Mele’s Musings

Fixing a Broken Agency Compensation Model

It’s an old adage that “you get what you pay for.” And generally I have found that to be true. Whenever I choose something based solely on price, that usually means some sort of sacrifice in terms of quality. I only have myself to blame when my cheap purchase fails to deliver, breaks, etc.My 2nd generation parents, who were born in the United States but were raised by frugal Italian immigrants, always believed that it was better to have fewer things if those things were of high quality. In return, those high quality things were treated as valuable investments. Hence the plastic covers on my grandma’s coach.

I was always raised to believe that payment is in fact a contract. In that contract, you indicate the type of relationship you wish to engage in. If I pay a premium for some product or service, I expect a lot in return, and I care a lot about that product or service. If I am most concerned with the lowest price, I don’t expect more than the basics, or I am at least willing to compromise on some level of quality or service.

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And, it’s also a truism that how you compensate drives behavior. If you compensate someone on hours worked, you incentivize them to work longer hours. If you compensate someone on completing a project, you incentivize them to finish the project as quickly as possible.

However, if you compensate someone in a way that indicates you are mutually invested - that you will pay for quality and reward that quality with guarantees of more work or continued loyalty - you are setting up a situation in which both parties win: you with high quality, the service provider with a valuable return client.

Ultimately, this is the issue when it comes to agency compensation. Clients want to get the best service, talent, and output possible from their agencies but are under pressure to reduce fees from upper management. Agencies are under pressure to compete for the best talent and deliver high quality service and output, but are often put in situations where compensation practices encourage them - or even force them - to focus on the wrong things.

I recently read an article in AdAge which talks about this very issue. The author of the article rightly indicates that everyone is generally frustrated when it comes to compensation models. In my job, particularly my previous role, it was my least favorite activity, especially when procurement got involved.

The problem with procurement-led compensation negotiations is that, in the words of a previous client of mine, they treat everything like it’s floor cleaner. As if paying less for something meant you were getting a bargain. While that may be true when what you are negotiating over is toilet paper with little impact on your business, it seems pretty ridiculous when it comes to compensating agencies, who ultimately should be partners in your business. But, we regularly see procurement trying to beat down prices without the requisite view of what it is that agency and client are trying to achieve together.

What is strange is that compensation models have not changed much over the years, and still largely encourage bad behavior, and I would argue outmoded behavior, in both agency and client.

The traditional percent of media compensation, while easy to administer and understand, is probably the worst compensation model but still widely used. It rewards agencies for spending money, it doesn’t tie compensation to effort (we all know that the number and complexity of campaigns is more relevant to effort than the cost of campaigns). Agencies have to make an investment in people, technology, overhead, etc. to service a client. But percent of media compensation gives them little guarantee that they will get paid as reductions in budget mean reduction in fees.

And in the modern era of paid-earned-owned media, tying compensation to percent of media makes even less sense. As we indicated in our Outlook report, and I wrote about in a previous post, media-based compensation, even tying agency compensation to media ratios, dissuades agencies from considering non-paid media and/or creating low-cost (but effective) experiences.

Project-based compensation is better, but is not perfect either. It at least encourages each party to think about scope and the effort required to deliver a campaign or website or project, but it rewards agencies for reducing costs and getting projects done on time rather than perfecting product, and it often pushes clients to want to “squeeze” as much out of the project as possible, leading to lots and lots of scope creep.

Ultimately, however, both compensation models are out of step with what both agency and client really want - a long-lasting, mutually beneficial business partnership that pays fairly based on both effort and outcome. Compensation models, if constructed carefully, should mirror the type of relationship that we know brings the best behavior:
• They encourage shared risk and reward based on mutually agreed upon results. Both parties share equally.
• They are focused on the quality and performance of the end product. And they honor the effort that it takes to get there.
• They reward quality with the promise of a larger, longer relationship.
• They pay homage to the “you get what you pay for” adage.

I know it’s not easy to find the right model and there is certainly no one-size-fits-all solution, but in the end, agency and client should be working as partners to find solutions and build the types of relationships that are built on mutual benefit and shared risk and reward. Otherwise, we run the risk of creating relationships that are myopic and one-sided, which do not benefit either party in the long or short run.