Transparency Not the Real Issue in Agency-Client Relationships
LinkedIn Article by Tim Williams
June 28, 2016
The attempt by some major marketers to launch "0% profit" agency reviews is a spectacularly relevant example of the real problem that underlies agency-client relationships.
For the past several years, marketers have been clamoring for ever-more "transparency" in their financial relationships with agencies. The result has been an uptick in price-focused RFPs and increasing requests for more extensive disclosure of agency costs. An intensely critical report issued recently by the Association of National Advertisers accuses agencies of a variety of "non-transparent" practices related to media buying.
This current furor over media agency transparency notwithstanding, lack of openness is not the underlying cause of friction in agency-client transactions; it's a fractured understanding of what agencies are really selling and what marketers are really buying.
When agencies unbundled themselves and replaced commission-based compensation with the hourly rate a few decades ago, they unwittingly unhooked the shared economic incentives of the Mad Men era and set the stage for what would inevitably become adversarial relationships with their clients. By deciding to sell their inputs (hours) instead of outputs or outcomes, agencies instituted a system that incentivizes clients to deconstruct agency costs.
In place of conversations about effectiveness and marketplace results, marketers insist on detailed discussions about efficiency and costs, often imposing their own calculation of agency overhead and dictating "allowable" profit margins, much like the governing bodies who approve the rates and profits of regulated public utilities.
THE LONG-TERM EFFECTS OF COST-PLUS THINKING
Several years ago our firm received a call from one of the top ten global marketers who asked a very reasonable question: "Do you think we should care what our agency's profit margins are?" Our answer was a resounding, "No. It's really none of your business. It's the agency's job to make a profit, not yours to grant them one by trying to manage their costs." Agencies can and should earn a living like every other business, by providing a service that creates value for their customers, priced in a way that returns a fair profit.
In virtually every kind of market, the seller sets pricing based on customer value, being careful to manage costs in a way that produces a reasonable margin. But in today's advertising agency business, the sellers have ceded price-setting to the buyers by disclosing all their costs, frequently right down to individual salaries. This is a direct result of the move to the hourly billing system, which effectively puts agencies in the business of selling activities, efforts, labor, and time of staff -- all of which are forms of cost, not value.
The "transparency" issue between agencies and marketers is a result of agencies' long march down the path of cost-plus pricing. Agencies have trained their clients to think they should be entitled to know the exact cost of all services, products, people, and activities. Any aspect of an agency's business model that is the least bit opaque is viewed with suspicion or even contempt. The cost-focused marketer wants to know "What is the agency hiding?"
Buyers of overnight package delivery, Airbnb rentals, automobiles, smartphones, clothing, insurance, and banking services don't have visibility into the seller's costs. In a market-based economy, sellers consider information about their costs not only confidential but irrelevant. As long as buyers receive value for their purchase, why would they care?
More to the point, what reasonable buyer would purchase a "cost" in the first place? The immense amount of time and money spent on agency audits, procurement inquiries, financial reconciliations and relationship repair would be much better spent focused on ensuring actual effectiveness, not perceived efficiency. Instead of worrying they might be "overcharged" for time of staff, the far greater danger for marketers is they won't get what they paid for in the first place: effective solutions to their marketing problems.
IT'S THE SELLER'S JOB TO CHANGE PRICING STRATEGIES
Clients can vote with their checkbooks whether they see value in the services provided by the various agencies available to serve their needs, which puts the burden on agencies to devote more energy to developing unique business models and high-value work instead of fretting over the rise of procurement. It’s precisely this lack of business model innovation -- fueled by a curious lack of self-confidence -- that has prompted client organizations to introduce standardized buying approaches into our corner of the professional services world.
In the end, only agencies, as the sellers, can fix this problem. It's the seller's job -- not the buyer's -- to change pricing strategies. Sellers re-educate buyers routinely in almost every kind of market you can think of. Airlines have re-educated their customers to buy online, buy early, and pay for extra luggage. Software companies have re-educated buyers to purchase annual cloud-based subscriptions in place of one-time purchases.
It's not unrealistic to think agencies can re-educate their buyers as well; indeed, some progressive firms already have. The way for the agency business to get back on equal footing with their clients is to stop selling their costs and stay focused on what their customers really buy: utility, effectiveness, outcomes, and marketplace results. It's time for the agency business to finally move past the cost-based approaches of the industrial age to the modern customer-based, solution-based, and value-based pricing approaches of the 21st century.