On Costs and Effectiveness

Even the best-run ad shops have learned a lesson or two about cost controls during the past three years.

Ad spending in the U.S. peaked in 2000, and most leading prognosticators reckon the industry’s total revenue won’t reascend to the millennium’s max until 2004. That dismal backdrop explains the urgency with which agencies have tried to get the most out of what- ever revenue they do generate.

Hence, the emphasis on economizing. Client-side companies face similar recession-induced pressure to trim costs, one of which, of course, is ad-agency compensation. This only adds to the financial pressure on the agencies. And the bad news is, no matter how good one gets at cutting costs, there’s a practical limit as to how much good all the squeezing will do. The rent must still be paid, and the staff, even in these tough times, won’t work for free out of gratitude for having a place to go during the day.

So while cost-cutting is important, you can’t save your way to prosperity. The best way for a business to grow its profits is to add more revenue to the top line faster than expenses grow. And the best way to do that is to win new business.

Although that seems pretty clear, one can never be too good at it, so a recent two-day conference on the theory and practice of winning new business, choreographed by the American Association of Advertising Agencies, drew a full house of agency managers seeking to acquire or sharpen their rainmaking skills. Indeed, this first-ever “summit” was so successful that the industry’s major professional association is thinking about making it a regular event.

Most assignments a shop wins are not truly “new,” but rather accounts that some other agency lost. So keeping accounts can be as important as winning them. And on this point, the conferees heard that “price,” meaning agency compensation, is almost never the reason clients leave. A survey by Ballester Consulting found that a shop’s inability to keep pace with a client’s progress, management changes either at the client or the agency, and industry consolidation are far more likely causes for divorce than mere money.

Senior financial executives from three agencies, Saatchi & Saatchi, VML and Euro RSCG MVBMS Partners, who between them have negoti- ated every conceivable sort of agency- compensation agreement, also agreed that compensation is seldom the reason shops get hired or canned.

These panelists identified four primary compensation approaches. The classic commission system, though no longer yielding the traditional 15 percent of ad spending, is still in use; a markup of agency resources, perhaps modeled on the taxi meter, has become increasingly common. Some work is performed for a fixed fee, although this usually covers projects rather than ongoing campaigns. Finally (and intriguingly), some shops are paid in proportion to how well the client’s business performs.

The first two methods—plus an infinite number of mix-and-match hybrid approaches—are based on input and exertion, such as how much is spent on advertising or how much work is performed. Those and especially the fixed-fee approach encourage the agency to perform on the cheap. They can be rewarding for shops that are highly aware and in good control of their operating expenses. Only the fourth method—in some instances a straight percentage of client-product sales—rewards results more richly than effort. A true results-based formula can be open-ended, with the client, believe it or not, happy to pay the agency more. However much more the agency gets, the client has already profited from superior sales results in the marketplace.