Decideware

With our thanks to Tim Williams from Ignition Consulting Group for this article

It surprises most agency professionals to learn that many advertisers are intensely interested in exploring a value-based compensation arrangement with their agencies.  A recent position paper from the Association of National Advertisers (ANA) states it clearly:  “Traditional metrics used in today’s cost-plus compensation agreements (usually based on time) have no relationship with the external value created for the client in today’s intellectual capital economy.  Therefore, pricing should instead be based on results and value created."

In our recent work with the ANA, Ignition has discovered that marketing, finance, and even procurement officials from client companies are actively engaged in internal discussions around value-based compensation.  Our view is that if the agency community isn’t more proactive in this area, clients will be the driving force behind a change in compensation practices.

Buying outcomes instead of hours

From a marketer’s perspective, the chief frustration with the traditional cost-based compensation system is that they’re not sure what they’re really buying.  Are they buying the agency’s time?  Dedicated staff? A set amount of work?  In the end, they don’t really want to buy any of these things; they want to buy results.

In a cost-based compensation arrangement, the marketer pays for efforts rather than results.  Agencies log and charge hours regardless of the outcomes the hours produce.  In a value-based arrangement, agencies and clients identify specific metrics of success and structure agency compensation around outputs instead of inputs.

Shared interests, shared risks and rewards

Value-based compensation works primarily for one major reason:  it aligns the interests of the agency and the client.  Both parties are working to achieve the same things.  They both have similar financial incentives.  Structured properly, value-based compensation agreements can also give both parties similar risks and rewards. 

Imagine how this could change the dynamics of an agency-client relationship.  Suddenly, the concept of “partnership” takes on real meaning.  Marketers start to view “risky” agency recommendations differently, because they know the agency has skin in the game.  A new level of trust and mutual respect emerges, because both parties have a stake in the outcome.

Value-based pricing is unquestionably where the marketing world is headed.  The question is, who will get there first: agencies or their clients?

Tim Williams is founder of Ignition (www.ignitiongroup.com), a consultancy devoted to helping agencies work in a value-based way with their clients.  He welcomes your comments at twilliams@ignitiongroup.com.

A few weeks back we had the pleasure of presenting a paper to the ANA Financial Management Committee in New York.

We were also extremely fortunate to have two of our champions, Kim McMillon (who implemented at Hanesbrands) and Zac Belcher (key driver of the global roll-out at Procter & Gamble) provide their stories and insights.

A key message of our presentation was that an effective Agency Relationship Management program can be used as a lever to improve many aspects of financial performance.

FINANCIAL PERFORMANCE METRICS

Some of these aspects of direct performance are well understood and commonly applied, see some examples listed below:

1. Increased Sales:

Getting the Agency 'A' team on your business leads to...

• Improved Growth
• Gain in Market share

2. Improved Efficiency:

Better processes and financial management leads to...

• Lower costs

3. Reduced Risk:

Better identification of issues and positive action leads to...

• Lower 'Churn'
• Improved Governance

BUT WHAT'S MISSING?

But, perhaps what's missing from this set of typical metrics are measures of brand value.

Brand value is, arguably, the most important long-term metric that an agency can influence.

The problem is that brand value is also widely recognised as one of the more difficult metrics to operationalize in evaluation programs.

Further, the conflict between a focus on long term brand value and with efforts to meet quarterly results for the financial market, is well documented.

In a recent Harvard Business Review article entitled "If Brands Are Built over Years, Why Are They Managed over Quarters?", Leonard M. Lodish and Carl F. Mela provided an interesting analysis of brand equity, and how short term tactics can have a terrible effect on the long term value of a brand.

MEASURE AND REWARD

The authors recommend every senior-level brand manager take a quarterly look at the 4 key metrics, below:

1. Estimated brand sales at a constant, non-discounted price
2. The change in baseline sales over months, quarters and years and the probability that the baseline sales have increased or decreased over those time periods
3. The regular price and promoted price elasticity -- or the percent change in revenue due to a percentage change in price
4. Change in brand price response over months, quarters and years, and the probability that elasticity has increased or decreased.

Our view is that we should at least consider incorporating measures of brand equity in agency evaluation / compensation frameworks. And even if they not immediately available, that we look to include them in future reviews. 

Author: Richard Benyon (Decideware)

This article introduces a tool we use to map agency or strategic supplier performance - the Relationship Matrix.

The Relationship Matrix helps clients visualize the two key dimensions that all suppliers must deliver on - Product and Process.

This is a powerful tool to deliver deep insights into performance, quickly. As such, it's a terrific "C" level report.

More than a Number?

With formal evaluation programs it is very easy to get caught up in the final, overall rating score.

However, it's also very useful to dig deeper into the data to understand how that overall score was determined.

The Relationship Matrix helps clients better understand where the strengths and weaknesses of their suppliers are. Then they can develop strategies based on those understandings.

Performance Dimensions

In the Relationship Matrix we label the two dimensions "Product" and "Process".

The Product dimension is what the agency / supplier actually does and relates to the craft or output that they deliver.

As an example, in advertising this would include such aspects as strategic insights, creative ideas and customer understanding. In strategic supply it might address the quality of a product, innovation and delivery.

The Product in an agency context has been referred to as the 'Magic'.

The Process dimension is how the agency / supplier does it and relates to the way in which they provide their goods and services.

Examples of this would be project management, financial administration and account service.

In an agency setting, this has been referred to as the 'Logic.

For more on Magic and Logic see the ISBA / CIPS / IPA Whitepaper 'Magic and Logic: redefining sustainable business practices for agencies, marketing and procurement' .

Mapping

Where do your key agencies or suppliers fit on this Relationship Matrix?

Using these dimensions we can segment agencies / suppliers into 4 key sectors. Potentially, clients can develop  different strategies to address each group. Hopefully, very few of your portfolio are in the final segment!

• Dynamic: Strong on both “Product” and “Process”

Your ideal partner. Learn from what they do and build best-practice models to leverage across others in your portfolio.

• Develop: Strong “Product” but weak “Process”

They are good at what they do but can be a nightmare to work with as their processes are inefficient. Help them to identify and improve the areas that are causing you concern.

• Diagnose: Strong “Process” but weak “Product”

This is a difficult segment, as suppliers may be easy to deal with and incredibly efficient, the issue is that don't deliver what you are actually paying them for. Diagnose quickly what the problems are as they can have a major negative impact on your business.

• Danger: Weak on both “Product” and “Process”

The big question here is whether you should continue to work with anyone in this segment. Is it worth having to not only improve their processes but also to address the critical problems they have with their outputs?

Author: Richard Benyon (Decideware)

We attended the AAAA Financial Conference in New York on Wednesday and much of the debate was again around the issue of Value-based compensation. This in the well publicised context that agency margins have been under considerable pressure as the basis of remuneration has swung away from commissions towards ‘cost plus’ pricing.

With the AAAA being the peak agency body it was interesting to contrast their views with those from the client side which we have been party to recently.

Slice of the Pie

At the heart of the issue it would seem that agencies feel they are being inadequately compensated at present with remuneration based solely on ‘cost plus’.   Accordingly, they would like to move to a system which more adquately reflects the value they bring to the businesses of their clients.   Of course this means that clients will need to be prepared to pay more when success is recorded, but if this happens, agencies I suspect will need to be prepared to accept more risk. This was brought up, though only in passing, and needs to be addressed in more detail.

Measurement Metrics

Another problem with Value based pricing which was mentioned but not resolved is how to measure added value.   What metrics will be used?   Sales growth?   Research measures?   Evaluation by the Client of Agency performance?   But even if evaluation metrics can be identified, what level of growth or improvement is required to warrant additional payment?   The difficulties resolving these questions appear to be a key barriers to widespread adoption of Value based pricing. 

Competition

One aspect I noticed that was not mentioned in any way was that most critical of market forces “Competition”. What has helped drive down margins is not just pressure from clients, it is also that there is a high level of competition in the agency business and as a result downward price pressure has been accepted. The market is an extremely efficient vehicle and the price point will always be where buyer and seller are prepared to meet.

Not all ideas are BIG

Another point I noticed is that when Value-based compensation is mentioned, most examples that are used are for the BIG ideas with a single traditional agency (as an example at the conference where Courtney Gibbons of MasterCard spoke, the idea for the ‘Priceless’ campaign was discussed).

• Could it be that BIG ideas are not requested and generated that often? There are a lot of other day-to-day functions that agencies perform that may not have as dramatic an effect on ‘value’ and are viewed by clients as simply mandatory agency business requirements.  Would a valid technique be to segment agency activities and apply Value-based compensation to those that do involve ‘ideas’ (rather than application of the idea) but use more traditional cost based techniques to ‘non-idea’ aspects of work?
  
• With the fracturing of the marketing landscape and multiple agencies working on campaigns & ideas; who gets what slice of the value, and who decides how it will be split and shared? This could be a challenge even to existing incentive compensation schemes.

Key Predictive Indicators

The highlight for me on this topic was Tim Williams from Ignition Consulting Group who gave a succinct presentation during the forum, which I felt nailed all the benefits and the problems with this area. He also tackled how best to implement this and it is great to get some measurables (concrete examples were provided) that can be used to navigate the minefield. Can I suggest for more detail you visit their website as there is a wealth of information on these topics and he is a thought-leader in this area.

I particularly liked his use of the term KPI, meaning “Key Predictive Indicator” (future based) rather than "Key Performance Indicator" (historically based).

With value being, by definition, realized in the future, predictive measures look to be a core way of looking at value and I welcome their inclusion in Incentive Compensation schemes.

Author: Richard Benyon (Decideware)