Last week I gave a presentation to the Association of National Advertisers (ANA—primarily the buyers of ad agency services), discussing the concept of Value Pricing and why I believe they need to move to this model, and away from cost-plus billing, in determining advertising agency compensation.
I presented the main problems with cost-plus pricing:
- misalignment of interests between the marketer and the agency;
- fosters a production menatlity focused more on inputs, activities and hours rather than value creation and innovation;
- places risk on the customer, since hourly billing rewards inefficiency and ineffectiveness;
- creates bureaucracy;
- establishes price in arrears, unlike any other business, which must price before the customer decides to purchase
I also discussed the labor theory of value versus the subjective theory of value, and why cost-plus pricing does not account for the value created. In an ironic twist, most of the members of the audience were from major corporations that already have pricing departments, are members of the Professional Pricing Society (among others), and attend seminars that teach the perils of cost-plus pricing. If moving away from this form of pricing is good for their companies, I simply asked, why wouldn’t it be good for your advertising agencies as well?
The purpose of any business is to create wealth, not to be efficient, or cut costs. By focusing on the mundane aspects of cost-plus pricing, the parties are chasing the wrong rabbit, too focused on costs and efforts rather than results and value.
One would think this would be a hostile audience to this message. They were not. They warmly embraced the paradigm, and almost every question I received in the 40 minute Q&A segment was, in effect, why aren’t we doing this and how can begin to make the transition?
This is the lesson I learned: It’s not the customers who object to certainty in price and service; it’s the professionals. They are set in their ways, and afraid of change. They are ignoring what their customers are telling them, and they are hiding behind the veil of hourly billing in order to perpetuate an anachronistic pricing model, a derivitive of Karl Marx’s labor theory of value. It is an idea from the day before yesterday.
The world has changed. We live in an intellectual capital economy, no longer dominated by smokestack and tangible industries, when there used to exist more of a correlation between inputs and value. In the knowledge economy, an ad agency executive could create a million dollar idea while standing in the shower. The fact that it only took 1 minute to produce does not make it any less valuable to the customer.
Merv Griffin wrote the theme song to Jeapordy in less than one minute, and he has earned $8 million in annual royalties ever since. I wonder what he put on his timesheet?
Customers recognize there is no relationship between hours and value. Now if we could only get the professionals to the same level of enlightenment.