THOUGHT LEADERSHIP | Article

Performance Based Pricing: Is It Time?

March 2, 2020

Performance Pricing

Should value and performance be factored literally into how brands compensate their agencies for the work they’re doing?

 

Putting your money where your mouth is. This is a concept as old as the business itself and for decades, we’ve shared many a conversation with client partners – existing and prospective – about establishing a compensation model based on the performance of the strategies and work we develop for them.  Harris Diamond, Chairman and CEO of McCann has called such an arrangement the “holy grail.” Particularly now.

 

Analytics, martech solutions and a wide range of marketing and media platforms have provided performance data so good, it’s almost getting to the point where it’s easy to take for granted that the work we do…works.

 

So why then, with success becoming so much more “predictable,” would we NOT want to tie compensation to performance? Afterall, budgets are actually getting leaner overall, there is less room for indulgences when it comes to those budgets and it’s precisely because of a greater emphasis on accountability, transparency and performance.

 

There are actually strong arguments on both sides of the question and we’d like to explore some of them, leaving the final verdict up to your own analysis, further exploration and personal insights. Food for thought, as it were.

 

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Compensation models.

According to Ad Age,  upwards of 85% of client/agency relationships are based on traditional compensation models, with 60% labor based and 25% still based on fixed fees.  Only 15% are classified as “other,” with value-based models and compensation tied to equity being only a fraction of those (though growing). Even considering blended arrangements, only 39% of the 168 agencies surveyed by Ad Age had any manner of incentive/compensation client arrangements.

 

Time and expenses. Retainer based models. Project-based pricing. In all likelihood, your own  relationships are based upon one of these models.  Still, revenue share and cost-per-action approaches based on maximizing results and reducing costs are showing some resurgence.

 

Some of this was first driven by clients themselves, with some early approaches attempting to blend compensation models.

 

In 2009, Coca-Cola, experimented with creating a base fee for a project and then building incentives on top of that. Coke integrated a pay-for-performance aspect that allowed their agencies to earn 23% margins or add a 30% markup to the base fee.  That fee was set, not based on agency labor or time/material costs, but through an assessment of previous fees, current value considerations at the time and established KPI, industry trends and other factors. Performance in this model is evaluated – and weighted – based on an objective agency evaluation, established metrics and performance factors, analytics results and, to a lesser extent, overall business/brand/profit performance. This was launched in 5 markets, expanded to 35 in 2011 and is still evolving today as part of Coke’s $6 billion global marketing initiatives.

 

Procter & Gamble is another major advertiser who has explored similar blended fee/performance approach as is Peets’ Coffee and Tea, who has a profit-sharing arrangement with Publicis Groupe’s Razorfish.

 

Equity: Question One In The Age Of The Startup.

One question every agency has probably been approached with is: “Would you exchange work for equity?”  This is particularly true when dealing with startups and smaller client partners (keeping in mind that most successful performance-based models are actually based on larger client/agency relationships). A fair question, to be sure. The upside can be huge. However, as with all such value-based propositions, it’s often an unrealistic consideration.

 

In the words of poet Evan Shipman: “the completely unambitious writer and the really good unpublished poem are the things we lack most at this time. There is, of course, the problem of sustenance.” In other words, with its own operations and cash-flow needs to consider, it’s often simply not possible for an agency to invest in relationships to this level, regardless of confidence in its ability to deliver successfully for its clients.

 

Case in point. An agency friend of and frequent collaborator with The Basement, in the last decade, has been offered no fewer than four value-based, equity opportunities with its client partners, startup all. Because of the afore-mentioned “problem of sustenance,” and the responsibilities of operating a shop with more than a dozen people, they’ve had to respectfully decline. The upshot is that all four companies grew exponentially and through various exits, collectively sold for more than $40 million combined. Ouch.

 

Sometimes you get the bear, sometimes the bear gets you. The point is, compensation arrangements have to be weighed from many angles, and performance/value based relationships are no different.

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Bullseye

 

Pros, Cons And Everything In Between.

The biggest factor in establishing performance or value-based compensation that works for everyone is actually defining what “value” is, in the first place. And representing it, honestly and fairly.

 

“The Catch 22,” according to Ira Maher, VP of Business Intelligence, “is that performance based pricing is specifically designed for when outcomes are uncertain, allowing client and agency alike to mitigate marketing risk. The problem is, it actually works best for all concerned when there’s clarity, alignment and agreement on goals and expectations. You need that before you can clearly set parameters that are mutually beneficial.”

 

Pros

Some of the benefits of performance-based pricing are self-evident. It manages risk for the brand, providing, essentially, a performance guarantee. It helps a client partner to essentially mitigate an agency misstep and provide a baseline for new relationships.  It can be a financial boon to both the client and the agency, with the client realizing both cost savings and an increased ROI while the agency actually sees an increase in profits.

 

A performance-based model also frees up the agency to focus on the work instead of productivity and pre-determined project limitations that can put time-based restraints on who works on what, when and for how long. It encourages a measure of risk taking and allows time for exploration.

 

So it can work for both parties. The biggest benefit, however, is that it promotes a true partnership between a brand and its agency versus what is often merely a vendor arrangement. Both parties really need to collaborate, cooperate, communicate and actively engage in defining strategies, executions and outcomes. It’s true risk sharing.

 

Cons

The downside? As mentioned, the arrangement really only works best with larger project and account relationships where both parties can manage the upfront costs involved and the generally high cost of entry, be it in dollars or sweat equity. There is also impact to cash flow, which is more easily mitigated by larger agencies.

 

Transparency and communication can be another drawback, with the arrangement itself providing a disincentive for clients to share good news/results and for the agency to report on outcomes considered less than ideal. According to Ad Age, upwards of ⅔ of clients say they are unwilling to share potentially sensitive performance and KPI data with their agencies.

 

Finally, perhaps the biggest hurdle according to Smart Insights, is that the model goes against the age-old agency paradigm of basing compensation on time and not value.

 

On The Other Hand…

It truly does take a special agency/client relationship for a performance-based model to work.  We’ll explore the agency/client dynamic further in upcoming posts, along with other associated trends like marketing insourcing, particularly with larger clients. We look forward to exploring this, and more, in relation to life, liberty and the pursuit of happiness in this wonderful industry of ours. So stay tuned.

 

As for performance and value pricing, there are a lot of factors to take into consideration.  So if a client or agency is unwilling to engage in a performance model, it’s not necessarily that they’re not good partners. They may just be particularly thoughtful ones and, indeed, it’s not right for everyone.

 

“We certainly are open to such an arrangement with the right partner,” says Jacob Leffler, President of The Basement. “But it takes the right partner, the right situation and the kind of communication, scoping, planning, transparency and trust that you only get with a truly great partnership.”

 

What are your thoughts on the subject? We’d appreciate hearing from you.

 

Further reading:

https://hbswk.hbs.edu/item/is-performance-based-pricing-the-right-price-for-you/

https://jasonswenk.com/performance-based-pricing/

https://www.chiefmarketer.com/big-brands-embrace-performance-based-pricing-agency-relationships/

https://digiday.com/marketing/agencies-embrace-performance-pricing—or-else/

https://adage.com/article/agency-news/agencies-earned-2-performance-compensation-finds-4as/293113/

https://cdn2.hubspot.net/hubfs/2395501/IDComms_Oct2016/Docs/IDComms_Guide_To_Agency_Remuneration.pdf?t=1494937733462/

https://www.smartinsights.com/managing-digital-marketing/planning-budgeting/marketing-agency-costing-and-budgeting-models/

Contributors:

Todd Bolster
Todd Bolster
VP, Account Services
George Evans
George Evans
DIRECTOR OF BRAND & CONTENT STRATEGY
Jacob Leffler
Jacob Leffler
President
Ira Maher
Ira Maher
VP Business Intelligence
Brian Phillips
Brian Phillips
CEO