Why Ad Agencies Need to Embrace Value-Based Compensation

Viewpoint: The Right Relationship Will Boost Accountability -- and the Bottom Line

By Published on .

Chris Kuenne
Chris Kuenne
Call it what you will -- value-based compensation, pay for performance or incentive-based compensation -- by now we all get the premise: Agencies are compensated above their basic costs if they achieve or exceed results as measured by agreed-upon metrics.

How much everyone is embracing the model -- or whether it works -- is less certain.

For the past several years, several marketers and agencies have striven to devise the right framework for value-based compensation. Some consumer-goods companies have publicly touted their participation in such agreements. It's still too early to determine whether any have been a success, but they are clear attempts to create more rational methods of compensating marketing agencies, and a way to focus the client-agency relationship on the highest value-creating initiatives and programs.

The traditional way clients pay agencies is on the basis of an annual relationship, in which the agency and client agree to the coming year's goals, tasks, staffing and hourly rate. That rate is generally called the blended rate, an average of all team members' rates.

The approach is imperfect to say the least, and heightens the chances that all work is treated as a commodity because an agency no longer has the incentive to put its best and most creative brains on the assignment. The potential outcome is that the client winds up with a team depleted of the right kind of senior talent and expertise, and therefore limited in its ability to create the "breakaway" effort that leads to market-share gains.

It is time for agencies to reassert themselves as the brand- and business-building partner they should be. They should be willing to "co-invest" with their clients by putting a portion of their profit at risk because they believe in their creative marketing solutions, and to reverse the commoditization of our industry.

That said, here are some contextual factors to consider for an effective value-based client-agency relationship:

The industry. The client must be in a market-driven industry where innovation can have an impact. It is unlikely, for example, that manufacturers of peanut butter or toothpaste -- products for which there is finite demand -- would benefit much from value-based compensation. On the other hand, a new drug for hypertension in which great investments have been made, and which would be at the high end of pricing, provides the perfect scenario for this approach. Connecting to the right consumer is critical, and doing so could easily generate that 1% breakaway value.

Control issues. There must be checks and balances that work for both sides. The client should be comfortable making rational control allocations. This does not mean handing over the keys but the client should be able to grant the agency a level of freedom that may, at first, feel uncomfortable. To achieve success, the client must be able and willing to at least "lend" the keys to the agency. Simply put, if the client doesn't let the agency drive the car, then performance can't be based on how fast the car moves.

CMO with a mandate. Additionally, the chief marketing officer should have the license to make significant changes and have full executive support for taking new approaches. If that is not the case, the value-based compensation partnership will be a painful experience for all parties.

Open culture. A client interested in value-based compensation likely believes in rewarding contributions and creativity. This kind of client is probably already using an agency scorecard and understands the value of measurement to gauge success. The ideal client probably would not leave decisions about agency compensation to a procurement officer.

The agency that chooses to offer value-based compensation options also requires a certain personality.

Healthy obsessions. The agency needs a work force that is obsessive about breakthrough results. It should have a management that knows how to create incentives and the type of working environment that encourages the account team to achieve client delight.

Metrics-based. Measurement is imperative. But it also takes skill in conveying to the client why specific metrics are the ones that matter, and why those should determine success.

Skilled at safe bets. For the sake of the agency's bottom line, there should be a culture of smart risk-taking. You can't bet the agency's profits on anything that isn't a sure bet. That means knowing the industry, and brand, better than the client does. Smaller, more entrepreneurial agencies are also more likely to embrace these compensation options. An agency that is part of a publicly traded company is likely to find it more difficult, if not impossible, to take these kinds of risks.

The ad business has changed dramatically, and today we see an industry ready to accept changes in what had become a hidebound method of compensation. Both clients and agencies are more interested in exploring and participating in this kind of collaborative, integrated approach and sharing of the upside.

Value-based compensation is unlikely to become the industry standard, but if in the next few years, even 30% of the top agencies' revenue comes from value-based compensation partnerships, this lengthy and sometimes rocky process in creating a new compensation model will prove to have been a catalyst for increased -- and needed -- accountability in our industry.

Chris Kuenne is chairman-CEO of Rosetta.
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