It has been decades since the advertising industry relied on a standard 15% commission as its primary form of ad agency remuneration. Yet, one aspect of this bygone standard is still in use today.
When it comes to traditional media, for example, the commission rates charged by agencies for media placement services are in the low-to-mid single digits. However, rather than applying the agreed upon media commission to actual costs (sometimes called “net media”), known or unknown to the client, many agencies “gross-up” the net media cost before applying the contractual commission rate. Further, they do not gross up actual costs by the compliment of the commission rate, but by the old standard of 17.65%. The net result is that the media agency yields more in fees (commission), the advertiser pays more, and the agreed to media commission is not applied to actual media purchased – it is inflated.
For example, if $50 million of net media has actually been purchased (substantiated by media publisher invoices), and a 3% commission rate for the media buyer is applied, then the client would be charged $1.50 million in commissions (net media cost x commission rate). Pretty simple – and how most client CFO’s (and most individuals not aware of this practice) would expect the agreed-to commission structure be applied.
However, it is still too common a practice for agencies to gross-up net media cost by 17.65% (using a 15% commission rate) before applying the agreed-to commission. Thus, had the same advertiser spent $50 million on media, they would be charged $1.765 million in fees (commission) – yielding the agency an extra $265k – akin to had the agreed-to commission been 3.5% of net media.
(1 + Mark-Up Rate / Cost) x Net Media Cost x Commission Rate
or
$1.765 million = (1 + .15 /.85) x $50,000,000 x 3%
The notion of calculating based on a “grossed-up cost” linked to an outdated industry standard from the 1920’s prior to applying the commission rate is quite simply non-sensical. Further, in the current environment, this practice could be perceived by many to be misleading.
To paraphrase Leo Burnett, one of the great advertising minds of the twentieth century; “The greatest thing to be achieved in advertising, in my opinion, is believability…” Thus, we would advocate eliminating the subterfuge and applying agreed upon compensation rates directly to actual costs for a cleaner and more transparent means of calculating agency remuneration in commission-based systems.