I want my agency to make a profit

We work for advertisers, advising them on all aspects of their agency relationships. Whether we are working on a pitch or a relationship management assignment, agency compensation is always a factor. Over the 18 years of Agency Assessments International (AAI) we must have helped negotiate well over 100 deals. Nearly all our clients (and all the ones we would like to work with again) say something along the lines of the title of this piece. Despite endless cost-cutting. Despite the attentions of an ever more powerful procurement function, the marketers who hire advertising and marketing communications agencies want their account to be profitable. But we find that relatively few clients – and sadly even some of their agencies – have a grasp of what it takes to be profitable in these tough times.

Historically agencies benefited from those non-identical twins, media commission and production commission (the latter being a bit of a misnomer, because it was effectively a 15% mark-up on all third-party costs). The more the agency grew and the more clients spent, the more money the agency made. Then came the triple whammy.

1. The Monopolies & Mergers Commission ruling that ended media recognition, stimulated the rise of the media independent, and caused the splitting off of media departments from full-service agencies.

2. The advent of split commission and commission rebates, and the eventual demise of commission and its replacement by people hours fees.

3. The rejection by most clients of the principle of production mark-up and the move to 'decoupling' or outsourcing.

Fast forward to today where fees predominate but are closely challenged by procurement, and the only significant additional revenue possibility is from payment by results (PBR). How can agencies prosper and make decent profits in this unpromising environment? Here are ten ideas, in the hope that even one or two might make a difference for a beleaguered agency and its sympathetic client.

CUT COSTS AND HEADCOUNT

I know it's obvious. But in any business profits grow just as surely from reducing costs as increasing revenue. Cost control has not traditionally been a strong suit in agencies – but that is changing, even to the extent of some setting up their own procurement function.

Elementary exercises like the '10% rule' (tasking all major cost heads and challenging managers to save 10% without losing quality or competence), settling only for 'must haves', and putting off the 'nice to haves' will make a real difference.

Also the availability of a talented freelance pool means that reducing headcount need not mean any loss of resource and capability. I also believe that sharing the philosophy and practice of an economy drive with clients will not only increase respect, but make fee negotiation easier.

2. APPLY BUSINESS PROCESS RE-ENGINEERING (BPR) PRINCIPLES TO THE WAY AGENCIES WORK

BPR was one of the major management fads of the early 1990s. Tom Peters, Michael Hammer and James Champy became household names as they preached the breaking down of departments in order to form teams, thereby slashing steps and transfers.

Relatively few agencies tried it for themselves, and I recall some of the problems encountered by JWT in Hong Kong and the ill-fated Wells Rich Greene in New York. But there were outstanding success stories, including the intrepid Tony Bucci at the Marc agency in Pittsburgh. I believe the time has now come for more agency managers – and indeed their clients – to revisit process re-engineering. In the 1990s it was unusual for clients to concern themselves too closely with how their agencies worked.

Now that people-hours fees have become the default setting for remuneration, and most companies have a competent marketing procurement function, it is very much the client's business how an important partner's process enmeshes with its own. The agencies that take the initiative here will not only be more efficient, they will make more money.

3. REPOSITION THE AGENCY AS 'MARKETING INVESTMENT MANAGERS'

As long as marketing, advertising and marketing communications are seen purely as costs, a defensive battle is inevitable. But advertising (and its marcoms family) does work, as effectiveness awards schemes throughout the world remind us. If marketing communications deliver commercial results, then the spend and the agencies responsible are investments, not costs. How much more convincing to make a case for an investment than to defend a cost.

Talking about managing marketing investment isn't just a semantic improvement on the normal promotional vocabulary of ad agencies. It gives those agencies a much more serious positioning and purpose, and two other major plusses: an association with metrics, and the longer term focus that is necessary to judge return on investment.

4. SELL MORE SERVICES

Integration and 360° are the new clichés. The demand-side equation is taken for granted. All clients are looking for service along the line, as well as above and below it. The agencies I grew up in 30 and 40 years ago offered what in those days we called 'full service'. Now we have myriad specialist agencies. But for the surviving creative agencies there are surely major opportunities to market a whole range of additional resources and skill sets, thus creating more revenue.

5. THINK FIRST MOMENT OF TRUTH (FMOT) AS WELL AS AIDA

FMOT is what P&G calls the point of purchase. The second moment of truth (SMOT) is when you use, eat, drive the product. The world's biggest advertiser has substantially increased its spend at and near the purchase point. Is it right? Is this going to be a major trend? What does it mean for advertisers and agencies?

Traditionally we start months – even years – ahead, planning for the target consumer to buy our clients' products. If everyone has done their job well, people will buy the product and sales will rise: advertising works. Ad people didn't worry much about the checkout.

The FMOT focus threatens this comforting theory. Classical advertising is still important for many brands – promoting FMOA (first moment of awareness) and FMOD (first moment of desire). But thousands of other brands need the new orthodoxy of FMOT-inspired, back-to-front thinking. They respond to impulse stimulus at the decision point.

This 11th-hour activity can produce a substantially greater return on investment. But it will happen only if clients and agencies are alive to the opportunity – and prepared to change the habits of a lifetime.

6. SELL DELIVERABLES – NOT JUST TIME

People hours. Resource package fees. Full-time equivalents. We now take fees as the norm. Give an agency a marketing challenge and a scope of work, and two days later you receive a spreadsheet explaining why so many people, at such and such percentage of their time, and factoring in overhead and margin, add up to a fee of £785,000 a year.

Does this really make sense? Is it commercially attractive to the client? Is it transparent? The answer is 'no' to all these questions.

Agencies will be profitable in the long term only if they are aligned with their clients' profitability. People hours are the input. The output can be expressed only in deliverables.

The deliverables are valuable only if they result in positive outcomes in the marketplace. Agencies will find it much easier to sell outputs and outcomes. Packaging and pricing deliverables is the way forward.

7. TAKE PAYMENT BY RESULTS (PBR) REALLY SERIOUSLY

PBR is a strange phenomenon. All agencies say they want to work that way. More than 50% of clients have some form of PBR in their compensation arrangements. It makes undeniable logic. Yet enthusiasm – in both camps – tends to be on the luke side of warm. Why? I will give you three reasons.

• Most schemes are too complicated to encourage any real uplift in agency behaviour or performance. Most people will only respond to clear KPI's.
• There is not normally enough money on the table. The more skin in the game for the agency, the harder they will work, and the higher priority that account will become.
• There is less gain if there is no pain. Agencies should not expect rich rewards if there is no risk attached in terms of downside penalties if they do not deliver.

8. LOOK AT WORKING 24/7 TO SWEAT THE OVERHEAD

Some agencies are there already. It is rumoured that Sir Martin Sorrell does it personally using three assistants in the process! Broadcasters, news organisations and, famously, the internet work round the clock. Why not forget the gentlemanly traditions of the 40- hour week (or less) and have the agency on active service 24/7? As you turn off your computer tonight, someone on the other side of the world will be booting up theirs. Keep your computer on. Share projects. Generate more ideas. Amortise the overhead.

9. RUN PITCHES DIFFERENTLY

Agencies need to pitch on their capabilities and achievements, rather than give away their best ideas.

Marketing the agency and pitching account for 20–25% of most agencies' time. It's a high percentage by comparison with most service businesses, but obviously justified if every year sees the addition of prestigious clients. The flaw in the argument is that, despite the IPA and ISBA's best practice guidelines, the new 'tradition' of pitching requires four to five agencies to give away ideas in the final shoot-out.

Is that likely to be a profitable strategy? Absolutely not. Agencies should work out the street price of the last five big ideas they gave away in terms of potential creative and consulting fees. Subtract the non-manpower revenue of any accounts they actually won by dangling these ideas in front of the client. The cash difference (and there will nearly always be one) is the profit sacrificed at the altar of pitching tradition.

10. GIVE CREATIVE THE SAME PRIORITY IN AGENCIES THAT FOOD GETS IN A GREAT RESTAURANT

Some questions for agency heads:

• Just how much creation is going on in your agency this week?
• What is the ratio between input and output?
• What creative quality control process is in place?
• Do creative teams get rewarded for IPA Effectiveness wins as well as D&AD or Cannes?
• Hot agencies produce idea after idea. How can you make your agency hot again?

Many agencies just do short-order cooking. Go back to the restaurant analogy. Think great chefs. Do Gordon, Marco Pierre and the rest spend hours with customers listening to their vision of what food they want? Do they hell! They put their energies into creating new ideas, and then selling them. Who said that wouldn't work in marketing communications? Who believes that wouldn't make agencies more profitable?

This article featured in Market Leader, Winter 2006.