Advertising Age Editorial Understands Where Profit Comes From

An amazing editorial was published on November 12, 2007 in Advertising Age titled “Agency Community Needs to Look at Risk Differently.” [I’d like to thank Tim Williams for pointing me to this editorial. We do not know who actually wrote it].

The tone of the article is excellent, and it’s main point is absolutely correct. We love to ask audiences around the world where profits come from? This is after demonstrating how income is earned from the three economic factors of production: land earns rents, labor earns wages, and capital earns interest, dividends and capital gains.

Most people do not answer where profits come from correctly. We get all sorts of answers: customers, value, revenue minus costs (this mostly from CPAs, which is the technical definition of profits but doesn’t explain their origins).

The correct answer is: Risk. Profits come from risk, which is the role of the business enterprise. Not safety, not a guaranteed rate of return for showing up and having overhead and profit desires.

The Ad Age editorial understands this, using it as a club to beat the head of agency leaders. After pointing out that only 3% of marketers actually use true value-based compensation agreements, here are some of its more profound points:

If agencies want to move beyond the time sheet, they’re going to have to accept risk.

The value-based concept requires a more fundamental reshaping of how an agency is paid. It’s predicated on results, but it’s not an additive part of the compensation deal [as are overlay bonuses]. It is the deal. And it often involves agencies forsaking the relative safety of the cost-plus-fee system and taking on more upfront risk in exchange for a bigger payout on the back end. As a result, a true value-based agreement may mean a shop is getting paid only if business targets are hit. Most importantly, it defines an agency’s value as something more than just the hours it logs on time sheets, something agencies have been longing for ever since the death of the 15% commission.

A lot of agencies—especially those under the quarterly pressures that come with being owned by a public company—would rather avoid the risk that goes with these agreements. That’s fine. Making big bets isn’t for everyone. Those fee agreements do keep the lights on and the bean counters happy and, in the best cases, leave a little left over for investment in talent and tools. But they also commoditize agencies and do much to ensure that ad shops are viewed as vendors rather than partners.

To get out of this cycle, the agency community needs to look at risk differently. It needs to take a hard look at whether its output for marketers has value beyond the churning out of a commodity product, whether its work is something worth making a real bet on. If the business isn’t willing to put its money where its mouth is, then maybe it’s time for it to stop flapping its lips on the compensation issue. Either give up some of that safety net or just stop worrying and learn to love the fee.

Wow. Amen! I can’t add much to that, since we preach the exact same message. In fact, in the October 2007 issue of The Advertiser, published by the Association of National Advertisers (ANA), senior fellow Tim Williams and I have an article entitled “The Future is Now: An exclusive ANA survey brings into focus new possibilities for value-based client-agency relationships.”

Kudos to Advertising Age for this brilliant editorial. Agencies need to stop whining about compensation methods and drive the change themselves, not their clients. Pricing is the responsibility of sellers, not buyers, especially changes in pricing models and strategies.

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