Tag Archives: agency overhead

Agency Charging Practices Questioned

9 Sep

ad agency charging practicesEarlier this week Digiday, a media company serving digital media, marketing and advertising professionals ran an interesting article regarding agency compensation and the “tricks” played by agencies to boost their bottom lines. 

In short, the article asserts that; “For ad agencies, it’s harder than ever to get paid. Their services are becoming increasingly commoditized, and their margins are getting squeezed as a result.”  According to the author, Jack Marshall, this in turn is “driving some to get creative with the ways they bill clients, as they exploit loopholes and tricks in an attempt to maximize their rewards.”  Examples of the bad practices employed by some agencies in this particular area include:

  • Artificially inflating the salaries of their employees when developing compensation programs
  • Double-charging clients by including items such as medical expenses in both salary costs and overhead calculations
  • Slow rolling projects and or throwing more people at a project than is required to boost billable hours

Andrew Teman, one of the agency executives interviewed by Digiday for the article suggested that;

“The problem with big agencies is they don’t make money being efficient; they make money billing more hours.”

For practitioners within advertising industry, the aforementioned revelations are not newsworthy.  Attempts to game the system have been ever present and serve as a reminder of the decades long struggle clients and agencies have had in structuring mutually beneficial agency remuneration programs in a post “15% commission” world. 

Ironically, advertisers and agencies want the same thing… a fair and efficient compensation program which incents extraordinary performance, good behavior among the stakeholders and which leads to a solid client-agency relationship.  To that end, neither party’s needs are being effectively served by the games and subterfuge described in the Digiday article.  The solution to the issue, which seems elusive, is actually rather straightforward: 

  1. Development of detailed scope(s) of work (SOW) to serve as the basis for agency resource investment modeling.  This is an important first step, since it is the SOW which will drive agency staffing and the resulting schedule of charging practices.
  2. Completion of a comprehensive agency staffing plan, with personnel names, titles, functions, utilization percentages and billing rates.
  3. Implementation of an agency remuneration program which aligns the client’s goals with the agency’s resource investment.  Of note, there should be full transparency into the various cost elements used to calculate agency fees, overhead and profit levels.
  4. Reporting and control mechanisms to monitor agency time-of-staff investment, performance and outputs to protect the financial interests of both clients and agencies. 

Unfortunately, as straightforward as the solution may appear, few clients and or agencies have effectively implemented the four steps suggested above at a sufficient level of detail as part of their continuous relationship management processes. 

Some would suggest that the real challenge has been in effectively scoping the work required on behalf of an agency.  According to Michael Farmer, Principal of Farmer & Company which specializes in assisting advertisers and agencies in developing and implementing accurate, effective Scope of Work practices and tools, “New metrics are required to track and measure workloads, prices and resource productivity. That’s the only way agencies can evaluate and negotiate changes in the fees they are paid in today’s marketplace — and halt the erosion in agency operational health.” 

We would suggest that putting in place an effective monitoring program in this area is long overdue at most advertisers.  If not addressed, the institutionalization of the bad behavior referenced in the Digiday article sets a dangerous precedent for treating relationship ailments with trickery rather than frank dialog between clients and agencies.  

 

 

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 [email protected] for a complimentary consultation.

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