Everything You Need To Know About Modern Agency Compensation Models

The increased complexity shaping marketing, the rising focus and customer experience, significant innovation stemming from data and technological advancements (such as programmatic buys); these are just a few of the many reasons marketers have been aggressively driving the review of agency ecosystems. Marketers have been demanding changes from agency partners in another area as well, compensation models. We have learned that the “one size fits all” compensation model is outdated, inefficient, and at this point, unacceptable. Transparency issues have run rampant in the press over the past couple of years. When Duracell realized how much of its money was swallowed by hidden fees versus what it spent on actual ads, it decided to build its own hybrid model. It struck a direct deal with a demand-side platform to manage its programmatic buys and a similar direct deal with a brand protection vendor so that it ran both the objectives and the reporting of its media buys. If you are searching for a new agency partner, here are the different types of compensation models to expect:

Commissions and Value-Based Compensation:

The entire point of these two compensation models is to build accountability. Under the value-based compensation model, the agency earns a profit based on the value of their strategy or creative thinking when compared to the actual cost to do it. The benefits of this model are that the client receives full transparency, takes less of financial risk and the agency is aligned with the client’s goals. With commission based models, the agency earns compensation based on goals. For the client, this is a great model as it is more predictable, needs very little management and it’s easier to negotiate downwards. As an agency, using these payment models means being confident in your work and knowing it will generate the results agreed-upon. Of course, there are some intense challenges that come with these models, which might be why only 7% of agencies utilize the value-based model and only 12% use a commission based model

Fee-Based or Hourly Rate Compensation:

Under this model, the agency charges it’s time for a set price or hourly rate. For the client, this model secures transparency, neutrality, which is specifically relevant for media, and insiders access to the agency’s overhead and profit. Keep in mind, however, that if your agency is slow or inefficient, as the client, you are paying for it and the agency gets paid with or without results.

Project-Based Compensation:

With a project-based model, the agency prices a specific project based on the estimated number of hours it will take to complete the project, plus a buffer fee or margin. The great thing about this model from a client perspective is that you know exactly how much you are going to pay and when. From the agencies’ perspective, this model is less than desirable as if the project estimate is not spot-on, they will lose money. Projects tend to change and as changes are made, projects take longer to complete and more agency hours are used, forcing the agency to lose profit or charge the client more. The majority of marketers have moved or are staying in a resource based model using direct salary costs multiplied by the overhead and profit multiple and divided by the number of annual billable hours in the year (~1800).     (Source: HubSpot, August 2016) There are a number of rational reasons for this option starting with it helps to avoid difficult reevaluations and potential scope creep down the line by clearly and firmly defining the project’s scope at the outset with the agency. This way, there are clear expectations on both sides about the project’s timeline, budget, what the work entails. In addition:
  1. Budget for your marketing expenses.  In many cases, marketers have a fairly consistent level of needs over the course of a year, and the costs to meet these needs can be accurately projected. Assigning a fixed fee, or retainer to this work allows you to easily budget for the majority of marketing expenses while also allowing the agency to forecast revenue.
  2. Proactive thinking on your behalf.  By retaining your agency, you give them the freedom to explore creative ideas that may never be finalized but would result in billable hours.  Without a retainer for the agency to bill this time too, you’ll likely not want to pay for this exploratory work, (which can sometimes lead to innovative ideas).
  3.  No disincentive to call the agency.  Retainers foster positive ongoing relationships between the client and agency by allowing the agency to quickly act upon requests or opportunities without awaiting budget approval.  And you don’t need to feel like “the meter is running” every time you call or e-mail the agency!
  4. You’re at the front of the line.  You have priority within the agency over those clients who do not have a retainer.  Simply put, you’re a preferred customer pre-paying for services so you get served first.
  5. Get a better deal. If the client is willing to commit to a retainer, the agency is often willing to offer somewhat reduced rates (just to be clear, slightly reduced rates) in exchange for the commitment.  
Bottom line?  No matter what the compensation arrangement, successful-client agency relationships hinge on equitable and appropriate compensation, as much, if not more, than open and constant communications, clear goals, strategies and sound stewardship of the relationships.  “Money talk,” however, can easily create a feeling of insecurity that can erode an otherwise solid relationship. Be sure clearly objectives are established up front, keep is as simple as possible, align advertiser and agency interests and priorities and be sure it’s fair for both parties.  The goal is to have an enduring relationship where both teams feel valued.

Lisa Colantuono

An avid writer, Lisa has contributed many articles in top industry trades such as Forbes, Huffington Post, Advertising Age, Adweek and HubSpot Blogs’ Agency Post. Recently, Lisa entered the world of publishing with her book, @AARLisa: New Biz in 140 characters (or Less), written for the on-the-go new business exec that needs cut-to-the-chase insights to nail new business wins again and again. Lisa is also part of the industry speaking circuit, presenting at national conferences including 4A’s Transformation Conference, AAF Admerica National Conference, BOLO, HOW Design Live, Mirren, and AdAge Small Agency Conference.