I recently had a conversation with a client who referred to an ANA article on trends in agency compensation.  Based upon our conversation, much of the ANA research seems consistent with what we see across our industry. A lot of clients would like to see it happen, however newer types of performance-based compensation are not readily apparent.

A January 2012 Advertising Age article showed that Interpublic Group of Cos.’ media agency, UM, had experimented with performance-based compensation with clients for several years. It further cited that after having some success with the model, UM has become more aggressive with it. However, the same article revealed a 2010 study by the Association of National Advertisers in which pay-for-performance accounted for less than 1% of compensation agreements.

What’s driving the conversation? CMOs are asked to do more with less every year, combined with the need to tie sales to marketing spend. As a result, the agency compensation discussion is one of the areas that come up on a regular basis. This often leads to a conversation about “Performance-based compensation (PBC),” which leads to the question: can it work?

The answer is yes, however, creating the basis for measurement takes some serious planning.

In an article in The Business Review, Laurie Stillwell writes: “The primary goal of a compensation policy should be to inspire profitable performance. Falling short of that goal can be disastrous to a professional firm and can result in partner dissatisfaction.”

Where to begin:

First, you have to have a baseline with the client. While it could be possible in some mediums to begin a PBC from the beginning, creating a baseline of marketing activities with tracked results helps frame and define expectations and ROI. Several years of marketing spend and sales numbers will help create this.

Second, you need to define and agree upon a) what you are measuring and b) the compensation for each measurement. This is the tough one! However, if you have historical data that you’ve been tracking – and you’re willing to be a little creative – it is possible.

And now the hardest one: deciding the compensation model.  While these models can vary, here are two that you may be familiar with:

1. Base Fee

Base fee with a performance clause if you exceed delivery of an agreed upon deliverable by certain percentage or number. This arrangement gives security to both parties because the client knows what the base fee is and the agency knows it is a guaranteed to cover expenses (staff) to manage the account and deliver the marketing objectives for the client. The “bonus” is a great benefit to both. The client and agency both win if the agency exceeds the proposed delivery! While there are nuances, it can be pretty straight forward.

2. 100% Performance Compensation

Client pays agency only for agreed upon deliverable (calls, sales opportunities, etc.). This one’s a little more complicated but doable. The risk/reward shifts to obvious and not so obvious areas:

Obvious – The risk/reward is well defined. Both parties understand their part. The agency delivers X that gives the client Y that results in $Z (a formula every organization knows and understands). If the agency delivers more X’s than agreed upon, the client pays for every X delivered above goal and may even give bonuses at incremental milestones above plan. Reward for client two-fold, first, knowing the benefit to the agency of financial incentive opens the door to work harder/smarter and extra hours than it would normally take. Why? Because of rewards for doing so. Second, the client knows that the X plus Y = Z “above and beyond plan” is usually frosting on the cake (better margins and higher profitability). Win/Win!

Not so obvious – Who’s calling the plays? If I’m the agency and my total compensation is based upon delivery of X, I’m going to want to make sure I’m in control of the marketing decisions to deliver X (or we don’t get paid). Risk/reward takes on a different light here. It also allows for some of the most candid discussions a client and agency can ever have. You know the ones that cause you to really identify the marketing mediums that are truly driving consumer engagement and sales regardless of whose idea it was. It allows data to rule over opinions and enables both client and agency to roll up their sleeves and collaborate to deliver the desired results. For this to work, it’s actually more about partnership than control. While this type of compensation is more the exception than the rule, it is worth exploring.

Does SA currently have clients in place that have PBC? Yes! Are they all the same? No!  Would you like to discuss if performance-based compensation is right for you? Contact njohnson@strategicamerica.com

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Special thanks to Kim Phillips for helping with research for this post.