fish

A good relationship boosts the balance sheet

Boosting the balance sheet

For years, there has been a recurring topic in agency remuneration – ‘payment by results’. How can you reward an agency for better, more effective work, and punish them for work which fails?

As some old hands occasionally remind us, the old commission system crudely obtained something along those lines. If your campaign was effective and long-lived, the agency would make much more money over time than otherwise. Clearly this system or remuneration is ill-suited to the present media world, but it is worth remembering that, while it lasted, it had some hidden virtues which we now miss.

Nobody ever thought of the commission system as being a form of ‘payment by results’. But, in a way, it was. As Joni Mitchell tells us, often ‘you don’t know what you’ve got ‘til it’s gone.’

We are, I think, in danger of making the same mistake with the adoption of procurement-led approaches to agency remuneration. Of losing something the value of which will only become apparent when it’s too late.

That ‘thing’ which we are in danger of losing is the relationship.

Many people in business – generally in, or closely affiliated to, the finance function – view relationships as inherently inefficient: something to be weeded out where possible. You are not supposed to consider the duration or strength of a pre-existing relationship in making any decision – instead you should define clearly what it is you wish to buy, and then buy it from anyone capable of delivering it who offers you the lowest price. You should then repeat this process, each time awarding the business to the lowest bidder, with no preference given to any incumbent. By this analysis, business consists of a series of essentially anonymous, stand-alone transactions. You essentially buy agency services the same way people are supposed to buy motor insurance.

This approach makes perfect sense in theory. It probably works quite well for a small number of transactions, where you are truly buying a precisely-definable commodity in a perfectly efficient market in an atmosphere of perfect trust. These are the conditions you generally find in ‘transactional capitalism’. The trading of Brent crude, I imagine, works much like this.

‘Relational capitalism’ is different, however. Here economic theory gives way to game theory. In most business transactions it is impossible to define in advance what is being bought. Humanity has solved this ambiguity through a kind of evolved, instinctive, ongoing reciprocation – i.e. a relationship. The rules inherent in such a relationship are usually unwritten and often only tacitly understood, but they almost always include the following. 1) Particularly good performance will be rewarded by prolonging the relationship. 2) Any egregiously bad behaviour will result not only in the relationship being terminated, but in a lengthy boycott. 3) As part of a relationship, I may call on you to go beyond the normal call of duty, but will increase my loyalty in response. 4) Duration of relationship counts. In short, ‘For richer, for poorer; in sickness and in health’ suggests a relationship. ‘Whenever it suits me’ does not.

There is a wonderful academic paper on this subject by Alain Kirman and Nicolaas Vriend. Called ‘Learning to be Loyal’, it is a study of the Marseilles Fish Market and how, in defiance of economic theory, buyers and sellers of fish resisted a commoditised auction system, with buyers preferring to buy loyally from one preferred fish merchant in a relationship, rather than buying indiscriminately from many.

Kirman and Vriend describe a ‘coevolutionary process, [where] buyers learn to become loyal as, sellers learn to offer higher utility to loyal buyers, while these sellers, in turn, learn to offer higher utility to loyal buyers as they happen to realise higher gross revenues from loyal buyers’.

Advertising agencies and fish merchants are similar in this respect. You can’t enshrine the difference between good and average cod in legal terms – just as there is no acceptable legal definition of a ‘good ad’ or an ‘average ad’. The best way to make sure you get the best cod for your restaurant is therefore to buy regularly from the same man, on the implicit understanding that he will not want to risk your future custom by giving you anything inferior. Moreover, a good fish merchant (or agency) can add value to the buyer in all manner of unchargeable ways – pointing out that ‘the loup is particularly good this week’, say. He will not be paid for this advice, but it is implicitly understood that his reward will come in the continuation of regular custom.

Once it becomes mandatory to repitch a piece of business every 18 months, with the business awarded on price, but the immediate savings appear on the balance sheet but the destruction of relationship capital is invisible. No fish merchant is going to save the best cod for someone who changes their supplier on a whim. No one goes the extra mile for an amnesiac.

Loyalty, hence, is a form of payment by results. Are we making it impossible for businesses to be loyal?


This article, by Rory Sutherland, was taken from the June 2015 issue of Market Leader. Browse the archive here.

 

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