fee-structures

The consensus is that 15% – 25% operating profit, as a percentage of gross revenue, is “fair agency profitability.” This translates to between 2% – 4% of billings on media and production.

The advertising agency business is a service industry and operates under conditions of unusual risk and uncertainty. A 15% – 25% operating profit is in line with comparable businesses, such as lawyers, contractors and accountants.

Guidelines For Effective Advertiser/Agency Remuneration

1. Define the scope of work required before completing the remuneration agreement. For example, will the agency buy media or just do the planning?*
2. Decide the remuneration system (commission, fees, incentive) that meets your needs.
3. Negotiate remuneration that is beneficial to all parties – win/win. This can be accomplished by understanding what each party wants to achieve, identifying the key issues/concerns, deciding what an acceptable solution is, and discussing options that will achieve the desired solutions.
4. Promote regular review of all aspects of your remuneration.**

* Exhibit I: Defining the Scope of Work For Agency Remuneration
** Exhibit II: Sample Agency Performance Review

The Commission System

Definition: A form of payment in which an agent or agency receives a certain percentage of media and production charges.

Advantages

  • Simple to execute. For example, if it costs $100,000 to run a television commercial, the agency commission, historically at 15%, is $15,000. Stated another way, the agency bills the client $100,000 but pays the station $85,000.
  • The advertiser benefits from all the agency’s services at no additional cost.
  • Once the media plan is in place, the advertiser knows what they will be paying their agency and the agency knows what it will be receiving.
  • Puts pressure on an agency to keep its costs down.
  • When the advertising is cancelled to save money, media remuneration to the agency is also reduced.

Disadvantages

  • Unlike a cost-based system, an agency may make profit on some brands while losing money on others.
  • Does not allow for ‘degree of difficulty’ or level of full-service.
  • Agency investment front-end loaded-compensation back-end, i.e.: agency is required to invest considerable time developing campaigns prior to earning commission.
  • High risk on new product development work.
  • Agency recommendations for higher expenditures may be perceived as self-serving.
  • The agency’s payments are based on the price a medium charges and not on their ‘work’, i.e.: agencies are not compensated for undoing/revising media buys.

What Happens When The Commission is Lower Than 15%?

In an attempt to reduce expenses when advertisers are looking for a new agency, they may suggest they will pay less than the traditional 15% commission. The rate is negotiated between advertiser and agency. What work will be done by the agency and what will be charged for separately are included in the negotiation. Here are some guidelines:

Included in Commission Some-
times Included
Charged Separ-
ately
Analysis of client research Layouts Advertising production
Preparation of overall strategy Telephone TV
production
Creation of advertising Travel
directly related to client
contact
Travel unrelated to client
contact
Media planning Alternate campaigns Shipping
Media buying Media research Postage
Payment of Suppliers Duplicating Market research
Billing to client Direct marketing
Research in support of recommend-
ations
Public relations
Discounts for prompt payment Interest for late
payment

The Fee System

The alternate form of compensation is the fee system. This system compares to the means by which advertisers pay their lawyers and accountants. The advertiser and agency agree on an hourly, annual or overall fee. This fee can vary according to the department or levels of salary within a department. In other cases, a flat hourly fee for all work is determined, no matter the salary level of the person doing the work. Charges are also included for out-of-pocket expenses, travel and the items normally charged separately under a commission system. These are charged net, without any markup or commission. All media are billed to the client net of any commission.
How is the agency fee calculated? First, the agency assigns costs for salary, rent, telephone, postage, internal operation, equipment rentals, taxes and other expenses. Second, the agency determines what hourly charge will recover these costs and provide the agency with a profit.
The common rule of thumb in setting a fee is to charge three times the person’s annual salary divided by the number of hours that person works on an annual basis (on average, 1,600 hours per year).

Advantages

  • Provides for better agency financial planning.
  • Advertiser pays only for desired agency services.
  • Tends to make advertiser/agency relationship more efficient.

Disadvantages

  • Hard to forecast workload, therefore fees to be charged to the advertiser by the agency a year in advance.
  • More administrative costs to advertiser and agency.
  • Advertisers reluctant to involve agency for fear of ‘running up bill.’

Variation of Commission and Fee Systems

1. Minimum Guarantee (Guaranteed Minimum Compensation)
This arrangement involves putting a ‘floor’ under the agency’s compensation. A minimum-income figure, including a profit, is predetermined by making assumptions about the level of service required for a period, usually a year. Payments are customarily made monthly. Commissions are credited against these payments, and the agency keeps the excess of commission over the aggregate payment during the contract year.

2. Hourly Rates
Hourly charges for time-reporting employees are designed to recover agency costs, plus a profit. There are two basic versions: (1) the agency credits all commissions against hourly fees, and (2) the agency retains any commission over the accumulated hourly fees. (The latter version is, in effect, a ‘minimum guarantee.’)

3. Fixed Fee (Flat Fee, Fixed Compensation)
A predetermined, fixed payment period (usually a year) is based on an anticipated workload, at an assumed level of advertising activity (customarily billed in monthly installments with media and production billed at net).

4. Flat Fee Plus Direct Labour Costs
This is a combination of ‘fixed fee’ plus ‘hourly charges’. There are several varieties. The fixed, or flat amount, can be the agency charge for either: (1) overhead, (2) overhead and profit, or (3) just profit. Correspondingly, the hourly charge would cover either: (1) direct cost and profit, (2) direct cost only, or (3) full cost. Each variety is a way of modifying the ‘cost plus’ fee arrangement, i.e.: the higher the cost to the advertiser, the greater the profit to the agency.

5. Reduced Commission/Sliding Scale
In this instance, an advertiser pays the agency an amount less than 15% for less than full-service, based on the volume of business being generated. The effect is to find economies of scale based on increased volume.

6. Volume Rebates
These are similar to reduced commissions but entail full-service to an account. This remuneration type works when advertiser billings increase beyond a certain level, without a proportionate increase in agency costs, the advertiser recovers an increasing commission rebate as the billing increases.

7. Cost-Plus-Profit
The cost-plus-profit system is really very much like the hourly rate arrangements, except that the profit factor is negotiated and added to the total annual service cost and usually billed in monthly installments. During the year, or at year’s end, the fee is adjusted to compensate for any difference between the estimated and actual cost.

Media Services Remuneration Methods

Media buying services grew substantially in the 1970’s. Such specialized agencies, often buying in more markets or in greater quantities than some advertising agencies, may deliver media at greater efficiency. Like full-service agencies, media buying services have a range of remuneration arrangements, depending on the volume of business handled.

Examples are:

Agency of Record (AOR) 2.0% – 3.0%
Buying, national, all media 2.5% – 3.0%
Buying, TV only, network and spot 1.5% – 2.25% + fees
Buying all media 2.25% + fees
Planning and buying TV network and spot 4.0% + fees
Planning and buying all media 5.0%

Significant economies of scale can be gained the larger the media assignment. Conversely, as the volume decreases or the target group narrows from a demographic, psychographic or geographic perspective, additional fees may be required.

Some Closing Thoughts

There are no easy solutions to Advertiser/Agency Remuneration. However, there is usually only one answer for an advertiser and that is the remuneration system that best meets the advertiser’s needs. Only the advertiser knows how much money the company is prepared to spend on advertising, and how large a part of it will be paid to an advertising agency. Whichever system is chosen, it must be one that includes five elements:

1. It must provide adequate professional service to the advertiser.
2. It must fairly compensate the agency for its work.
3. It must provide an incentive to both the advertiser and the agency.
4. It must be simple to operate.
5. It must be reviewed periodically.



Introduction

The process of deciding which remuneration system is best for an advertiser and agency can be difficult. This booklet has been prepared to help this process by:

  • reviewing the current trends
  • addressing the issue of agency profit
  • providing information on media-only services remuneration

The Association of Canadian Advertisers (ACA) and the Institute of Communications & Advertising (ICA) have produced this booklet to address this topic. The information should shorten remuneration discussions and ensure focus on the more important advertiser/agency relationship.

Acknowledgements

Special acknowledgement and thanks are given to those members of the Remuneration Task Force and others whose help and wisdom have led to the publication of these guidelines.

Ann Boden – McKim Media Services
Erwin Buck – MacLaren McCann Canada Inc.
Christine Coleman – Hershey Canada Inc.
Joan Curran – Association of Canadian Advertisers
Yvan Garceau – Dairy Farmers of Canada
David Haan – FCB Canada Ltd.
David Harrison – Harrison, Young, Pesonen & Newell Inc.
Lowell Lunden – Quaker Oats Co. of Canada
Graham Lute – Nestlé Canada Inc.
Patrick McDougall – Association of Canadian Advertisers
Michael Palmer – Bozell Palmer Bonner
Cam Reston – Harrison, Young, Pesonen & Newell Inc.
Adrian Sark – Media Buying Services Limited
Ian Watson – Nabisco Brands Ltd.

Background

Advertisers, agencies and media-buying services review their methods of remuneration for different reasons:
– advertisers want to be sure they are getting value for their money;
– agencies and media buying services want to be profitable so they remain viable.

Results from the ACA/ICA “1993 Agency/Client Relationship” study state:
– compensation is the primary area where advertisers/agencies are at odds;
– 52% of advertisers feel “they pay a fair price for services they get” (neutral 28%);
– 32% of agencies do not feel “the client compensates fairly for services required” (neutral 42%);
– 28% ACA members stated the situation had improved over past three years;
– 71% ICA members stated it had worsened.

The U.S. Association of National Advertisers, Inc. (ANA) “Trends in Agency Compensation 1995” asked advertisers their concerns about “current agency compensation practices.” In reviewing the general pattern of concerns expressed, a distinct evolution in advertisers’ views is apparent:
– in the late 1980’s, the dominant concern was with the mechanics and procedures of agency compensation;
– in 1992, this concern shifted to the impact that a compensation system might have on the quality and stability of the advertiser/agency relationship itself;
– in 1995, the sense is that the compensation system itself should actively promote the well being of the advertiser – by motivating the agency to perform at a level that is generally more satisfactory to the advertiser; or by performing in a way that will be reflected in marketplace results; or by performing in a way that maximizes the cost effectiveness of agency service; or all three.

Current practices – based on the ANA Trends in Agency Compensation 1995:
– 14% of advertisers pay full 15% commission in 1995 vs. 33% in 1992;
– 35% of advertisers use a fee system vs. 32% in 1992;
– 45% of advertisers pay a reduced-rate commission vs. 26% in 1992.

Profitability: What is Fair?

Based on the opinions and experiences of ACA and ICA members, the Association of National Advertisers, Inc. (ANA) and the European Association of Advertising Agencies (EAAA), the consensus is that 15% – 25% operating profit, as a percentage of gross revenue, is “fair agency profitability”. This translates to between 2% – 4% of billings on media and production.
The advertising agency business is a service industry and operates under conditions of unusual risk and uncertainty. A 15% – 25% operating profit is in line with comparable businesses, such as lawyers, contractors and accountants.

Guidelines For Effective Advertiser/Agency Remuneration

1. Define the scope of work required before completing the remuneration agreement. For example, will the agency buy media or just do the planning?*
2. Decide the remuneration system (commission, fees, incentive) that meets your needs.
3. Negotiate remuneration that is beneficial to all parties – win/win. This can be accomplished by understanding what each party wants to achieve, identifying the key issues/concerns, deciding what an acceptable solution is, and discussing options that will achieve the desired solutions.
4. Promote regular review of all aspects of your remuneration.**

* Exhibit I: Defining the Scope of Work For Agency Remuneration
** Exhibit II: Sample Agency Performance Review

Review of Current Remuneration Methods

The Commission System

Definition: A form of payment in which an agent or agency receives a certain percentage of media and production charges.

Advantages

  • Simple to execute. For example, if it costs $100,000 to run a television commercial, the agency commission, historically at 15%, is $15,000. Stated another way, the agency bills the client $100,000 but pays the station $85,000.
  • The advertiser benefits from all the agency’s services at no additional cost.
  • Once the media plan is in place, the advertiser knows what they will be paying their agency and the agency knows what it will be receiving.
  • Puts pressure on an agency to keep its costs down.
  • When the advertising is cancelled to save money, media remuneration to the agency is also reduced.

Disadvantages

  • Unlike a cost-based system, an agency may make profit on some brands while losing money on others.
  • Does not allow for ‘degree of difficulty’ or level of full-service.
  • Agency investment front-end loaded-compensation back-end, i.e.: agency is required to invest considerable time developing campaigns prior to earning commission.
  • High risk on new product development work.
  • Agency recommendations for higher expenditures may be perceived as self-serving.
  • The agency’s payments are based on the price a medium charges and not on their ‘work’, i.e.: agencies are not compensated for undoing/revising media buys.

What Happens When The Commission is Lower Than 15%?

In an attempt to reduce expenses when advertisers are looking for a new agency, they may suggest they will pay less than the traditional 15% commission. The rate is negotiated between advertiser and agency. What work will be done by the agency and what will be charged for separately are included in the negotiation. Here are some guidelines:

Included in Commission Some-
times Included
Charged Separ-
ately
Analysis of client research Layouts Advertising production
Preparation of overall strategy Telephone TV
production
Creation of advertising Travel
directly related to client
contact
Travel unrelated to client
contact
Media planning Alternate campaigns Shipping
Media buying Media research Postage
Payment of Suppliers Duplicating Market research
Billing to client Direct marketing
Research in support of recommend-
ations
Public relations
Discounts for prompt payment Interest for late
payment

The Fee System

The alternate form of compensation is the fee system. This system compares to the means by which advertisers pay their lawyers and accountants. The advertiser and agency agree on an hourly, annual or overall fee. This fee can vary according to the department or levels of salary within a department. In other cases, a flat hourly fee for all work is determined, no matter the salary level of the person doing the work. Charges are also included for out-of-pocket expenses, travel and the items normally charged separately under a commission system. These are charged net, without any markup or commission. All media are billed to the client net of any commission.
How is the agency fee calculated? First, the agency assigns costs for salary, rent, telephone, postage, internal operation, equipment rentals, taxes and other expenses. Second, the agency determines what hourly charge will recover these costs and provide the agency with a profit.
The common rule of thumb in setting a fee is to charge three times the person’s annual salary divided by the number of hours that person works on an annual basis (on average, 1,600 hours per year).

Advantages

  • Provides for better agency financial planning.
  • Advertiser pays only for desired agency services.
  • Tends to make advertiser/agency relationship more efficient.

Disadvantages

  • Hard to forecast workload, therefore fees to be charged to the advertiser by the agency a year in advance.
  • More administrative costs to advertiser and agency.
  • Advertisers reluctant to involve agency for fear of ‘running up bill.’

Variation of Commission and Fee Systems

1. Minimum Guarantee (Guaranteed Minimum Compensation)
This arrangement involves putting a ‘floor’ under the agency’s compensation. A minimum-income figure, including a profit, is predetermined by making assumptions about the level of service required for a period, usually a year. Payments are customarily made monthly. Commissions are credited against these payments, and the agency keeps the excess of commission over the aggregate payment during the contract year.

2. Hourly Rates
Hourly charges for time-reporting employees are designed to recover agency costs, plus a profit. There are two basic versions: (1) the agency credits all commissions against hourly fees, and (2) the agency retains any commission over the accumulated hourly fees. (The latter version is, in effect, a ‘minimum guarantee.’)

3. Fixed Fee (Flat Fee, Fixed Compensation)
A predetermined, fixed payment period (usually a year) is based on an anticipated workload, at an assumed level of advertising activity (customarily billed in monthly installments with media and production billed at net).

4. Flat Fee Plus Direct Labour Costs
This is a combination of ‘fixed fee’ plus ‘hourly charges’. There are several varieties. The fixed, or flat amount, can be the agency charge for either: (1) overhead, (2) overhead and profit, or (3) just profit. Correspondingly, the hourly charge would cover either: (1) direct cost and profit, (2) direct cost only, or (3) full cost. Each variety is a way of modifying the ‘cost plus’ fee arrangement, i.e.: the higher the cost to the advertiser, the greater the profit to the agency.

5. Reduced Commission/Sliding Scale
In this instance, an advertiser pays the agency an amount less than 15% for less than full-service, based on the volume of business being generated. The effect is to find economies of scale based on increased volume.

6. Volume Rebates
These are similar to reduced commissions but entail full-service to an account. This remuneration type works when advertiser billings increase beyond a certain level, without a proportionate increase in agency costs, the advertiser recovers an increasing commission rebate as the billing increases.

7. Cost-Plus-Profit
The cost-plus-profit system is really very much like the hourly rate arrangements, except that the profit factor is negotiated and added to the total annual service cost and usually billed in monthly installments. During the year, or at year’s end, the fee is adjusted to compensate for any difference between the estimated and actual cost.

Media Services Remuneration Methods

Media buying services grew substantially in the 1970’s. Such specialized agencies, often buying in more markets or in greater quantities than some advertising agencies, may deliver media at greater efficiency. Like full-service agencies, media buying services have a range of remuneration arrangements, depending on the volume of business handled.

Examples are:

Agency of Record (AOR) 2.0% – 3.0%
Buying, national, all media 2.5% – 3.0%
Buying, TV only, network and spot 1.5% – 2.25% + fees
Buying all media 2.25% + fees
Planning and buying TV network and spot 4.0% + fees
Planning and buying all media 5.0%

Significant economies of scale can be gained the larger the media assignment. Conversely, as the volume decreases or the target group narrows from a demographic, psychographic or geographic perspective, additional fees may be required.

Some Closing Thoughts

There are no easy solutions to Advertiser/Agency Remuneration. However, there is usually only one answer for an advertiser and that is the remuneration system that best meets the advertiser’s needs. Only the advertiser knows how much money the company is prepared to spend on advertising, and how large a part of it will be paid to an advertising agency. Whichever system is chosen, it must be one that includes five elements:

1. It must provide adequate professional service to the advertiser.
2. It must fairly compensate the agency for its work.
3. It must provide an incentive to both the advertiser and the agency.
4. It must be simple to operate.
5. It must be reviewed periodically.

Further Reading

1. Agency Compensation – A Guidebook – 1989
Association of National Advertisers, Inc.
155 East 44th St.
New York, N.Y. 10017
USA
212-697-5950

2. Rewarding the Advertising Profession – 1991
Institute of Practitioners in Advertising
44 Belgrave Square
London SW1X 8QS
UK
44-171-235-7020

3. The Great Uneven Agency Playing Field: Some Perspectives on Agency Compensation
by H.E. McDonald – 1989

4. Client/Advertising Agency Partnerships – 1994
A fresh look at how to reach the right agreements on remuneration and exclusivity
European Association of Advertising Agencies
3-5, rue Saint Quentin
B-1040 Brussels
BELGIUM
32-2-280-1603

5. Advertising: Principles and Practices, Third Edition
Well, Burnett, Moriarty
Published by Prentice-Hall, 1994

6. Trends in Agency Compensation 1995 – Results of ANA’s Triennial Survey
Association of National Advertisers, Inc.
155 East 44th St.
New York, N.Y. 10017
USA
212-697-5950

7. A Client’s Guide to Agency Compensation
American Association of Advertising Agencies (Copyright 1994)
666 Third Ave.
New York, N.Y. 10017-4056
USA
212-682-2500

Exhibit I: Defining the Scope of Work For Agency Remuneration

Critical to the plan of action for agency remuneration is the clear definition of advertising services required – both current and anticipated. It helps agencies forecast the annual workload more precisely.

Here is a list of agency services that may be required. Each category should be considered in detail, before finalizing a remuneration system.

1. Strategic Corporate/Marketing Planning
2. Budgeting
3. Strategic Advertising Planning
4. Strategic Creative Planning
5. Strategic Media Planning
6. Strategic Research Planning
7. Tactical Creative Execution
8. Tactical Media Execution
9. Tactical Research Execution
10. Direct Mail
11. Public Affairs
12. Interactivity
13. Infomercials
14. Newsletters
15. Print & Broadcast Production
16. Data Base Management
17. Event Marketing
18. Special Projects

Exhibit II: Sample Agency Performance Review

Exhibit III: Sample Advertiser/Agency Remuneration Agreement

Note: This is an actual system currently being used by an ACA member. This system is based on forecasted hourly fees, a performance bonus and a regular evaluation of the advertiser/agency working relationship.

ADVERTISER/AGENCY REMUNERATION AGREEMENT

Remuneration Principles

No matter what remuneration system is applied, it must provide the agency with a fair remuneration, including a reasonable profit.
This is to protect both the advertiser and the agency. It protects the advertiser from payment of an excessive number of hours and exaggerated profit. It protects the agency from excessive demands from the advertiser and ensures a reasonable profit scaled according to performance.
These principles apply to both a fee system, as well as a commission system and lead to regular reconciliation between costs and revenues.

Remuneration

This agreement covers all aspects of remuneration with agency with the exception of Agency of Record (AOR) functions which are subject to a separate agreement.
The fee arrangement covers all standard agency services. Client will be billed net for all other services, as well as out-of-pocket expenses such as facsimiles, photocopies, travel expenses, long distance and messenger services.

Formula

Agency’s total remuneration will be calculated on a fee basis using the following formula to calculate the hourly rates, per individual, working on the account:
(Total actual annual remuneration* + fringes) x 2.75** / 1,500 hours = hourly rate

* Salary + other allocations appearing on T-4 and TP-4.
** Includes direct costs, overheads and a normal pre-tax profit of 18%.

In order to effectively manage this fee arrangement, agency will calculate a uniform average hourly rate that best reflects forecasted revenues and will use this average rate for monthly billing to the advertiser awaiting final year end reconciliation with actual individual rates and actual hours. The average projected hourly rate will be: $xx.xx.
This uniform average hourly rate will be subject to change on (month/day) of every subsequent contractual year and will be used only for billing purposes, as solely the above mentioned formula will validate the actual rates and the actual fees that the agency will be entitled to for any given period.
Agency will also supply the advertiser with estimates of the hours to be spent on the account for any contractual period and after agreement these estimates will be used to set out a monthly installment to be made to agency which will be subject to reconciliation at year end.
Therefore, the monthly installment based on the estimates will be as follows:

Fees and Hours Report

Monthly
Agency will supply to the advertiser, a report showing the hours spent on the account, grouped and detailed by department or by project, depending on the circumstances.

Quarterly
A reconciliation will be performed between the fee billing to date and the actual fee value of the hours worked on the account at the same date. Any difference will be dealt with at this time.
If the average hourly rate needs to be adjusted to a higher or lower level to better reflect reality, it will be done at this time.

Year End
The fourth quarter reconciliation report will also take into account hours to be billed at half rate (if applicable) as per the clause dealing with surplus hours.

Sub-contractors
All sub-contractors that agency mandate on behalf of the advertiser (e.g. specialists, promotion specialists, production houses and public relations firms) will be billed net to the advertiser. Any pre-approved administration costs, based on a submitted quote, will be handled on a case-by-case basis.

Temporary Personnel
If agency requires temporary personnel, it must respect the spirit of the present agreement. The rate rebilled to the advertiser should correspond to the calculation specified above by using the actual fee and billable hours worked by temporary personnel while ensuring that the specified rate would not surpass the maximum rate that regular agency employees performing similar tasks would normally charge.

Rate For Surplus Hours
The hourly rate used will be as follows:
a) 1,500 hours to be paid at full rate;
b) the balance to be paid at half rate.

For individuals who have logged more than 1,500 hours during a given year, and logged at least 750 hours on advertiser business, the rate structure will be as follows:
a) determination of actual hours attributed to advertiser;
b) determination of actual hours worked over the 1,500 hours limit (excess hours);
c) determination of % of hours worked over the 1,500 hours limit (excess hours);
d) application of % to advertiser hours resulting in excess advertiser hours to be billed at half rate;
e) remaining advertiser hours to be billed at full rate.

Example:

Individuals have logged 2,000 hours in total, 1,000 attributable to the advertiser:
excess hours = 500 hours or 25% of total hours worked
therefore 1,000 x 75% = 750 hours (full rate)
1,000 x 25% = 250 hours (half rate)

Performance Evaluation Program

As well, agency agrees to a performance evaluation program under which 50% of its normal profit is subject to an annual performance evaluation.
This amount will be calculated as follows:

  • actual fees earned by agency after reconciliation for any given year or period x 18% (normal profit, see above);
  • 50% of this amount will be subject to the performance evaluation program.

Example:

The total fee earned after one year is $1,620,000. Profit of 18% is $291,600. Agency accepts to submit 50% of this total ($145,800) to an annual performance evaluation program. How much of this $145,800 will remain with the agency will depend on the evaluation.
The formula used for this purpose will be part of a separate agreement between the advertiser and the agency at the beginning of the fiscal year. (This agreement could include the possibility of an incentive package for exceptional performance.)

Exhibit IV: Other Types of Actual Remuneration Systems

Event Bonus

The agency is paid a bonus above the fixed fee, if the attendance goal for an event is exceeded.

Media Savings

The agency receives a share of the media savings it achieved versus the previous agency.

Agency Guarantee

Based on forecasted hours, a percentage of an agency’s fixed expenses (overhead) and profit are added to form the Agency Guarantee.

A ‘blended’ hourly variable rate is developed based on the direct labour cost of people assigned to the business. This blended amount, based on the annual forecast, is then added to the Agency Guarantee to reach the annual fee which is then billed in equal monthly installments.

Note: Variable rate excludes fixed costs and profit, as this is covered in the Agency Guarantee. Should needs exceed ongoing hours estimate, additional hours are charged at the variable rate. Conversely, if actual usage is below estimate, unused hours are credited back at the same variable rate.

Forecasting System

Fee system based on expected hours required to service the advertiser. Monthly summaries are prepared to monitor actual versus forecasted fees. Adjusted as required. No surprises at end of fiscal.

Unit Sales Incentive

Base fee and payment for unit sales over target.

Extra Performance Incentive

  •  A bonus system based on extra performance. An agreed benchmark is established and a bonus is awarded, if the agency can exceed that mark.
  • Base fee (which equals a commission % on gross) plus a performance bonus against:
    1. quantitative advertiser dollar volume objectives
    2. qualitative assessment of added-value business-building ideas
  • A basic 13% commission on all advertiser spending. The advertiser then uses a variety of criteria to evaluate agency at the end of the year:
Performance Rating Final Commission
A 16%
B 14%
C 13%

Full-Service – Excluding AOR

Based on gross media billings, the agencies are paid 11.2%, the AOR 1.8%, and 2% is held in bonus reserve. Agencies receive a commission of 15.29% of net commissionable production costs (i.e.: 13% of actual gross billings). 2.71% of net is held in bonus reserve. At year end, each agency is evaluated on their performance for their assigned brands and dependent upon the grade, they are paid a bonus based on total media and production billings. The bonus payment is calculated at 3% for Grade A, 1% for Grade B and no payment for Grade C.


A fixed price structure for advertising could be by size-column inches by column inches, or by seconds (as in a television or radio advertising piece); or it could also be by frequency-how often an advertisement is aired or printed. This is a fairly standard way to price and pay for advertising. For example, if you purchase a print ad in a magazine, traditionally the price would be calculated based on the size of the ad.

Some advertising is a combination of size and frequency. In this case, you would purchase a .30 second radio advertising spot and you would pay based on the production of a .30 second spot and on the frequency and the time of day that the advertisement is broadcast. Complicated pricing schedules can be established based on how often, what time, and for what audience advertising is being made available.

Increasingly, both advertisers and those offering advertising opportunities are looking at more individualized or per piece (or per view in the world of internet marketing) pricing structures. In this case, payment is calculated based on how many times an advertisement is seen, or how many pieces of the marketing message are produced and/or distributed. For example, 1,000 copies of a flyer will be distributed in a registration packet and you are paying per piece. Pricing plans may include a sliding/variable scale where you are actually paying less per piece for larger inserts or advertising views.

In order to accurately evaluate what sort of advertising fee structure is best for your situation, you need to have a good handle on your marketing goals and your intended audience. Not to mention, an accurate budget and overall marketing plan.


Which Advertising Agency Compensation Structure Is Better For Me?

There are a myriad of ways in which advertising agencies can be compensated. For full-service shops, it typically consists of some form of hourly billing, media commission and/or production commission. While there are standard industry norms, it is common practice to engage in negotiations specifically tailored to the unique needs of each client. Finding an agreement that is fair and mutually beneficial is the foundation to building a successful long-term partnership.

Part 1 of this series is going to solely focus on non-commission forms of compensation. This is generally the foundation of the agreement. Media and production commission will be explored in parts 2 and 3, respectively.

What are “hours”? Ad agencies sell ideas – along with the expertise and strategy to execute them. The tangible product is a written communications plan, creative concepts, and finally, the advertising assets that go to market. As it is impossible to inscribe a sku number on an idea, it gets translated into the amount of “time” it took to develop it.

It’s often a vague concept to dissect, but billable hours are the core of most shops in one facet or another. To be operational in any capacity, the agency has to cover salaries, internal resources and all overhead expenses. Thus, the agency exists by compensation for invested time. However, this “time” should not simply be thought of as the clockwise journey of the minute-hand – as it encompasses the knowledge, experience, education and collective wisdom of specialized “idea makers” and “problem solvers”.

How are hourly rates established? Agencies take into consideration the total cost of running the agency and divide that by the number of billable hours available from all non-administrative employees. Comparable to any other business, revenue, minus cost of goods/service sold (adjusted gross income) must exceed total expenses for the business to be profitable. Overhead / total billable hours = hourly rate.

Typically, hours are compensated in one of two ways: monthly retainers or per-project estimates. There are pros and cons to both structures. Here is an overview to help determine which option is better suited for your needs.

MONTHLY RETAINER

A monthly retainer is an agreement to purchase a preset amount of hours every month. You do not have to determine what the specific details of each project will be in advance, although the initial hours were predicated on a basic assessment of overall needs. In other words, retainers are calculated based on a scope of work coupled with estimates of man-hours and staffing needs for that scope of work (based on past experience). From this, a monthly fee is arrived at and proposed.

Each month you get one (1) invoice for the exact same amount. That invoice covers a specific block of agency hours at a blended rate across all departments (copywriting, graphic design, account management, etc.). Under the right conditions, a retainer can be advantageous. For example, a retainer can work well if you require long-term strategic planning and an ongoing partnership that works in a proactive capacity.

Pros

  • Consistent billing for both parties.
  • Allows for ongoing proactive solutions.
  • Clients can more accurately forecast an annual marketing budget.
  • Retainer clients are often the priority in the agency.
  • The hourly rate for a retainer structure is typically lower than its per-project counterpart.
  • Projects can start immediately after being requested, there is no additional paperwork required (pending it is within the scope of the retainer).

Cons

  • Retainers can lead to liberally requested assignments that often eat up hours.
  • Often time, the amount of hours needed to complete the full scope of work in a given month is underestimated. This means that the client must be able to prioritize projects and work within the allotted hours.
  • Neither party wants to hear “over hours”, but an agency can lose major resources if it consistently gives away hours. Time can’t be resold or recouped. Everyone must agree on the hour allotment and work within that parameter.
  • With a retainer structure, there is no set amount of changes to any particular project. Unfocused rounds of revisions are often the culprit of hours usage. On estimated projects, a change order estimate is generated after three rounds of revisions. This can lead to a more tightly focused approach.

PER-PROJECT ESTIMATES

A per-project estimate is an agreement to a predetermined amount of hours to complete one specific project. This works best when you know exactly what you both need and want. “Need” is relative to your target audience. If you don’t know what you need in order to stimulate action among them, then it is important to take a step back and focus on a strategic plan first. “Want” is relative to knowing what the end product must achieve to gain approval in your organization. If you don’t know, the agency certainly doesn’t know.

Estimates are based on past experience. It’s a culmination of collective wisdom from the agency for the development of a similar type project. Typically, ad agencies will develop two to three design options for client review. One option will be further revised for final execution. The estimate assumes there will be a set number of client revisions to the chosen concept. Additional revisions that cause an overage of quoted hours typically results in a change order estimate prior to commencement of new work. The client should notified of approaching hours at 70% completion.

Pros

  • Working on a per-project estimate has a higher perceived workload visibility and transparency.
  • There is no ongoing payment for the client.
  • If you need reactionary solutions, this is a better option.
  • The review process is often more tightly focused, as the estimate allots for a finite number of revisions.

Cons

  • No work can commence until a formal estimate is approved. Estimates generally take 48-72 hours to create. This means projects cannot start immediately upon request.
  • This structure does not allow for ongoing proactive solutions, it simply covers the exact task requested.
  • It is hard for an agency to staff based on project work because there is no clear determination when projects will come in or how large they will be.
  • The hourly rate is often higher than what retainer accounts receive.

The success of a good agency/client financial relationship is based on having a clear understanding of the project up front. Expectations of both parties must be defined prior to the commencement of any work. 99% of billing issues are a result of poor planning or miscommunication.

It is important to truly evaluate both compensation models to best determine what will meet your needs. It’s also important to understand that there is no perfect science to estimating hours. Just ask yourself, how much will a new kitchen cost? Every single project is unique and there is no way to predetermine the exact amount of time needed to create the exact design a client will love. Because design is subjective, the agency could hit a home run with the first concept or it could go to ten rounds of revisions because of a multi-person approval process. It’s truly in the client’s hands.

FAQ’s

Q: My retainer covers 200 hours per month. My agency is telling me I used up 150 in the first week. How is that possible?

This is the most common reason for client dissolution with the retainer structure. First, it’s very important to prioritize project needs. You can’t expect to have a fully-dedicated agency team for the entire month without considering it is 8 hours per day for each staff member working on your projects. Often times, client’s think of 40 possible hours in a workweek. However, if multiple people (Account executive, Art Director, Copywriter) are all working on your projects at the same time, you have to consider the total hours of everyone. If you have a retainer of 200 hours per month, that roughly translates to 15 hours per week of Account Management, 15 hours of copywriting and another 15 hours of graphic design. That’s less than 2 days a week of service among all the departments.

Q: How will I be able to keep track of hours?

For retainer accounts, your Account Manager will keep you informed of hours used every week. As the month progresses, the client can decide which jobs to hold until the following month and which will take priority. On estimated projects, you will be notified of hours only when it gets to a 70% completion. If more time is needed than what is remaining on the original quote, an addendum estimate is created. There should be no surprises with hours, once you understand how they work.

Q: What does “out of scope” mean?

These three dreaded words affect both parties. Out-of-scope means the project has shifted to include more deliverables than what was originally quoted. For example, let’s say you have started a print ad project and the estimate covers one full-page layout. Then, it is later revealed that you will need it resized to both a full page and ½ page, and you need a full color version as well as black and white. If those mandatories were not specifically line-itemed on the original estimate, a change order estimate will be generated to cover the additional scope of work. Simply put, the agency did not allocate enough hours to complete the additional needs of the project.

Q: What do I do if my agency can’t complete all my needs in my allotted monthly retainer?

There are several options for this situation. The most common is to have a rate negotiated with your agency that is billed hourly once you are in excess of your retainer allotment. For instance, if you have 200 hours in your retainer, but you need an additional 50 for the month in order to complete your needs, then you can simply purchase them. The client is in control of this situation and can determine if those projects truly warrant the purchase of additional hours or if they can be postponed to the following month. If you experience the need for more hours on a continual basis, then you should consider renegotiating the contract. It can be disparaging for both the agency and client to run out of hours every month. Your agency should be able to provide audited time sheets so you can see exactly where your hours are going and how much time is needed in a given month to cover the totality of requests.

Q: None of the initial concepts resonated with me, do I still have to pay for the work?

Ad agencies are not set up to do selective selling. Meaning, hours start accruing at the conceptual stage, which may require several rounds of revisions before it meets a client’s needs. No matter how much research goes into the creative brief before concepting, the end product will always be “subjective” to the approver. The important thing to remember is that you shouldn’t solely focus on it resonating with you; instead, look at it from your target audience’s perspective. Ask your agency why they chose that image, headline, etc. If you simply don’t like it, be as specific as possible as to what you don’t like about it to help them achieve success in the next proof.


Which Advertising Agency Compensation Structure Is Better For Me?

There are a myriad of ways in which advertising agencies can be compensated. For full-service shops, it typically consists of some form of hourly billing for creative services, media commission and/or production commission. While there are standard industry norms, it is common practice to engage in negotiations specifically tailored to the unique needs of each client. Finding an agreement that is fair and mutually beneficial is the foundation to building a successful long-term partnership.

Part 1 of this series examined non-commission forms of compensation, generally the foundation of the agreement. Part 2 of the series will explore media commission and the final installment will cover production markup.

Today’s Media Landscape

The landscape of media buying is changing. Most print and broadcast companies still utilize agency discounts, but we don’t know what the future will hold. This is especially true of online initiatives, which are fast becoming a major component of integrated plans. Is it possible for you to place your media direct in some instances? The answer is yes.

So why pay an advertising agency a media commission? Well, there are several reasons. Compensation should be relative to the agency’s expert planning and research abilities, negotiation skills for maximizing your budget and their buying power. Buying power often leads to free bonus media and significant added value.

Sure, you can buy your own oil and change your own tires, but there is something very reassuring about having the mechanic do it for you. You know that you are getting the right tires, the right oil and a quality assurance benefit (not to mention a warranty). And, chances are, you’ll also get a free tire rotation and air fill up.

Media Services Responsibilities

  • Create innovative and cost-effective plans designed to fulfill media objectives through the development of strategies and tactics
  • Determine the right media mix
  • Determine which specific media outlets offer access to the target market
  • Outline when advertisements should run, and how often Compensation

The success of a good agency/client financial relationship is based on setting clear expectations and billing transparency. In the case of media, planning, placement and negotiation is typically covered through space reservation. Standard agency commission is 15%. Client invoices reflect a ‘gross rate’ that accounts for a 15% mark up. Then, media vendors bill the agency at a ‘net rate’, with the difference compensating for the media planning services.


Why does my agency put a mark up on production?

We’ve had a look at several different compensation structure models. Some clients prefer to work under a retainer model, which allows for long-term strategic planning and an ongoing partnership that works in a proactive capacity. However, if not carefully prioritized by the client, this can also lead to liberally requested assignments that often eat up hours. We also looked at fixed-fee project estimates. With the downturn economy, clients who don’t feel comfortable with long term commitments are choosing this route.

Then, part 2 of the series explored media commission and the various ways agencies are compensating for planning, negotiating and purchasing media in an ever changing landscape. Part 3, the final installment, will cover production markup.

Once the strategic direction is set, the media is planned and the creative direction is chosen, agencies may utilize third-party vendors for the production of campaign assets as necessary. This may include TV and Radio production, collateral, printing, outdoor production, list purchases, shipping, “emerging media” production and any other tangible asset not supported internally.

All third-party services procured on behalf of the client are often billed to the client at gross rates with an agency commission (between 5-20%). In efforts of obtaining the best possible price, it’s typical that three (3) bids are obtained.

The agency commission covers time and effort spent in selecting and supervising production of all outside services associated with the development of creative. Specific tasks covered by the commission include:

  • Estimating / comparative bidding
  • Vendor selection
  • Ensuring vendor file requirements are met
  • Sending materials out to service
  • Vendor communication for project success
  • Quality control
  • Press checks (may be multiple)
  • Coordination of product delivery

So, can you go to Kinko’s and make your own brochures? Of course you can. Client’s may elect to faciliate production on their own. However, will you be able to identify issues with the spot varnish, color saturation or adjust issues from pagination? If not, the commission is well worth the quality assurance.


There is a software company that delivers value to its customers by either (a) reducing costs (b) increasing revenue or (c) both.

The company offers a choice of pricing models:
1. Fixed price – lets say $1mill
2. Two part pricing of (say) $500k, plus a payment based on the value created (% cost savings / revenue improvement)

With the two-part P4P pricing option, the customer has to submit to and independent ROI assessment, which usually takes about 3 days.

Between 1998- 2002, 20% of this company’s customers took up the P4P option, and overall sales increased 94% in 2002. The remaining 80% either hesitated at the risk of paying more or preferred not to undergo the ROI assessment.


Model #1: Percent of revenue SEM agency fees

Some advertisers like paying their SEM agency based on resulting revenue. They reason rev-share will incent their SEM to grow top line, just like commissioning a sales force. Here’s our take on the downsides of rev-share SEM fees.

First, under this approach, the SEM could earn the bulk of their monthly fee via sales on the client’s brand name. The SEM didn’t create the client’s brand equity. These sales don’t reflect the SEM’s effort, and brand search is often non-incremental—so why should these brand clicks drive the invoice?

Another problem with rev-share fees: Order allocation. Here’s the scenario. Searcher clicks a paid link to client’s site, doesn’t buy today but instead signs up for client’s email list, then buys two days later from link in first email received. If the SEM and email agency are using different tracking cookies, likely both will “claim” that order. Now, whether that PPC click or that email should get credit for that order is an important and subtle marketing question. (Aside: a major cataloger mentioned to me last week that a whopping 96% of their web orders involve customers with recent marketing touches in two or more channels: Catalog, search, email, affiliate, print, list rental, etc). It is hard enough for an agency to help clients suss out multi-channel allocation, and I’d suggest an agency can’t provide impartial guidance on this critical topic when their comp depends on the outcome.

Yet another problem with rev share: No economies of scale for client. When revenues double (think Christmas), the agency’s fees double. In most cases I don’t think that’s right. (You’ve probably guessed by now my resume has more years on the client side than on the agency side.) The agency doesn’t cause Christmas. So why should the agency earn double fees in November and December? Like a cataloger amortizing printing press make-ready fees over larger print runs, online advertisers deserve some economies of scale from their partners. Heck, given the rising cost of clicks and the new postal rates, direct marketers often require favorable economies of scale to stay afloat these days.

Rev share encourages SEMs to act like affiliates (stifling data sharing), and rev share can lead some agencies to “skim” (only tackling low-hanging opportunities)—but let’s move on.

Model #2: Percent of ad spend SEM agency fees

Some paid search agencies bill clients based on a percentage of their SEM advertising spend. Rates range from 5% to 20% of spend.

Percent of ad spend fixes several of the problems discussed above. Search costs are pretty unambiguous, so order allocations don’t impact the agency’s fee. (Advertisers: if you’ve not done a PPC cost audit and a PPC sales audit recently, do so.) The client’s brand name and trademarks, while responsible for a large chunk of tracked sales, usually comprise a modest chunk of PPC ad spend, so that mitigates the brand name problem discussed above. And Percent of Ad Spend billing should incent an agency to build out and maintain a robust keyword and copy portfolio, capturing value from the long tail.

But Percent of Ad Spend isn’t perfect. As with the Percent of Revenue model, the client doesn’t enjoy economies of scale. While holiday sales typically soar faster than holiday ad costs, many clients will still get hit with super-sized SEM invoices in November and December. Does this reflect more work on the part of the SEM? Somewhat —campaigns do need closer attention during the holiday madness, due to stock-outs, shipping windows, and competitors’ actions. But has the agency’s actual work increased as much as the ad spend? Nope.

For many advertisers, the glaring flaw with Percentage of Ad Spend pricing is that it incents the SEM agency for spending the advertiser’s money regardless of results. Point well taken. We’d suggest that if a SEM agency isn’t hitting mutually-agreed-upon performance metrics—that is, if the agency is failing to keep the ad-to-sales ratio within acceptable limits, or is failing to stay within budgets, or is failing to meet sales commitments, then the client should simply dismiss the agency. Advertisers, give an underperforming agency two weeks or 30 days to remedy, and if they can’t get their act in order, exercise your out. We recommend SEM contracts have 15 or 30 day outs for this very reason.

For the agency, pure Percent of Ad Spend fees can pose a downside risk if the work is too great and the fee is too little. Some SEM clients demand/require considerable effort managing modest PPC budgets. Examples include B2B clients in highly specialized verticals, or national specialty store retailers running numerous complex local campaigns in hundreds of geographies.

Model #3: Flat monthly fee

This is the simplest model: The client pays the agency a consistent flat monthly fee. Don’t laugh—this is the structure in use when advertisers choose to manage paid search in-house. Salaries for in-house PPC staff, accompanying benefits, bid management software—those are essentially flat each month, regardless of ad spend or sales.

Simplicity is a key advantage to the flat fee approach, and it certainly provides the advertiser economies of scale. But it has disadvantages. Going into the deal, neither agency nor client has a firm sense of the true work required. One side is likely to guess wrong, leaving either advertiser or agency disgruntled about pricing. And certain agencies might view a flat fee as a disincentive to hustle. But as above, fast-out clauses ensure clients stay satisfied.

Model #4: Percent ad spend, capped, with fast out

We believe Percentage Ad Spend, Capped, with Fast Out offers the best pricing model for SEM management. Client pays agency a monthly management fee calculated as a percentage of ad spend. Client and agency also agree on a monthly minimum fee cap to protect the agency if the ad spend is very small, and a monthly maximum fee cap to protect the client if the ad spend is very large.

Choosing different values for the min cap, the max cap, and the percentage allow agencies to signal potential clients where they’re positioned in the market place. For example, dividing the monthly min cap by the percentage yields the typical minimum suggested monthly ad spend for target clients.