The advertising industry has long wrestled with the challenge of determining the optimal manner and level of compensation between advertisers and their agency partners.
While there is little in the way of consensus on the best approach or normative data on the appropriate rate, the Association of National Advertisers (ANA) 2022 “Trends in Agency Compensation” survey found that labor-based fees remain the predominant mode of remuneration. Further, the gap between labor-based fees and other approaches (e.g., value-based compensation) has widened. Of note, the survey identified the fact that advertisers “increasingly questioned” whether the use of performance incentives to complement fee arrangements had a positive effect on agency performance.
Ever since the industry moved away from the commission-based compensation model that was in place through the 1980’s there has been interest in a range of different remuneration solutions including the following:
- Labor-Based Fees where agencies charge for the hours required to complete a given statement of work, with hourly bill rates assigned by function. Of note, these bill rates compensate agencies for their direct-labor costs, overhead, and a negotiated profit level.
- Commission-Based Compensation, which is most typically used in the media buying area, pays agencies based upon a percentage of the advertiser’s media spend.
- Value-Based Compensation where agency remuneration is directly linked to the attainment of actual results, regardless of the time or effort required on the part of the agency.
- Performance-Based Compensation most often used to complement other fee arrangements, providing agencies with additional incentive to pre-determined KPIs.
Additionally, there are variations on each of these approaches along with hybrid compensation models that integrate aspects of two or more remuneration schema (i.e., labor-based fee for media planning, commissions paid for media buying for media agency partners).
One of the key challenges faced by clients and their agency partners when it comes to outcome-based approaches is the difficulty with identifying the proper metrics for assessing agency performance. This is even more challenging for advertisers using multiple agencies when it comes to attributing in-market results to a particular partner’s efforts.
The goal for clients and agencies has always been straight forward. Identifying a compensation model and rates that fairly compensate agencies for their resource investment, while aligning their efforts with the client’s expectations and desired business outcomes.
While no two relationships are the same, there is one truth that has guided agency compensation in the post-commission era ad agencies, like consultants, attorneys, and accountants provide professional services. The fact is that the most prevalent manner of compensating these providers is linked to one common denominator… the time required for the service provider to deliver against a pre-determined set of deliverables.
Thus, we believe that labor-based fee compensation is and will remain the most viable and least contentious mode of agency compensation. Why? The basis for developing these fees is straightforward, linking the time spent by specific employees at agreed upon hourly bill rates. Further, employee hours are the basis for agencies when internally assessing labor utilization rates and client profitability. The good news is that virtually all agencies track employee time at the job or campaign if not task level thus providing a stable basis for monitoring an agency’s resource investment against a particular statement of work.
Importantly, this approach lends itself to full transparency and is highly flexible for both advertisers and agencies to deal with changes in scope or the need to access/ deploy specialized agency resources. Even with the myriad of changes being ushered in by technology advancements, labor-based compensation models provide advantages over the subjectivity and attribution challenges inherent with outcome or performance-based compensation models.
In the end, good faith dialog between clients and their agency partners to clearly articulate expectations and to assess the resources required to achieve a mutually agreed upon set of outcomes is the key to developing fair, mutually beneficial compensation arrangements.
“The best compensation for doing things is the ability to do more.” ~ Napoleon Hill