The Value of 20/20 Foresight

March 28, 2010

"Price is what you pay.

Value is what you get."

-Warren Buffett

In his 1997 book titled Why People Believe Weird Things, author, Scientific American columnist, and publisher of Skeptic Magazine, Michael Shermer, cited twenty-four reasons why people accept the dubious. Reason number one was "Theory Influences Observation." Preconceived notions can trump reality, like the world is flat (Tom Friedman notwithstanding). Well, here's a new one.

17 Trumps 15

Many advertisers believe they are now paying their agencies less than before. They believed that by converting from commissions to fees, agency compensation would decline. However, published data tells a different story.

Not long ago, clients paid full service agencies a 15% commission. Today, the top 100 creative agencies equivalent commission rate (ECR) is just over 12%. The ECR for the top media agencies is just under 5%. Combined, these represent the offering of the old full service agency at a 17% ECR and that does not include digital. Even the most innumerate among us would admit that 17 is bigger than 15. So clients are now paying more.

Less Trumps More

Some say clients are getting less for their money nowadays. When I started in this business there were ten people for every million dollars in billing at the average agency. Today there is one for every three million dollars in billing. That's a 30:1 ratio. Even with inflation the ratio is still 5:1, or one Mad Man is now doing the work of five. Sure computers have compensated for staff erosion, but they have also introduced more data to analyze with more urgency.

Work is much more complex now. The three major broadcast networks have been supplemented with more than one hundred cable choices. Media plans were tweaked from year to year, now we think in terms of multiple communication channels. Econometric modeling replaced testing, PCs replaced slide rules, and audits replaced post-buys. More resources-fewer people.

So do agencies need to pony up more staff? Let's ask the question a different way-if you squeeze a stone hard enough, will you get lemonade? Agencies used to make a 15% to17% profit. Today they average 12% to 13%. Even on incentive plans the average high is 17%, but the average low is 5%. And that's in good times. Not much lemonade there. Perhaps we need a paradigm shift. Maybe instead of paying their agencies less, clients should reward their agencies for making them more money.

20/20 Foresight

Today there is an opportunity to re-frame the agency relationship with a kind of insured stimulus package to drive more value. Despite many other external forces, agencies can affect sales. It is the major reason they are hired. With sales averaging twenty times media spend and media agency ECRs averaging 1/20th media spend-there is a four hundred times multiple between media agency commission equivalent and client brand sales (20 x 20). This is an incredibly powerful leverage point, which does vary by category and brand and marketing situation.

At the 2010 ANA Annual Conference in Phoenix, there were twenty-one sessions over three days, fifteen of them were devoted to the economy, accountability and value compensation. Value seems to be everyone's favorite subject, but few are attempting to leverage agency compensation to create more value-more sales. Some very intelligent attempts were presented, but more clients and agencies need to reinvent their relationship value framework.

Value Trumps Cost

Value compensation models reward agencies for their output, not their input. They get rewarded for achieving certain specified goals in the marketplace, rather than being paid fees for their time and labor. The three major objections to this scenario have been...

  1. Agencies are businesses and they must cover their costs and make a decent profit.
  2. There are too many other factors influencing the marketplace beyond the scope of an agency's responsibility.
  3. In a recession we are in a cost cutting mode, not business building.

To the first point, even in value compensation systems basic agency costs can be covered, with "value payments" assigned to specific deliverables and marketplace results compounded above and beyond basic payments.

To the second point, with the right "Accountability Framework" an agency can be assured that their output does affect enough of the value criteria to be realistic, with overall goals like sales as an overarching umbrella. The trick is to construct the right framework of criteria and rewards to drive positive results.

To the third point, there is very little risk involved because if the agency does not meet goals, there is no value payment, which constitutes cost cutting. If they meet or exceed expectations, incremental sales will pay the bonus value fees up to 400-fold.

By re-focusing agency compensation on value and output, we can drive increased business at both client and agency organizations. To gain agreement, value has to be carefully defined to be fair to both parties. We are now ready for 21st century value accountability. It is an economic necessity.

Further Your Learning

To return to Steve Fajen's Insight Brief, Maximizing Media Agency Value, please click here.


"The Value of 20/20 Foresight." Steve Fajen, president, Steve Fajen Consulting Inc. ANA Marketing Toolkits.