incentives.

There is an interesting parallel with the early '90s trend from commissions to fees. Fees during that period grew at a slow and steady pace, much like the growing use of performance incentives today. Growth in fees skyrocketed in the late '90s and early part of this century.

another trend

Are incentives poised to do the same? A number of indicators suggests they are. First, marketers that use incentives overwhelmingly believe that incentive pay works. Second, compensation practices tend to gravitate from larger to smaller advertisers; more than half of larger advertisers now use incentives. Third, marketing measurement techniques continue to become more sophisticated.

Advertisers and agencies must pay more attention to the performance side of the value equation. Cost cutting represents the low-hanging fruit. Once clients and agencies have looked under all the rocks, there will be nowhere else to go but to consider how agencies add value and how that value can be improved.

Cost control will continue to bear scrutiny, but the really important bottom-line impact of a successful client-agency relationship will come from big, market-changing ideas-what the agency was hired to deliver in the first place.

Clients that get the most out of their agencies will be those that clearly define the role and expectations for agencies and then reward strong performance when there is a significant improvement in business results. Agencies that embrace the notion of holding their work and compensation accountable should enjoy a bigger paycheck when they meet or exceed clients' expectations.

About the Author

David Beals, president-CEO of client-agency relations consultancy Jones Lundin Beals, is author of the 13th edition of "Trends in Agency Compensation," published in September by the ANA.

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