Ongoing debate: 4A's sets definition of agency overhead

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The American Association of Advertising Agencies is adding to the ongoing overhead debate with a booklet that aims to clarify the definition of agency cost-based compensation arrangements.

The cost components are generally divided into direct labor, overhead and profit; of the three, marketers are particularly interested in overhead. Last December and again early this month, the finance committee of the Association of National Advertisers hosted discussions titled, "Taking the Mystery Out of Overhead" to sort out the components included in agency overhead. Overhead definitions-specifically, the costs that should fairly be included in the category and paid for by marketers-have been a controversial topic as marketers increasingly strive to understand what, specifically, agencies are being compensated for.

"Overhead is typically close to 50% of compensation cost, so marketers are trying to understand all the detail that comprises overhead," said Brad Simmons, VP-media services, Unilever U.S. and chairman of the ANA's advertising financial management committee. "We are also striving for more consistency and standardization across the industry."

keeping it simple

In its primer, the Four A's excludes profit to simplify its explanation of cost components. Direct labor equals the "cost of staff related to the direct servicing of advertiser business," while overhead is "all other agency operating expenses, except direct labor ... and including indirect staff costs," it said. The end result of a cost-based scheme, according to the Four A's, is for the agency to recover all costs and earn a competitive profit within its industry.

The Four A's definition of overhead is certain to be debated by marketers. Examples of components that might be debatable include an agency's bad debt or the cost of real estate leased but not used after an account loss.

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