• by Arthur Anderson , May 7, 2009

In Wednesday's article, I noted the importance of having marketers craft Best Practice Scope-of-Work (SOW) documents to codify their expectations for their agencies. From the SOW document flows the agency staffing resources plan. Now it's time to calculate agency compensation, starting with a base that incorporates a "risk" element that is balanced by a "reward" element contained in an incentive aspect.

Today, more than 50% of client-agency relationships involve a base fee with an incentive fee. The base fee typically has some risk built into it, for example a lower-than-average profit margin for the agency. The incentive part is an opportunity for the agency to garner a bigger profit margin based on performance. Performance has to be defined, of course, and it has to be acceptable to both client and agency.

If the client has budgeted $10 million for agency compensation but the SOW developed by the agency and agreed to by the client calls for $12 million, what happens? This is where the client must decide which agency activities will have the highest priority (i.e., "in-scope" and thus covered by the base compensation) and which activities will be more variable (out-of-scope and hence requiring an additional fee if accomplished). The variables are often based on competitive conditions. Out-of-scope may not be affordable unless the client's business can succeed to the extent that an additional $2 million becomes available for agency compensation.

The goal of the reward element is to motivate the agency to contribute a high performance level. It is driven by three metrics, each having sub-metrics: 1) business metrics, 2) advertising metrics, and 3) client-agency work practice and process management performance.

Business metrics can be measures derived from the marketer's brand tracking studies, linked to brand goals, client "success" criteria, client revenues and client market share. These are weighted and rated, usually through a marketer/agency brokering process, and then agreed upon.

Advertising metrics for a general advertising creative agency can be derived from TV advertising testing, Web site/digital results, e-mail response rates and ROI from addressable direct marketing programs. These are weighted and rated using the same brokering process as for business metrics. For other types of agencies (e.g., digital, DM, PR, media), these measures can be linked to the specific contributions of that discipline.

Client-agency work practice and process performance, the third element of the incentive fee, provides important feedback on what is working and not working in client/agency work practices, management processes, and agreed-upon guidelines for the partnership. Its specifics are defined and brokered by the marketer with the agency, or an independent third party acting on their behalf. The focus is usually on what needs to happen in the client-agency management of practices, procedures and protocols to achieve successful business results for the marketer.

These can be determined by paper-based survey, Web-enabled survey or diagnostic interviews, allowing many stakeholders to be included in the evaluation. Rather than a laundry list of tasks, measures can include a combination of the agency's vital contributions such as thought leadership, innovation, collaboration, key service contributions by discipline, process management and "stewardship." (Stewardship addresses such metrics as the agency's stewarding of the marketer's fee and expenditures, staffing the right resources on the account, and trending costs for the account in a downward direction.)

In a recent survey, 82% of major marketers said agency performance evaluation was the single most important metric in an incentive arrangement. Achieving this is easier said than done. Fortunately, there are an increasing number of techniques to craft incentive plans that can be benchmarked to industry best practices. In the current economic environment, such plans have never been more critical.

Editor's note: This is the third in a four-part series.