Modern agency remuneration models focus on shared risk, reward
by Angelika Kempe. Brands are coming under pressure to ensure that they get the best possible return on investment from their marketing spend in a tight economy. One of the areas coming under scrutiny is the model used to determine the fees paid to advertising and marketing agencies. There are several options to choose from, ranging from the traditional monthly retainer to complex formulas that seek to reward agencies for high performance and penalise them for underperformance. Let’s look at six basic models, each of which has its pros and cons:
- A retainer based on scope
- A retainer based on a percentage of the client’s budget — extraction rate/top down model
- Ad-hoc, project-based billing
- Value-based compensation
- Commission-based compensation
- A hybrid combining two or more of the other models
1. Retainers based on scope
This is one of the most-popular and -straightforward approaches, familiar to experienced marketers and their agencies. You simply give a marketing plan or the anticipated scope of the work you need done by the agency. In turn, the agency will draw up a resource plan and a monthly fee for the services you need.
In return for paying a retainer, the brand will get a preferential rate for the services and resources it uses. When retainers are scoped, agencies will often allocate more-senior resources to the work than they will use, driving up the cost of the retainer to provide a buffer. In most cases, medium-weight staff will do most of the work, with senior directors involved at the periphery of the account.
This model is suitable when you need an agency of record but don’t have a constant requirement for creative work. You would usually pay a small retainer to cover an account management team. Other services would be billed for when you brief in the job. It gives the continuity of an agency that understands your business but with a lower monthly retainer.
This model works well if your workload has a low-strategic and -broadcast requirement.
2. Retainers based on total investment — extraction rate/top down model
It’s more common than it should be but marketers sometimes don’t have a marketing plan defined for the year. The easiest way to set a retainer, in this instance, is to earmark a percentage of the total budget for the agency referred to as the extraction rate. For example, you might extract between 12.5–15% of your total budget for your creative agency.
You’d use a formula that looks like this: media budget + production budget * extraction % = annual fee.
3. Value-based compensation
Under this complex model, the client pays the agency a base fee plus a reward based on the effectiveness of the output. The agency bills the monthly retainer minus a risk rebate. The client will pay back some or all of this rebate according to how well the agency performs against its key performance indicators (KPIs).
This compensation method carries a high risk for the agency. The final cost is fixed with no recourse for the agency to recover overspend.
This model is only suitable for large, sophisticated markets and in a relationship where the client and agency know each other well. The KPIs should be defined and agreed upfront, and the formula used for risk and reward needs to be fair to both parties. You would ideally evaluate the performance of the agency bi-annually to give it an opportunity to fix any areas of concern. This is preferably led by an independent facilitator guiding both parties through the process and drawomg up a solid action plan.
4. Ad-hoc compensation
If you can’t commit to a scope of work and a fixed retainer for the fiscal period, you can commission work and pay for it on a per-project basis. It means you don’t need to commit to a retainer and that you can pick the best agency for each job, rather than working exclusively with one jack-of-all-trades partner.
The drawbacks of this approach include:
- Higher agency costs with more-expensive rate cards and markups
- No guarantee that the agency will have resources ready to do the job when you need it
- The agency will not get to know your business as well as it would in a retainer relationship
- Generally, the costs are not subject to reconciliation
5. Commission-based compensation
This remuneration model is a dinosaur because it’s expensive and unaccountable but a few clients still use it. The agency earns its fee from commissions from media owners, and may also charge the client for creative supervision, project management and markups on third-party services.
The approach may be expensive for the client; what’s more, the agency will not be neutral on media placements because it will choose them based on the size of the commission, rather than the client’s best interest. Agencies are vulnerable to the client ending its media spending, so it’s risky for them, too.
Agencies are facing demands from brands to drop their fees but they are finding ways to compensate for the lost income. They may, for example, keep credits from recons, unbilled media, media discounts and so on, unless you have a clause forbidding the practice in your contract.
It’s far better to have a fair contract that pays the agency fairly for its work while meeting your objectives.
Getting the billing model right becomes easy if you are clear about:
- How strategic the work is
- How creative you want the work to be
- Your account management requirements
Understanding those factors, you may then identify the right agencies in terms of your budget and the expertise you require.
Angelika Kempe heads up AdOps as the head consultant for creative and media agency relationship management. Her strengths include managing all media agency types related to all commercial and process-based issues, with a special focus on contract negotiation, performance management and good governance. She also specialises in mediation.
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