Tag Archives: ad agency compensation

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.”

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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.

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Do Advertisers Value Their Agencies?

4 Aug

client - agency relationshipsThis question came to mind when reading the results of a recent survey conducted by the Institute of Advertising Practitioners in Ireland (IAPI) dealing with the state of the advertising industry.  One of the survey respondents expressed an opinion that clients were “much more aggressive and much less loyal.” Further, the representative from a creative agency stated that clients were “aggressive on cost and expectation and less committed to supporting their agency in their efforts to deliver excellence.” 

Subjectively speaking, many of us involved in the advertising space would likely answer this question with an unqualified “no, not as much as they once did.” 

The reasons for holding such an opinion may be many and varied, but the evidence manifests itself in the fact that client/ agency relationships simply are not as enduring as they once were.  There have been a number of studies conducted over the last half-dozen years which have pegged the average relationship length in the 3 – 5 year range.  If advertisers truly valued their agencies surely this would manifest it in longer, more productive relationships.  Wouldn’t it? 

Once full-service ad agencies “unbundled” this set the stage for advertisers to expand their agency rosters to address their “specialized” marketing needs.   In turn, this created bench strength and ultimately allowed advertisers to more readily re-allocate brand assignments across their stable of agencies, which certainly accounts for some percentage of client/ agency change.  Over time, the notion of transitioning work from one network partner to another became more acceptable and perhaps led advertisers to view going outside of their current agency rosters as less of an issue. 

Change costs.  Whether measured in terms of the time required to effectively transition an agency or the opportunity costs tied to a “new” agency’s learning curve on the business.  This in turn creates risks with regard to an advertiser’s demand generation and market share accretion efforts.  Yet in spite of the cost of change, advertisers continue to change out agencies at an alarming rate.  

One cannot place blame for this trend solely on advertisers.  The actions and behaviors which precipitate the termination of a client/ agency relationship both parties have a shared responsibility.  Similarly, clients and agencies each hold the keys to extending both the length and productivity of their relationship.  It begins with a simple, but powerful concept… mutual respect.  After all “respect” is an important proof point of the extent to which one organization values the contributions and support of another. 

Advertisers can take the lead in this area with a series of simple, yet meaningful processes which will demonstrate the extent to which they value their agency partners:  

  • First and foremost, advertisers can and should align agency compensation with desired agency outputs, measured both in terms of detailed statement of work outputs and the resource commitment required by the agency to deliver on those expectations.  
  • Minimizing project reworks and the number of start / stops in the planning and execution phases of creative and or media development will go a long way to demonstrate the regard in which advertisers hold their agency partners.
  • Look for opportunities to improve the briefing process.  Advertisers who can effectively and succinctly prepare their agency partners at the start of a project provide a huge morale boost for their agencies and greatly enhance the odds of producing great work.
  • Reinforce the fact that as a client, you value the input of your agency partners.  Encourage candid, two-way communication among all stakeholders involved in the Client/ Agency relationship.  To be effective, this concept must extend beyond the annual 360° performance review process.
  • Encourage full transparency when it comes to agency reporting and financial management.  Supplement this with periodic (i.e. quarterly) business reviews so that both sides have a clear understanding of where everything stands, both as it relates to budgets/ project completion as well as with the relationship itself. 
  • Consider rewarding successes with incentive programs tied to the efficacy of the agency’s marketing efforts, using brand relevant milestones as the guideposts (i.e. awareness, sales, market share).

As Henry Ford once said: “Coming together is a beginning.  Keeping together is progress.  Working together is success.” 

Taking these proven steps will go a long way toward demonstrating the extent to which advertisers value their agencies, as well as the respect which they have for the art of crafting and delivering effective marketing communications.  In the end, they can also represent an important building block in extending the length and productivity of their agency relationships. 

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