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.
Agency Compensation 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 clientswill 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.
Value-base Pricing 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.
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)