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January 24, 2004
Old Ad Problems Never Die...They Don't Even Fade Away

One of my favorite forms of entertainment is to watch classic movies or television broadcasts. It is enjoyable to me to predict the memorable dialogue and look for new details in the plot or character development, or laugh once again at the same jokes, even though the ending is well-known. Unfortunately, I wish that the past need not be relived with the same frequency in the industry in which I have spent the last 36 years plus, but is seems that those of us who have made a career in advertising must deal with certain matters that recur on a consistent basis. A few that come immediately to mind - taxes on ad media or the production of advertising materials, attempts to control advertisers' ability to participate in marketing segments due to the opinion of special interest groups on their content and the issue of advertiser compensation of marketing companies. This latter item is the subject of this column.

When I entered the industry in the late sixties, the commission system still reigned supreme. However, by the mid-1980's, various versions of this system were being replaced by alternative compensation systems that were largely various approaches to a fee system based upon agency costs plus an agreed profit factor. This method was then called a "cost plus" system. Most of the discussions since have involved the efforts of clients and their representatives (whether from inside or outside the client organization) to challenge a number of the calculations that are required to generate this "cost plus" amount, such as:

  • How do you calculate the hourly rate attributable to direct personnel?
  • What items are properly included in overhead?
  • What limits should be placed on the upper range of the results of any of the calculations?
  • What is a fair profit?

There are others as well.

And the focus is thereby placed on process and work practices, not on the product itself. Perhaps for this reason, despite all the attention this subject has received, a recent survey by Continental Consulting indicated that 81% of their respondents felt both that their agency was overpaid and its people stretched too thin. In effect, the solution would be for the agency to be paid less and hire more people, despite evidence that agency margins have been falling (especially since the economic recession began in 2001).

My point is that it is time that advertisers need to realign the balance they apply to the quality of the work they receive versus its price. Otherwise, the ad industry will simply be unable to compete for the best and brightest minds and the talent in the industry will continue to deteriorate. Let me provide an example of how inconsistent methodologies may provide lesser resources than an agency needs to fund appropriate servicing capability:

A. Client "X" and Agency "Y" agree on a "cost plus" system for paying for "Y's" services.

B. "Y" quotes its overhead rate, which "X" agrees is within acceptable standards. Overhead, as a point of clarification, includes for this purpose three categories of expense:

  • Payroll related costs, such as payroll taxes, employee insurance benefits, etc.
  • Costs of running a business which are not directly related to a client, such as rent, depreciation, corporate insurance, professional fees, etc.
  • And most importantly, the non-client payroll of the company. This comes from two sources: (i) the personnel within departments which by their nature do not work on client business (such as human resources, office operations, some management, accounting) and (ii) the time that the staff in direct departments spend on non-client business (training, administration, new business).

C. "X" then insists that "Y" use a higher number of hours as the denominator for calculating the hourly costs of "Y's" personnel, as well as imposing a change in the hours "Y's" personnel can charge to "X's" activity. As a result, the non-client payroll cost of "Y" increases, as well as its overhead rate.

D. "X" does not accept an increase in the overhead rate, as it now exceeds what it deems to be an acceptable standard. "Y's" profit on "X" is lowered, probably below its standards.

E. "Y" responds by reducing personnel and stretching its remaining staff over its business.

We will end up with a more efficient process. But what about the impact on the agency's product? And will we sell more widgets?

To those who are always trying to get something for less, I worry that they may end up getting less for something.

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Many marketers may believe creative comes first, but solid financial health is a necessity. Few people may understand that fact better than Jerry Germain. President of SunDance ADvisors, Jerry is an expert in advertising financials. Jerry advises top agencies, and recently moderated an AAAA Management Conference called "Your Agency: What's It Worth and How Do You Realize Its Value?" When Jerry speaks, listen up.
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