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Marketing MathTM

Tag Archives: remuneration

So Long Trading Desks

07 Sep

benchmarkingInteresting article from AdExchanger regarding the evolving agency trading desk model. Embedding specialists on client teams to boost impact and transparency makes good sense, assuming the talent level is there to support that.

Thus eliminating certain “centers of excellence” such as the trading desks and or consolidating agency brands will be a necessary (and welcome) approach. While clients seek the best possible solutions, they do care which business cards agency/ affiliate personnel carry… when they’re paying incrementally for those services.

So, yes, remuneration schema will have to evolve to support this new approach Read More

Guilt or Innocence? You Be the Judge…

23 Aug

transparencyInsightful piece by Mike Farmer on MediaVillage.com. It remains clear that one key to rebuilding client-agency relationships and improving the levels of trust and transparency is the need to address the issue of agency remuneration.

Eliminating non-transparent sources of revenue, aligning scopes of work with required resource levels and incenting good work from agency partners will require meaningful dialog on the means and level of compensationRead More

Building a Relationship and Managing to Scope Are Not Mutually Exclusive

04 Aug

project scopeAdvertisers are comfortable paying their agency partners for services performed and the work product which they deliver. Conversely, agencies are comfortable billing for the services provided and work which they complete. More often than not, advertisers and agencies have contractual agreements, which specify how the agency is to be remunerated for such work.

So what is the root cause contributing to continued industry concerns over agency compensation and profitability?

Consider that, most agency compensation systems establish guaranteed profit ranges of between 10% and 20% with the opportunity for additional incentives tied to performance. Further, most client-agency relationships begin with fairly well defined “Scopes of Service” and “Agency Staffing Plans” which serve as the basis of the agency remuneration program. The obvious answer has to be that regardless of both parties good intentions, actual practice must not mirror the agreed upon contractual terms.

From our perspective, the answer comes down to one key aspect of any professional service provider’s business model… the ability to align staff investment with the scope of services required by their clients. As a contract compliance auditor and marketing accountability consultant we have had the good fortune to analyze a broad range of client-agency relationships, across industries and around the globe. In virtually every scenario where an agency asserts that they are not being adequately compensated on a given client, these two items are misaligned. The only acceptable instances we’ve come across are in the context of an agency knowingly investment spending to assimilate a new client and or on a particular aspect of a client relationship.

The primary issue for ad agencies is that their time-keeping practices are less than optimal and their systematic ability to accurately track time at a project or task level is often times poorly setup or woefully lacking in capabilities. This is frequently compounded by inadequate controls and reporting, making it extremely challenging for agency management to have the proper information necessary to course correct on a real-time basis. Finally, even if the agency does have the proper tools and is aware of any shortfalls, agencies often aren’t comfortable engaging their clients in meaningful discussions surrounding project burn rates, inefficient processes, demands exceeding the original agreed to scope, or variances in planned staff mix and utilization levels. Consequently, these issues are often left unresolved until the year-end relationship evaluation meeting, leaving the only option for the agency but to approach their client with a plea for additional remuneration to offset its over investment of time. Not surprising, the timing of these discussions are such that it is often too late for the client to even consider such a request. In the words of Roman statesman and philosopher, Seneca:

“When a man does not know what harbor he is making for, no wind is the right wind.”

Fortunately, this scenario is easily remedied through improved controls and good communications.

For starters, agencies must educate their employees and contractors on the purpose and importance of accurately tracking their time by client, project and or task, in fifteen minute increments and the need to submit their time sheets on at least a weekly basis. Ideally, these guidelines along with any other agency or client specific requirements, should be published and reviewed periodically with the agency staff.

Secondly, time-of-staff reports should be issued to clients on a monthly basis and should incorporate staff investment detail by person, by department and should be compared back against the total hours and utilization rates identified in the staffing plan along with an explanation of any noteworthy variances. This should be supplemented with a quarterly meeting between agency and client executives to review progress against the contractual Scope of Services and to discuss the agency time-of-staff investment to-date and, if necessary, any actions required to realign the two going into the next quarter.

While the agency will usually be the direct beneficiary of this approach, clients will genuinely appreciate and respect the timeliness and thoroughness of this “no surprises” process. Simple? Yes. Straight forward? No doubt. Who’s responsible for taking the first step… the agency. This methodology is part and parcel of every professional services provider’s responsibility to their clients and shareowners. Importantly, it allows agencies to effectively build rapport and manage their client relationships on a profitable basis.

 

 

 

 

How Do Agencies Do It?

13 Feb

ad agency profitsEarlier this month the Japanese agency holding company Dentsu announced quarterly financial results.  For the nine-months ending December 31, 2012 revenues were up 4.5% and net income was up 48.1% year-over-year.  Impressive?  Certainly, but not inconsistent with other players in the ad sector; WPP achieved a 43.3% increase in net income on a 7.4% revenue gain and Omnicom Group reported a percentage net income increase which was twice that of its revenue growth. 

A healthy advertising sector represents good news for clients and agencies alike.  Growing, profitable advertising agencies are able to invest in; infrastructure, personnel and research which ultimately allows them to better serve their clients.

There are two interesting observations with regard to the aforementioned agency financial reporting; 1) the recent results fit a pattern of extraordinary net income growth for the category, relative to revenues. 2) In a professional services business, the ability to generate net income growth of 2X to 10X that of revenue can only be achieved through a combination of significant expense reductions and or dramatic increases in direct margin.

Let’s be clear.  Like most other professional service providers whether in the financial, legal or consulting sectors, payroll makes up a disproportionately high percentage of an advertising agency’s expense base.  The publicly traded agency holding companies break out salary expense within their financial reports, allowing for a review of this cost center.  In a 2010 review of agency expense structures, Adweek reported that for the top five agency holding companies, expenses represented between 83% and 94% of revenues.  Salary expenses ranged between 59% and 72% of revenues.  The difference between the two is largely made up of real-estate and overhead costs.

Thus it is unlikely that agencies are relying on expense reduction as the primary source of net income accretion.  This would have a dramatic, negative impact on the caliber of work, service levels and ultimately, client retention and would be unsustainable over any prolonged period of time. Therefore margin growth would appear to be the primary contributor to the extraordinary net income gains.  But how you ask?  After all, industry compensation surveys consistently report that the average agency profit level identified within client/ agency agreements is 15%.   

Unfortunately the answer is clear, while not altogether transparent to advertisers.  A portion of the improved margin is tied to the provisioning of agency-owned services such as in-house studios, trading desks, poster specialists, barter firms and production companies. These services have tremendous margin upside for an agency because there is limited disclosure to the advertiser of the rates paid to the ultimate media seller and or the fees earned by the agency in the form of incremental commissions, spread between planned and purchased costs or volume rebates paid by the media.  Then there are sources of agency revenue which are seldom discussed and rarely audited which contribute to an agency’s bottom line profits.  These include but are not limited to AVBs, interest income from float, earned but un-processed discounts, rebates and no-charge media weight.

These practices are neither good, nor bad they simply represent the nature, albeit murky, of the global advertising industry today.  In the end, knowledge is power.  For example, the agencies that have been smart enough to vertically integrate and to leverage non-transparent income “opportunities” have generated solid bottom line performance. 

For advertisers the answer is simple, extend your knowledge of what is clearly a dynamic and often opaque marketplace: 

  1. Revisit your agency contracts to make sure that the requisite legal and financial controls have been incorporated to protect your interest. 
  2. Make sure that your agency contract extends to the parent company and any sister divisions which may be engaged as part of your agency’s service offering.   
  3. Examine your agency performance evaluation process and remuneration methodology to ensure that you are incenting the behavior and outcomes which you desire.
  4. Engage an independent auditor to assess your marketing service agencies contract compliance and performance to make sure that the requisite level of transparency is always maintained.

In the words of Sir Edward Coke, the renowned seventeenth-century English jurist;

Precaution is better than cure.”

If you’re interested in a second opinion of the soundness of your client/ agency agreement or would like to discuss the benefits of an agency contract compliance audit, contact Cliff Campeau, Principal at AARM via email at ccampeau@aarmusa.com.

There are no guarantees. Are there?

10 Sep

profit guaranteeWhether it relates to new product launches, store openings, catalog sales or a new advertising campaign, there are no guarantees that marketers will meet with success.  No matter how sound the strategy or crisp the execution or the level of investment made to support these initiatives, there is no certainty that response rates, sales, market share or profitability results will achieve expectations.

The same can be said of an organization’s investment in marketing.  Just because a firm spends 5.0% of revenues on advertising support, the investment alone doesn’t automatically guarantee an upward move in the organization’s key indicators.  Further, there is always the risk of campaign failure, or under-delivery, which can have negative consequences on an advertiser’s bottom line. 

Despite this risk, many advertisers continue to contractually guarantee a profit margin to their advertising agency partners.   And yet, agency pundits continue to lament how “unfair” current remuneration programs are, and that the agencies don’t fully participate in the “upside” results of their clients’ demand generation efforts.

Turn it around.  If a client-side CFO knew  they could book guaranteed profits as a result of the advertising investment made by their organizations they would surely take that deal.  Further, the industry would see a steady increase in advertising spending.

Shared pain, shared gain.  As investors know, generally financial returns are directly proportionate to the risks incurred.  In light of this truism, should there be any upside potential when agencies benefit from the security of a guaranteed profit floor?  

With the move toward direct labor based compensation programs, agencies are able to recoup their sunk costs (i.e. labor, employee benefits, rent, corporate expense, etc…) and to secure a guaranteed profit margin typically ranging from 12% – 18% (excludes additional profit from in-house studio and the like).  Perhaps it is time for advertisers to begin to question the efficacy of this practice.  Don’t get me wrong.  I believe that an agency should have the opportunity to earn a profit on each of their client account, and I don’t believe that agencies should bear inordinate risks to their remuneration for items and outcomes that are beyond their control.  However, it seems that agency profitability should be more aligned with resource investments and the outcomes of their efforts.

Further, from a financial control standpoint, without the benefit of tight controls and audit oversight, a cost-plus / fixed profit margin remuneration system can inflate an advertiser’s fees as a percent of marketing spend.  Too often client-agency contracts fail to adequately define key components of agency overhead or to identify employee compensation levels, agency staff utilization and out-of-pocket cost expectations.  Beyond inadequate contractual clarity on these items, there is another factor which compounds an advertiser’s risk in this area… the lack of a disciplined process to verify actual financial performance for each of these categories.

To optimize agency fee investments and enhance transparency into this aspect of advertising spend, there are three items that an advertiser can include in their letter-of-agreement (LOA):

  1. Comprehensive definitions of key remuneration program components and examples of how various factors will be calculated.
  2. Quarterly reconciliation process for agency fees, time-of-staff investment and billings.
  3. An advertiser’s “Right to Audit” clause and an “Agency Records Retention Policy.”

Successful optimization hinges on a commitment to actually following through on the right to audit, whether through the advertiser’s Finance/ Audit team or by engaging a 3rd party agency contract compliance auditor. 

To kick off the process, we would suggest an open dialogue and information exchange between client and agency to discuss profit expectations and to review those items which impact agency costs and client fees.  This conversation should take into account a client’s total spend with the agency and its parent company, which offices the client’s account is serviced from, agency employee compensation, retention & training philosophies and the agency resources that will be brought to bear on the client’s business.

In the end, it is in each parties best interest to develop an agency remuneration program that incents an agency to deliver superior performance, recognizes an agency’s resource investment and where there is a shared investment in market-based performance stemming from the client’s and agency’s efforts. 

If you would like to gain the benefit of what we’ve learned through first-hand experiences and would like to schedule a complimentary consultation on “Client-Agency Contract Trends,” please contact Don Parsons, Principal at Advertising Audit & Risk Management at dparsons@aarmusa.com.

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