• by Matthew Greitzer , Op-Ed Contributor, June 19, 2009

I'm reading a book right now, The Mirror Makers, by Steven Fox. It chronicles the history of the advertising industry from its birth as a business -- the health tonic and bromide gold rush in the 1800s -- up to the mid-1990s. The book is fascinating on many levels. Matthew Wiener, creator of "Mad Men," actually used this book for background and source material, and some of the scenarios in the show are pulled directly from real events in the book. Beyond that, it's full of interesting facts and tidbits that both entertain and help one better understand how we got where we are as an industry today.

Consider this fact: Sometime just after the Civil War, an up-and-coming ad man named Francis Wayland Ayer (founder of N.W. Ayer & Sons, absorbed by Publicis in the early '90s) invented the "open contract." The open contract is open in the sense that the advertiser knows exactly how much its agent, the ad agency, is making in commission on media spend.

Prior to Ayer's open contract, ad agencies were in the arbitrage business, maximizing the spread between what they were paid by advertisers and what they paid out to publishers. Ad agencies, in fact, were the very first ad networks. That the ad network model is over 150 years old blows my mind. So, too, does Ayer's open contract, which fixes the commission on media spend at a flat 15%. That the standard agency commission model is as old as the transcontinental railroad is a fact of which I was not previously aware.

Of course, no one pays 15% commissions today. The incentive for advertisers, for the last decade, anyway, has been to cut the agency commission down, percentage point by percentage point, to allow more of their dollars to go towards "working media." In the days of Ayers, working media meant newspapers. There was a finite number of newspapers, so the placement of media was a relatively easy job. The agency delivered value by its ability to negotiate better ad rates (enhanced by its prompt payment of publisher invoices), but even more so through their expertise in creating effective ads; that is to say, their creative.

Shortly after Ayers invented the open contract, advertisers realized buying clout and creative acumen did not always reside in the same agency. They began to separate creative and media-buying services, placing a premium on the former and treating the latter as a cost to be borne with extreme prejudice, reasoning that the higher the agency commission, the fewer dollars flowing through to "working media."

Today, I believe, the concept of working media is totally broken. This isn't my idea. I've borrowed it from Joe Zawadzki of Media Math, who probably explains it better, but here's my take, in the context of The Mirror Makers. The idea that the only media dollars being put to work on an advertiser's behalf are the dollars flowing through to a publisher may have made sense in Ayers' day, but today the concept is as antiquated as it is old.

In an auction-based environment like search, or the budding ad exchange field, buying clout is meaningless. Creative is still important, but what's even more important is campaign optimization and segmentation, the effective use of which enables the creation of highly qualified audiences independent of the media on which those audiences are found. The media themselves are now interchangeable (feel free to debate me on this last point). Optimization and segmentation require people and technology, and the relentless downward push on agency commissions causes the agencies themselves to under-invest in both.

This has the perverse effect of making the advertiser's dollars, a greater amount of which are flowing through to working media due to single-digit agency commissions, perform less well because of the advertiser's resistance to paying for services and technology, which makes that media more effective. I don't think Ayers saw this coming.

I'm not the first to observe that a performance-based model for agency compensation could reconcile this conflict. In such a model, advertisers incur little risk, and agencies are rewarded if their efforts succeed in driving the advertiser's business goals. The trouble is in defining performance metrics and measuring them accurately.

This problem is especially acute for advertisers with offline distribution channels and multi-channel advertising campaigns. Maybe that's why a 150-year-old business model has stuck around for so long. At Razorfish, we've only just dipped our toes in the performance-based compensation model, and we're far from figuring out a solution as elegant as the 15% commission.

Procter & Gamble recently made a push in this direction as well, but I'm not sure how it reconciles the measurement of success. As an industry, I think we are far from figuring this out. I'd love to hear how others in the marketing community, both on the advertiser and agency side, are grappling with this issue.