To understand how compensation works is simple yet requires in-depth understanding of the project. along with some of the most common compensation models. Many clients feel in the dark about how their compensation to agencies is broken down.
Since the agency business is a service business, about 50% of the compensation goes to labor, such as agency employees’ salary and bonuses. About 30% goes to the agency’s operating expenses, like equipment, payroll expenses such as benefits, or travel expenses. And that leaves about a 20% profit margin. Remember, agencies are for-profit businesses, and they are entitled and expected to make a profit margin, just like many of your businesses. As far as compensation models go, there are many of them, and they continue to evolve. Let’s discuss the four most common models.
The commission-based model
This was most popular years ago, but it’s used less and less today. Media commission is a percentage of your total media budget. So, for example, if your media budget is $1 million, and the agency commission is 15%, then the agency receives $150,000. The pros are that it’s simple and predictable, but the cons are that you might under- or over-compensate the agency.
The fee-based model
This model has been replacing the commission model. It can be a fixed fee, like a retainer, or labor-based fees for services rendered, or a combination of both. For example, agencies might charge a monthly retainer for a set number of hours, or an hourly rate on a per-project basis.
According to studies conducted by Ad Age, this is the most commonly used compensation model today. For the client, it provides the flexibility to only pay for the services they need, and allows the agency to provide a built-in profit margin on services rendered. The downside is that it requires more agency resources to manage, which ultimately they need to charge you for. Also, sometimes clients may hesitate to involve the agency more deeply in their business discussions for fear of running up the bill.
The project flat fee
In the past this was most popular for public relation and event agencies, and design firms. But it’s becoming more popular for general or traditional agencies. It’s an ideal arrangement for limited assignments because you simply decide one total fee for a project. But it creates sort of an a la carte relationship with the agency, versus setting the foundation for a truly collaborative and long-term relationship.
The incentive-based model
This is an interesting one. There’s a lot of industry interest, but you won’t actually see it implemented all that much. What is it? Well, it’s compensating the agency based on perceived value, not costs. It was developed to address shortcomings of the other models. Strong trust is required to implement this model. The pro is that it aligns the client and agency interests economically. However, the con is that it’s really difficult to define value in fee terms.
Whichever model you choose, here are a few best practices to keep in mind. Keep it simple. The more complicated to execute, the more resources required at both ends.
Align the compensation with the scope of work. And, as we discussed earlier, don’t leave compensation to the end of the process with only your preferred agency. Obtain compensation recommendations from all the agencies so you have a basis for comparison and have leverage in your final negotiations.
Lastly, think about the value in addition to costs. For example, if the agency will be training you in new social media technologies. It’s hard to figure out these specific costs, but it definitely requires time and resources at the agency. Remember, if the agency feels they’re being under-compensated, you won’t get the top-notch service or attention you desire, and they may look for a different client in a similar industry to replace you.
If you feel that you’re over-compensating the agency, you may have unrealistic expectations and likely won’t be able to sustain that budget, which will lead to problems later, such as having to decrease the budget or cut agency staff and scope of work. So the most important objective to keep in mind as you negotiate the compensation agreement is to go for a win-win for both you and your agency.