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The level of mutual trust between agencies and their clients is at an all-time low. There are many culprits, some historical and perennial, some temporary and episodic. The current debate over media “transparency” is a manifestation of the erosion of trust in agency-client relationships. But it is also symptomatic of the underlying cause of this mistrust.
Clients surmise that agencies are making money on media transactions that are not being fully disclosed. In many regions of the world, agencies earn not only a commission from the media, but also an AVB (agency volume bonus) — effectively a rebate from media properties based on total spend. In areas like Latin America, this is completely understood by clients and fully disclosed by the agencies. In fact, many agencies in these regions are heavily dependent on these volume rebates to make their numbers.
In the realm of digital media, the digital media distribution chain extracts up to 60% of every media dollar spent. Clients are understandably concerned that less than half of their digital media budget actually results in consumer exposure (and even then, just a few seconds’ view of a banner ad often qualifies as “exposure”). The digital media chain can indeed seem bloated and wasteful, and large marketers like P&G and Unilever have called for greater efficiencies and fewer handoffs in this chain.
An important part of this string is the audience data owned by third-party aggregators, the media themselves, or even agencies. Many of the large agency networks are able to add considerable value in the digital buying process by applying algorithms, appending data, and employing machine learning to enhance the effectiveness of audience targeting and delivery. In some cases, these technologies are viewed as “black boxes” by clients, and some marketers are concerned they don’t have full visibility into the process and costs involved.
The wrong end of the telescope
Underlying all of these issues is what I believe is the real problem: agencies have taught their clients they can have a full, complete, detailed view into every aspect of the agency’s business, right down to salaries, overhead costs, and margin. This, in effect, puts the client in charge of the agency’s finances. Procurement professionals now dictate which agency individuals are assigned to which projects and how many hours they can spend. They impose “industry benchmarks” on virtually all aspects of agency overhead costs, right down to rent and health insurance. In some cases, they decide the individual year-end bonuses of agency team members. That, by any reasonable standard, is insane.
Since when is it the buyer’s job to manage the margins of the seller? Why should it be the prerogative of a client buyer to dictate to a professional service firm how much profit they’re allowed to make? More to the point, how did this happen? It happened when agencies made the misguided decision to adopt a pricing methodology that dates from the industrial age: cost plus. The cost plus approach spawned a series of unintended but nonetheless pernicious consequences, ultimately producing today’s undesirable state of affairs.
By definition, the cost plus method requires that all seller costs be disclosed, and buyers therefore feel they must be vigilant in tracking and verifying these costs. What if the agency is submitting inaccurate timesheets? What if they’re charging for time that was never spent? What if they’re overstaffing the business? What if they’re earning money in ways we can’t see?
In the world of multinational agencies, what should be purely internal agency management decisions are now monitored and governed by client buyers. Hence mandated audits of agency time and materials. Hence third-party cost consultants. Hence lack of agency-client trust.
To illustrate the futility of buying buckets of time, my friend Bruno Gralpois of Agency Mania Solutions provides the analogy of enjoying a fine meal at a restaurant. As you take your place at the table, instead of ordering items from a menu with published prices, you instead ask the restaurant how many cooks will be needed, how much each of them will be paid, and how many hours it will take them to prepare your meal. Ridiculous? Yes. And it’s also a ridiculous way to buy professional services.
A simple remedy
The prevailing cost plus approach appears to be a circular conundrum, but the remedy is actually simple: agencies must stop selling their costs.
Imagine the immediate change it would make in agency-client relationships if clients bought effectiveness instead of efficiency. Marketers would cease to care how many people are assigned to their business if the agency compensation was based on the quality of the outputs instead of the quantity of the inputs. In this scenario, both parties would care about the same thing: deliverables and results, not time and materials.
In retrospect, the original commission system was far superior to cost plus. The only way for agencies to earn more money was to create effective work and make effective media placements, because that’s what spurred increases in client spending. Success breeds success. Clients in the days of Mad Men could have cared less how many people were in a meeting, because they knew the agency had the right incentive to include only the people who were essential to producing effective work and growing the brand.
If there’s one overarching principle of economics, it’s that incentives matter. As economist Stephen Landsburg observes, “Most of economics can be summarized in four words: ‘People respond to incentives.’ The rest is commentary.”