Ad Agencies need new business model

An excellent article in Advertising Age by Avi Dan, the former global executive director-new business development at Euro RSCG, and executive VP-new business director at Saatchi & Saatchi: "Agencies Must Wake Up to a Different Business Model," published September 24, 2007. (You must register with the Web site to view the article).

Dan's article discusses many changes and challenges agencies must face to revitalize their increasingly ossified business model, based on selling hours. He discusses compensation, based on value, not costs; outsourcing; licensing and intellectual property revenue streams; the importance of speed; and social responsibility.

I will only discuss value-based compensation in this post. I have grave reservations about his views on social responsibility, especially since it is such a nebulous concept and means different things to different people. I totally agree with his views on intellectual property, and how important it is for agencies to own more of their own ideas.

Dan's article starts by equating the agency business model to the 1993 Bill Murray film, Groundhog Day, wherein Murray is trapped in the endless loop of repeating the day over and over again. Most humans learn from experience, but Dan is right—it seems most PKFs just keep mindlessly repeating the same mistakes and lost opportunities over and over, with no end in sight.

Here's what he say with respect to compensation:

Take compensation: Instead of compensating agencies fairly, based on their contribution to wealth creation for their clients, clients adopted labor as the metric for evaluating the contribution intellectual property has on wealth creation. Yet most intellectual-property wealth creators, whether they are J.K. Rowling, Steven Spielberg, Damien Hirst or Georgio Armani, don't fill time sheets and don't get compensated based on how many hours they toll, but on the basis of the value that their artistry creates.

Why should agencies be different? Why shouldn't clients recognize that intellectual property [VeraSage would say Intellectual Capital, a much broader definition than just the legal term IP] is part of asset value and compensate agencies accordingly.

Amen.

But here's my problem with Dan's statement, reminiscent of what Elanor Roosevelt used to say: "No one can make you feel inferior without your consent." Where Dan believes clients and agencies need to adopt a fairer compensation model together, I put the onus on the agencies, not their customers.

Throughout history, sellers have nearly always changed pricing strategies, not buyers. None of us asked the airlines, hotels, rental car companies, and retailers to switch from cost-plus (or break-even) pricing to yield management. The sellers made these decisions, and implemented them, unilaterally. Some industries moved all at once, as when the airlines were deregulated in the late 1970s and started moving towards yield management. Others were shown the way by a few, brave thoughtful trailblazers.

Customers simply don't sit around thinking about the pricing strategies of the businesses they patronize. Agencies have the power to change the paradigm, as Crispin Porter, Anomaly and others attest. I fault the agencies for being timid and lacking the faith to make this change.

Instead, like Dan's article, they bemoan the existing compensation structure, but aren't willing to do anything about it on their own. It's as if they are supplicants to their customers. And by the way, their customers know that labor based compensation is unfair, rewards the wrong behavior, misaligns incentives, and wastes precious human capital on analyzing costs, efforts, activities at the expense of focusing on results, output and value.

Customers aren't stupid. They'd never price their product and services based on labor time. They want to change the method as well, but it is simply too hard in large customers to overcome the inertia. This is why agencies must force them to change, or walk away from the business.

Sound tough? It is. Profits come from risk. I can't think of anyplace that's worth going that's easy. And if everyone already understands the existing business model is broken, who's going to change it? My colleague Tim Williams and I firmly believe that the first agencies to completely abandon time-based pricing [and timesheets] will have an enormous advantage in the marketplace. Sure, they may lose some clients, but we'd bet they'd gain many more for showing leadership and offering a viable value proposition that does the right thing.

Here's my clarion call to ad agencies around the world: we've diagnosed the problem, which is labor-based compensation. We know where you need to go, which is value-based compensation based on the subjective theory of value. We have examples of agencies that have successfully implemented these models, such as Crispin, Anomaly, etc.

So start experimenting. Place one customer on a value-based compensation model. Stick your toe in the water and build your confidence. Pricing is an art, not a science. But it's also a skill, meaning the more you do it, the better you get.

It's not up to your customers. It's up to you.

I rarely agree with Elanor, but she's right about this.