Archive | Agency Compensation RSS feed for this section

It’s Only Money…

5 Jun

digital mediaThere was one particularly startling revelation that came from the ANA’s recent Agency Financial Management conference in San Diego. During the presentation of this year’s “Agency Compensation Trends” survey results it was noted that the ANA found that almost half of the members it surveyed had not reviewed the findings of the ANA’s 2016 Transparency study.

Think about that. If an organization did not review the Transparency study’s findings, that means that there must not have been any resulting internal dialog with or among marketing’s C-Suite peers, no direct interaction with their agency network partners, no review of existing Client/Agency contracts, no improvements in reporting and controls in which to illuminate how an advertiser’s funds are being managed.

This, in spite of the level of trade media coverage regarding transparency issues ranging from rebates, discounts and media arbitrage, to the Department of Justice investigation into potential ad agency bid rigging practices or the level of ad fraud, traffic sourcing or non-disclosed programmatic fees on both the demand and sell side of the ledger.

There is only one conclusion that can be drawn from this remarkable revelation…many marketers simply don’t care how their organization’s advertising investment is being allocated or safeguarded. Unfortunately, we regularly see the ramifications of this attitude of indifference in our contract compliance audit practice:

  • Client / Agency agreements that haven’t been reviewed or updated in years
  • Failure among clients to enact their contractual audit rights with key agency partners
  • Limited controls regarding an agency’s use and or disclosure of its use of affiliates
  • No requirement for agency partners to competitively bid third-party and affiliate vendors
  • Lack of communication to media sellers regarding ad viewability standards
  • Failure to assert an advertiser’s position on not paying for fraudulent and non-human traffic
  • No requirement for publishers to disclose the use of sourced-traffic
  • Incomplete instructions on buy authorizations to media vendors, minimizing or blocking restitution opportunities
  • Poorly constructed media post-buy reconciliation formats that lack comprehensive information and insights

Interestingly, there have been many positive developments from key industry associations such as the ANA, 4A’s, IAB and public assertions from leading marketers such as P&G and L’Oréal to further inform and motivate marketers on the topic of transparency accountability. Yet, given the materiality of an organization’s marketing spend and the publicized risks to the optimization of its advertising investment, many organizations have not yet taken action, tolerating the risks associated with the status quo. As the noted British playwright, W. Somerset Maugham once said:

Tolerance is another word for indifference.”

The failure to proactively embrace transparency accountability can pose perilous risks to an organization’s marketing budget which in turn directly impacts its company’s revenue. Many would rightly suggest needlessly.

In these instances, the fault for the increased level of attendant financial risk, fraud and working media inefficiencies lies squarely with those companies that have adopted an attitude of indifference toward these very real proven threats. One cannot blame an ad agency, production house, tech provider, publisher or media re-seller for taking advantage of the status quo and acting in manners that, while not in the best interest of the advertiser, are not expressly contractually prohibited.

The good news is that advertisers can address these issues head-on in a quick and efficient manner, mitigating the risks posed by transparency deficiencies. It all begins with a review of existing Client/Agency contracts and engaging one’s agency partners in dialog regarding the adoption of industry best practice contract language to facilitate an open, principal-agent relationship. The Association of National Advertisers (ANA) has a wealth of information on this topic and can also recommend external specialists to assist an advertiser with agency contract development and or compliance auditing.

Interested in safeguarding your marketing investment? Contact Cliff Campeau, Principal at AARM | Advertising Audit & Risk Management at ccampeau@aarmusa.com for a no-obligation consultation on this topic.

How Well is Your Agency Compensated?

30 Jan

do advertisers get what they pay forThe answer to this oft discussed question is easy; “If you’re an agency CFO, not well enough. If you’re a client-side finance executive the answer is likely too well.” Thus it is no surprise that agency remuneration remains a hot topic as we enter 2017.

Make no mistake, both agencies and advertisers alike want to address this topic in a manner that works for both sides. So why is this such a difficult item to resolve? There are three reasons:

  1. There are no industry norms in this area and haven’t been since the days of a standard 15% commission. The net result of this is that there are few benchmarks for advertisers when establishing remuneration guidelines. No standard commission rate ranges by media type, no normative data on agency overhead rates and no clear standards for assessing agency direct labor rates by position and little insight into agency direct margins. This makes it difficult for advertisers to gain a comfort level into the relevance and competitiveness of the rates that they are paying their agency partners.
  2. While agencies want to be compensated fairly, they remain hesitant to fully disclose the financial dynamics that drive their businesses and impact account profitability. This may have something to do with the contribution of non-transparent revenue sources and or the fact that actual direct labor and overhead costs simply don’t allow agencies to optimize their fee income.
  3. Agencies generate revenue by selling time-of-staff. Assembling a team, calculating utilization rates and full-time equivalent standards and applying a multiplier to direct labor costs to cover overhead and a desired profit margin. Whether these variables are transparent to a client or not, this is the basic approach for the pricing of agency services. It is important to understand this dynamic, because very few, if any, client/ agency relationships are able to directly link remuneration to SOW outputs or deliverables.

As an aside, the one collaborated piece of information that we do have specific to compensation relates to acceptable profit margin ranges. The 4A’s and ANA’s compensation surveys have suggested that an acceptable profit margin range to both clients and agencies is between 14% – 17%.

So, without an industry guideline to follow, advertisers and agencies will likely continue to negotiate remuneration schema the same way that they have over the years. Both parties will look at the relevancy of the prior year’s billable rates and SOWs, fine tune those items and adjust the overall fee up or down accordingly.

If both parties are looking for a better balanced, more transparent approach to establishing a remuneration program, we would suggest the following steps:

  • Negotiate a tight, descriptive statement-of-work (SOW) which clearly identifies client expected agency deliverables. An obvious, but oft overlooked component to crafting a fair and balanced remuneration program.
  • Allow the agency to establish a staffing plan, reflecting the resources required to execute the SOW. Review, discuss resource levels in the context of hours by department/ function and the level of experience necessary (junior vs. senior level staffer) based upon the deliverables.
  • Independently review and validate the agency’s direct labor costs for the agreed upon staffing plan. This will give clients confidence in the accuracy of the agency’s labor expense, without divulging employee salaries.
  • Negotiate a definition of overhead and those items that should be included as part of these indirect costs/ charges.
  • On a periodic basis, have the agency’s financial accounting firm verify the overhead charges specifically attributable to the management of the client’s account.
  • Negotiate a profit margin to be applied to the sum of the agency’s direct labor costs plus overhead assessment.
  • Negotiate a bonus/ malus incentive compensation program if desired. The goal should be to maintain a simple, straight forward set of criteria that allows both parties to efficiently track progress against goal attainment.
  • Reconcile fees based upon actual agency direct labor costs at the end of each contract year.

In this context, we believe that advertisers should focus on operating agency account level costs and profitability and not focus on agency holding company financials.

Why? Because at a holding company level, profit represents the difference between agency client revenues (from media commissions, mark-ups, fees or other forms of client compensation) and holding company operating expenses. As we know, the level of centralized support provided to each operating agency will vary from one agency group to another, from one year to the next. Further, agency holding company expenses include items ranging from merger and acquisition expenses to re-branding costs, technology development and business development… categories that don’t directly benefit a client.

In so doing, while it may be difficult for advertisers to assess how “competitive” their agency compensation program is relative to the market, they will have the peace of mind in knowing that they have secured a fair and transparent remuneration program that works for their organization and for their agency partners. As American educator, Michael Pollan once said:

“I think perfect objectivity is an unrealistic goal; fairness, however, is not.”

Did You Trust the Banker When You Played Monopoly?

26 Jan

Monopoly

If you were a “gamer” (in the days when board games were the norm) that implicitly trusted both the banker and the individual who controlled the distribution of the real estate properties when playing Monopoly, than this article isn’t for you.

On the other hand, if you are one who turns a wary eye toward those in control of assets, particularly your assets, then we would like to pose one question: “Do you know what happens to your company’s marketing funds once checks have been distributed to your agency partners?

In our experience, few if any individuals within an advertiser organization have a clear perspective on the disposition of approved funds once an agency invoice has been paid. The primary reason for this is that the industry still operates largely on the concept of “estimated” billing and the pre-payment of funds from the advertiser to the agency. Over the years the resulting transparency gap has been compounded by the fact that few if any advertisers require their agencies to provide copies of all third-party vendor invoices with their final project or campaign billing. Most advertisers have document retention and audit rights clauses in their agreements, but few act upon these contractual rights.

As contract compliance auditors, we review thousands of agency bill-to-client invoices as part of our hard copy vouching and testing process. In general, the lack of specificity contained on these invoices, particularly when one recognizes that there is often little accompanying back-up can be startling. For example, imagine coming across an invoice for the production of television commercials for a major seasonal advertising campaign that simply stated; “Holiday Campaign TV Production – $785,000.” Was that for one commercial or six? Were these :15 second spots or :60’s? Is this for a U.S. campaign or a global effort? Apparently, answers to those types of questions aren’t always required to process payment for that invoice… as long as the invoice amount doesn’t exceed the approved purchase order, if there is an approved purchase order.

Do you know if your agencies are abiding by the contractual guidelines for competitively bidding jobs? Do you know whether or not the agreements with the agencies in your network even requires three bids or at what spending threshold? More broadly, do you know which of your third-party vendors are actually related to your ad agency partners (i.e. shared financial interests, investors or corporate lineage)? If so, was this disclosed in advance of work being awarded to those related parties?

If you’re like most advertisers, you are billed in advance of production or media commitments being made on your behalf, or at least prior to the activity occurring. Likely, your company pays that invoice within 45 days of receipt. Any idea how much time elapses prior to your third-party vendors being paid or whether their billing to the agencies is scrutinized for accuracy? Let’s assume there are credits issued by third-party vendors or approved funds that are not spent by the agencies, how long does it take for the agencies to identify and return those funds to you? Who is involved in determining the disposition of those funds? Marketing? Or are checks cut and sent to finance?

Do you compensate one of more of your agency partners based upon a direct labor model, with estimated monthly fees tied to a contractual staffing plan predicated on the hourly time investment of specific individuals? How often to you see time-of-staff reporting from the agencies? Monthly, quarterly, annually, ever? Have those fees ever been reconciled to each agencies actual time investment? Have you ever tested your agencies time-keeping systems to assess the accuracy of the reports that may be shared with your team?

We have good news for you, news that can provide answers to each and every one of these questions. There is a proven means of closing this transparency gap and providing your organization with the processes and controls necessary to assess the disposition of marketing funds at each step of the advertising investment cycle.

It is called agency contract compliance auditing, it is an industry best practice and it will provide insights, answers and recommendations that will benefit an advertiser’s agency stewardship efforts and their agency partners’ financial management performance.

If you still have some apprehension about this complex ecosystem called marketing, consider the words of former Supreme Court Justice, Oliver Wendell Holmes when weighing the pros and cons of a contract compliance audit; “When in doubt, do it.”

Interested in learning more about safeguarding your firm’s marketing investment? Contact Cliff Campeau, Principal with AARM | Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation on how to implement or enhance your organization’s marketing accountability initiative.

 

 

 

Clients Paying Too Much, Agencies Too Little

13 Oct

agency compensationAs one who has experience on both the agency and client side, it was with great interest that I read Shareen Pathalk’s article; “Anatomy of an Agency Talent Crisis” on Digiday.  

Before we examine the talent challenges identified by the author, let’s take a look at the current agency compensation landscape.  As advertisers and agency practitioners know, agency remuneration practices have clearly migrated from a commission based system to a fee based model, which is now employed in approximately three out of every four client-agency relationships (source: ANA Agency Compensation Survey, 2013). 

Further, a majority of those relationships utilize a labor-based rather than output based or fixed fee approach.  Thus, one way for agencies to optimize revenues involves deploying more experienced, personnel with higher bill rates on client assignments… at the expense of less experienced individuals compensated at a lower rate.  In labor-based remuneration systems, higher bill rates are directly correlated with higher compensation levels.

This dynamic, which emphasizes “experience” is at least partially responsible for one of the advertising industry’s challenges… attracting fresh talent.  Why?  Entry level agency salaries, which have always been low relative to other potential career endeavors, are failing to entice new graduates to pursue a career in advertising, even though there is much about the industry which appeals to them.  As support, the author references the ANA’s 2014 Employee Compensation survey which found that “most entry level salaries” were between “$25,000 – $35,000.  Further, the author suggests that much of the work available is “either too temporary or too high-level for the applicant pool.” 

For an industry which relies so heavily on people, it is imperative that agencies find a way to address this dynamic in order to attract their fair share of intelligent, energetic college graduates looking for meaningful career opportunities.  So what’s stopping agencies from paying better wages for entry-level talent?  According to Nancy Hill, President, CEO of the 4A’s; “The benchmarks are in a place where we can’t raise our salaries.”   While it is not entirely clear which “benchmarks” Ms. Hill is referring to, one potential concern is likely the agency communities desire to maintain their cost competitiveness in the eyes of the advertisers. 

While this has some merit, direct labor cost is but one component of an agency fee and the corresponding bill rates which it charges advertisers.  Overhead rates for example can vary greatly from one agency to another often running between .85 and 1.25 times an agency’s direct labor cost.  Additionally, profit margins used to calculate base fees also differ from one shop to the next.  

For the sake of example, let’s look at two hypothetical scenarios.  Agency #1 is offering entry level media planners $28,000 per year in salary and presently uses an overhead multiplier of 1.25 x direct labor and a profit margin of fifteen percent applied to the combination of direct labor and overhead.  Based upon an eighteen-hundred hour annual full-time equivalent level, this would result in a fully-loaded hourly rate of $40.25 for that media planner.  Agency #2 is offering entry level media planners $35,000 per annum, uses an overhead multiplier of .85 and a profit margin of seventeen percent.  In this latter example, the fully-loaded hourly rate would be $39.27. 

In our experience as agency contract compliance auditors, working with several of the world’s leading advertisers, we have a breadth of experience in reviewing agency remuneration practices.  As such, there are two things which we can share.  First and foremost, in our opinion the difference in bill rates in the aforementioned example is imperceptible from an advertiser’s perspective.  This is largely because most labor based compensation agreements utilize functional or departmental billing rates, rather than actual direct salary costs as a base for calculating fees.  Ask any advertiser when they saw a billable hourly rate of less than $55 for an assistant media planner, which is still significantly higher than either of the fully-loaded rates referenced above.  Secondly, there is a great deal of subjectivity utilized by agencies in establishing overhead rates and much of the methodology employed to calculate those rates is not transparent to the advertiser or subject to independent review.   

The net take away… agency’s have a choice when it comes to talent recruitment, development and retention.  The fact is, there are no advertiser imposed constraints or industry benchmarks which restrict an agency’s ability to rethink entry level salaries or in limiting what an agency spends on training and development of their new hires.  Perhaps the only impediment is the lack of creativity currently being demonstrated by many in the agency community when it comes to talent management.

GSK’s Pay to Stay Program Ignites Firestorm

31 Dec

gsk decision ignites firestormEarlier this month, it was reported by the British press that GlaxoSmithKline, the global pharmaceuticals giant, had asked its marketing services agencies to tithe back to the advertiser if they wanted to remain on the advertiser’s roster.   

The multi-point program allegedly contained two provisions which have sparked a controversy within the advertising industry.  The first involved asking roster agencies for rebates on 2013 work already performed and the second was a requirement that agencies make a bonus payment to GSK to remain on the roster in 2014.   The Marketing Agencies Association (MAA) spoke out against the aforementioned tactics and a similar approach employed by Premier Foods earlier this year, calling for a “crisis summit” to discuss “counterproductive demands by advertisers” which would include client-side procurement heads, marketing directors, member and non-member agencies and the Institute of Practitioners in Advertising (IPA). 

If there is a silver-lining to the controversy, it is that stakeholders on both sides of this issue come together to air their perspectives and to lay the groundwork for continued dialogue surrounding the appropriateness of certain supplier relationship management tactics imposed by advertisers on their agency partners.  

Without casting judgment on the aforementioned advertisers or their respective “savings” initiatives, it is fair to say that there are consequences which will result from these actions that will impact advertiser and agency alike.  

From an advertiser perspective, it would have been interesting to be the proverbial “fly on the wall” during the internal discussions between marketing and procurement when the nuances of this initiative were being hammered out.  One would assume that the client-side marketing teams within GSK and Premier Foods were no more enthusiastic with the approach ultimately taken than their agency resources were when the details were shared with them.  

If this is an accurate hypothesis, than what does that say to professional marketers about the environment within these two organizations and their regard for marketing’s role in managing their marketing services agency networks?  In turn, what impact will those perceptions have on the two firms’ ongoing efforts to recruit and retain top-notch marketing personnel?  

In an industry where procurement and their marketing stakeholders have been working diligently to establish the basis for a productive collaboration in the area of agency selection, remuneration and stewardship will there be a spillover affect?  Or, to the extent that decisions such as this create “bad blood” between the two functions will that be limited to the organizations in question?  

Agencies have been down this path before and they have choices, as difficult as they may be from a bottom-line perspective.  Accept the terms being offered by the advertiser or reject them and forgo the opportunity to work on that account. In this scenario, the question may be less about remuneration and more about the impact on employee morale, the work product and agency culture when serving an advertiser who views the agency not as a partner, but as a vendor upon which it can impose heavy handed pricing tactics as and when it deems appropriate.   

Based upon our experience, we would offer one cautionary note at this stage of the discussion.  It would be wrong to paint all clients or all procurement professionals with the same broad brush, falling back on the “see, I told you so” refrain when it comes to procurement’s role in the marketing area.  The tithing practices referenced above are not widespread.  We are talking about a handful of advertisers in an industry where there are a myriad of “good actors” that embrace a fair and balanced approach to the issue of remuneration and the stewardship of their marketing agency partners. 

Let’s hope that the light shined on this topic serves to advance the relationship between procurement and marketing in working together to achieve their organizations pricing and expense reduction initiatives in a more even handed manner.

 

 

What is the Right Approach to Agency Compensation?

14 Nov

agency compensationThe topic of effective, mutually beneficial ad agency remuneration methodologies has been discussed ever since the mid-1980’s when full-service agencies and 15% commissions became passé.   

There has been no shortage to the variations on compensation structure that have been explored, adopted and debated over the last thirty years, well before the emergence of procurement in the agency sourcing and contract negotiation mix.  The perception among many industry professionals is that agency compensation is a “zero-sum” proposition… somebody wins and somebody loses.  Further, agency representatives have long alleged that procurement wants one thing, year-over-year rate decreases in spite of the fact that advertisers are asking their agency partners for increasing levels of support. 

Experience has taught all of us who have been participants in constructing agency compensation packages that there is no silver bullet.  The variables which come into play to customize a fair remuneration program which optimizes an advertiser’s return on agency fee investment while properly incenting the agency vary greatly from one relationship to the next.  In our agency contract compliance practice we have reviewed commission only, fee only, base fee plus commission, direct-labor based fees, retainer fees tied to SOWs, flat fees and on and on.  Each has its pros and cons. 

In our opinion, the key to crafting a proper remuneration package comes down to one item, measurement.  It has been said, “If you aren’t measuring, then you are just practicing.”  Time and time again we find that neither the advertiser nor the agency has the requisite inputs to assess and effectively negotiate and or monitor a balanced compensation program.  Ultimately, the way to create a “Win-Win” scenario in this area is for an advertiser to tie agency compensation to agency deliverables.  Unfortunately, advertising is a complex sub-set of the professional services arena and valuing deliverables is a major challenge. 

The good news is that consultants such as Farmer & Company have made inroads in the area of connecting compensation to outputs.  Like most things worthwhile, the initiatives are challenging, but can be tackled.  Farmer & Company takes an in depth, data-driven approach to compile historical project / task level information that many agencies and clients have not maintained.  Why?  They’ve simply never tracked variables such as the effectiveness of the client briefing process, time-on-task, rework levels and or the quality of the outputs.  All are achievable and rewarding, but require a commitment among both client and agency stakeholders to begin capturing this data at the requisite level of detail. 

Recently, I came across an article written for Procurement Leaders by Danny Ertel a partner with Vantage Partners entitled: “Complex Services: Alternative Pricing Models.”  The article addressed the topic of service purchasers achieving their “budgetary concerns with pricing models that do a better job of aligning incentives.”  Importantly, marketers and agencies alike can take solace in the balanced approach proposed by Mr. Ertel for a more “strategic” approach to negotiation, rather than focusing on “trading volume for discounts.”  To quote noted actor and martial artist David Carradine: 

There’s an alternative.  There’s always a third way, and it’s not a combination of the other two ways.  It’s a different way. 

If you’re interested in learning more about balancing risks and outcomes, you will find the article to be thought provoking.  Separately, if you’re interested in discussing how to lay the groundwork for valuing outcomes on this important topic, contact Cliff Campeau, Principal at AARM at ccampeau@aarmusa.com for a complimentary consultation.

There Must Be a Reason Agencies Do What They Do…

14 Oct

deliverables based compensationI just finished reading an excellent AdAge article entitled;How Much Longer Can Agencies Afford to Undersell Themselvesby Syracuse University Associate Professor of Advertising, Brian Sheehan a long-time advertising agency executive which deals with the notion of basing agency remuneration on “deliverable units.”  Of note, I wholeheartedly agree with the Mr. Sheehan’s premise regarding the efficacy of this approach and its ability to strike the requisite creativity/ profitability balance so often referenced in the context of agency compensation discussions.

The core issue, however, is less about the path forward and more about the reasons for agency resistance to this concept, which also serves as the root cause of the challenge with valuing agency delivery… the lack of systematic controls, processes and a disciplined commitment to accurately tracking time-of-staff investment and agency outputs in a timely and transparent manner to enable all parties to correlate agency resource investments to delivery.

Let’s be fair.  No agency ever signed a contract it didn’t choose to.  While client procurement teams may be wired to push for advantageous terms and pricing, agency-side negotiators are no less clever or determined in their approach to insuring their profitability when sitting down at the negotiating table.  The issue isn’t what is negotiated into the letter-of-agreement (LOA), but how (or whether) the agency delivers against the statement of work and or staffing plan agreements.  To be sure, this is necessary for clients to have confidence in the agency’s performance vis-à-vis the LOA.  However, it is even more important to the agency in assessing its return on their resource investment.

As Mr. Sheehan rightly points out, “other” professional services providers, such as management consultants have been able to bridge this gap.  Thus, the issue appears to be rooted in culture rather than a technology or methodology.  Agency holding groups, which represent a disproportionately high share of sector revenues, are publicly traded organizations, run by some of the most astute management and financial executives in the business.  That being said, there must be a reason for agencies “deep aversion to regular tracking of their scope of work” as the author suggests.  This can be evidenced by the fact that there has been little movement to change current charging practices and begin attaching value to agency deliverables. 

Part of the reason, I believe, is that agencies have done an excellent job of integrating technology into their work processes to enhance efficiencies which have boosted outputs per salary dollar invested.  When combined with guaranteed profit levels of between 12% – 15% (which are typical of most LOAs), incremental intercompany revenue yields on core client business, the non-transparent revenue generation opportunities being realized and the agency community’s unquenchable thirst for new business, one might assume that agency bottom-lines aren’t under stress at all. 

With regard to agencies being rewarded for the “value” of their work and or their ability to “completely transform business performance,” how are they any different than other professional services providers such as management consultants?  It can easily be argued that the technological, logistical, financial and marketing strategies which emanate from a management consultant are no less transformative than the creative ideas generated by the advertising community.  Too often we forget that for every “Aflac Duck” success, at the other end of the spectrum, there is a Schlitz beer, a Lisa computer or an Edsel automobile.  Advertisers are the ones who are financing these brands and incurring the risks associated with the marketing and advertising campaigns which support them.  When there are successes, today’s LOAs provide incentive compensation opportunities which reward agencies for their contribution.  And let’s not forget the most important financial reward of all… the opportunity to continue working with an advertiser to insure a future revenue stream.

Why Agency Overhead Matters

30 May

overheadAt the ANA’s 2013 “Advertising Agency Financial Management” conference I attended an interesting session surrounding perceived misconceptions about the role of agency overhead rates in assessing the efficiency of an agency.   

My takeaway was twofold.  One, I agree with the premise of the speaker’s presentation that “overhead rates are not efficiency metrics.”  And secondly, overhead rates are both an important and often little understood component of any agency remuneration program.  Ironically, many advertisers spend little time in familiarizing themselves with the various components that make up agency overhead.  Further, most client-agency agreements are weak with regard to defining the composition of the overhead rate which gets applied as part of the compensation calculation.   

To be fair, this is an area where often time advertisers and agencies can “agree to disagree.”  In 2006, the ad industry’s two leading advocacy groups the Association of American Advertising Agencies (4A’s) and the Association of National Advertisers (ANA) jointly published a “Compensation Guide” that delved into this very topic.   

Let’s start with why agency overhead matters.  In short, it is a primary component of the multiplier utilized in marking-up agency costs to arrive at a total compensation rate in a “Cost-Plus” or “Labor-Based” fee arrangement.  Therefore, determining what is included in or excluded from overhead rate calculations has a direct impact on the fees paid by the advertiser to the agency.  Detailing these inclusions and exclusions within the agency Agreement is of utmost importance to promote clarity.  It should be noted that these are not static measurements; overhead rates vary within holding companies, from one agency brand to another and across geographic locations.  For advertisers utilizing services in numerous offices across an agency network, this can be an important consideration. 

The basic approach in the application of overhead is to base the allocation on the client’s  pro-rata share of the agency’s direct-labor costs.  However, sophisticated advertisers can and do negotiate overhead rates utilizing custom methodologies.   

It is in the advertiser’s best interest to understand the individual components included in the aforementioned categories prior to negotiating overhead rates.  Does “Indirect Labor” include agency personnel time invested in new business development?  Are other non-billable new business costs embedded in “Corporate “Expense?”  What parent and or holding company costs are assigned to the “Space & Facilities” and or “Corporate Expense” categories.  Transparency into this area is vital for advertisers to begin to understand the differences in overhead rates across agencies and geographies and will result in a much greater level of comfort when discussing this topic with their agency partners.  As well, costs that the agency is including into the overhead pool should be verifiable, and the client’s allocated portion should be recalculatable.  Such that the agency is not covering their overhead costs more than 1x across the client base.  Lack of transparency in this area can lead to abuse opportunity and inflated fees. 

Just as important as defining “what” is included in overhead and negotiating the overhead rate, is monitoring what this rate and or the resulting multiplier (i.e. direct-labor costs% +  overhead allocation% + profit rate%) is applied to.   

As an example, are there hours from individuals at the agency incorporated into direct-labor costs that should not be?  For instance, freelancers, independent contractors and or consultant time investment should not have overhead applied and therefore not be allocated to agency direct-labor costs.  The expense for these individuals’ involvement on client business should be handled on a pass-through cost basis and billed to the client with no mark-up.  The subject of part-time and or temporary W-2 employees is a topic for conversation between the advertiser and their agency.   

So while, overhead rates may provide limited insight into agency efficiency, they do have a significant impact on an advertiser’s agency fee investment and therefore the components of overhead need to be understood, discussed, defined and tracked. 

Interested in finding out how an advertiser can verify whether its agency is adhering to what has been mutually agreed to be included in overhead?  To learn more about advertising agency overhead and or agency remuneration practices, contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation.

Agency Remuneration Poll

5 Mar

How Do Agencies Do It?

13 Feb

ad agency profitsEarlier this month the Japanese agency holding company Dentsu announced quarterly financial results.  For the nine-months ending December 31, 2012 revenues were up 4.5% and net income was up 48.1% year-over-year.  Impressive?  Certainly, but not inconsistent with other players in the ad sector; WPP achieved a 43.3% increase in net income on a 7.4% revenue gain and Omnicom Group reported a percentage net income increase which was twice that of its revenue growth. 

A healthy advertising sector represents good news for clients and agencies alike.  Growing, profitable advertising agencies are able to invest in; infrastructure, personnel and research which ultimately allows them to better serve their clients.

There are two interesting observations with regard to the aforementioned agency financial reporting; 1) the recent results fit a pattern of extraordinary net income growth for the category, relative to revenues. 2) In a professional services business, the ability to generate net income growth of 2X to 10X that of revenue can only be achieved through a combination of significant expense reductions and or dramatic increases in direct margin.

Let’s be clear.  Like most other professional service providers whether in the financial, legal or consulting sectors, payroll makes up a disproportionately high percentage of an advertising agency’s expense base.  The publicly traded agency holding companies break out salary expense within their financial reports, allowing for a review of this cost center.  In a 2010 review of agency expense structures, Adweek reported that for the top five agency holding companies, expenses represented between 83% and 94% of revenues.  Salary expenses ranged between 59% and 72% of revenues.  The difference between the two is largely made up of real-estate and overhead costs.

Thus it is unlikely that agencies are relying on expense reduction as the primary source of net income accretion.  This would have a dramatic, negative impact on the caliber of work, service levels and ultimately, client retention and would be unsustainable over any prolonged period of time. Therefore margin growth would appear to be the primary contributor to the extraordinary net income gains.  But how you ask?  After all, industry compensation surveys consistently report that the average agency profit level identified within client/ agency agreements is 15%.   

Unfortunately the answer is clear, while not altogether transparent to advertisers.  A portion of the improved margin is tied to the provisioning of agency-owned services such as in-house studios, trading desks, poster specialists, barter firms and production companies. These services have tremendous margin upside for an agency because there is limited disclosure to the advertiser of the rates paid to the ultimate media seller and or the fees earned by the agency in the form of incremental commissions, spread between planned and purchased costs or volume rebates paid by the media.  Then there are sources of agency revenue which are seldom discussed and rarely audited which contribute to an agency’s bottom line profits.  These include but are not limited to AVBs, interest income from float, earned but un-processed discounts, rebates and no-charge media weight.

These practices are neither good, nor bad they simply represent the nature, albeit murky, of the global advertising industry today.  In the end, knowledge is power.  For example, the agencies that have been smart enough to vertically integrate and to leverage non-transparent income “opportunities” have generated solid bottom line performance. 

For advertisers the answer is simple, extend your knowledge of what is clearly a dynamic and often opaque marketplace: 

  1. Revisit your agency contracts to make sure that the requisite legal and financial controls have been incorporated to protect your interest. 
  2. Make sure that your agency contract extends to the parent company and any sister divisions which may be engaged as part of your agency’s service offering.   
  3. Examine your agency performance evaluation process and remuneration methodology to ensure that you are incenting the behavior and outcomes which you desire.
  4. Engage an independent auditor to assess your marketing service agencies contract compliance and performance to make sure that the requisite level of transparency is always maintained.

In the words of Sir Edward Coke, the renowned seventeenth-century English jurist;

Precaution is better than cure.”

If you’re interested in a second opinion of the soundness of your client/ agency agreement or would like to discuss the benefits of an agency contract compliance audit, contact Cliff Campeau, Principal at AARM via email at ccampeau@aarmusa.com.

%d bloggers like this: