Agencies Earn Little From Performance-Based Compensation, 4As Finds

Roughly Half of the Arrangements Put Agency Compensation at Risk

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Tom Finneran
Tom Finneran

Marketers seem increasingly eager to link their agencies' pay to performance, with arrangements like Razorfish's profit-sharing deal with Peets' Coffee & Tea held up as a possible future for agency compensation. But the tactic isn't as common, or as popular, as everyone thinks, a new report by the 4A's suggests.

Only 39% of agencies answering a survey by the group, 66 out of 168, reported having any incentive-compensation arrangements with clients last year. And for the two-thirds of agencies that did tout incentive-compensation arrangements, the impact on overall agency gross income – a total comprised of commissions, fees and incentives -- was less than 2%. About a third of the programs affected income by less than 1%.

"We had record levels of marketers making profits, and agencies were virtually able to make none of them," said Tom Finneran, exec VP of agency management services for the 4As. "There's been a lot of debate and interest in this topic but the truth of the matter is we haven't cracked the code on how to do it. It's disappointing to everyone that so-called value-based compensation has not gained greater traction. Everyone would like to get to value-based. Nobody quite knows how to implement it."

Agencies that have some pay-for-performance experience have often come away disappointed.

Of the 201 incentive deals the survey's agencies inked with their largest clients, more than half (53%) were structured as "skin-in-the-game" arrangements, meaning the agency put some base compensation at risk in return for the potential to earn more. Agencies put more than 10% of their base compensation at risk in about a third of the deals. For the majority of these incentive deals, however, the amount the agencies put at risk was usually between 5% and 10%.

Whatever the scope, it didn't seem to pay off for the agencies. "Agencies in aggregate were not able to earn back what they put at risk," Mr. Finneran said. "It reinforces the agency mindset that these incentive arrangements are often nothing more than a disguised cut in compensation, and that the agency is really self-funding its own incentive."

The other incentive deals were structured as bonuses tied to performance. The potential maximum bonuses clients dangled in front of agencies were below 10% of base compensation, and actual earned bonus amounts ended up below 5% of base compensation.

For clients and agencies looking to do incentive-based deals, Mr. Finneran said it's beneficial to build at least a year-long relationship first. "An evaluation program that helps build confidence between the parties forces the discussion of what the priorities are and where there needs to be improvement on both sides of the table," he said.

Sales and market share were the most relevant criteria for evaluating performance, respondents said.

Incentive-based arrangements in general appeared to be most prevalent among the major creative and media-service agencies, as opposed to digital agencies, Mr. Finneran added, attributing the gap to digital shops' greater reliance on project assignments.

"The reality is clients are not going through the effort of negotiating performance incentive relationships with agencies where there's a lot of project work," Mr. Finneran said. "It's too much work."

That may start to change as digital agencies get more retainer work. Razorfish's deal with Peet's, a new client, drew attention by putting all of the agency's compensation on the line. Razorfish is handling the coffee retailer's e-commerce business in exchange for a share of its e-commerce profits.

Digital agencies' better ability to measure the effect of their work on actual sales could also prove an advantage in striking these sorts of deals going forward.

And marketers are likely to keep seeking incentives in their deals. Coca-Cola, which has long run its incentive program on a project basis, said this week that it had revamped its compensation system to pay agencies more for work in newer and groundbreaking areas.

Performance incentives are based on qualitative agency evaluations, metrics related to the specific work of the agency, metrics based on changes in brand equity and perception, and sometimes on improvements in volume or sales, Sarah Armstrong, Coca-Cola's director of worldwide agency operations, said at the ANA's Advertising Financial Management Conference. Coca-Cola's agencies averaged a 18.3% bonus on their projects last year, she said.

Incentive agreements aside, agency respondents' largest client deals were broken down by labor-based fees (44%), which are annual fees based on an estimate of labor costs; agreed-up annual fixed fees (24%) that agencies collect over a certain period; and hourly arrangements (12%) in which the final agency payment is based on actual hours for the year at an agreed-upon rate.

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