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Selecting the right agency is a crucial decision for any brand looking to improve their marketing results. However, the agency compensation model you choose can be just as important for aligning incentives and driving performance.
This guide explores the most common agency compensation models, no matter if the agency is specialising in marketing, media, production, creative, advertising…the list goes on.
Fee-Based Agency Compensation Model
A fee-based agency compensation model involves paying the agency a fixed monthly or annual fee for their services, regardless of performance or results achieved. This offers predictable costs and steady cash flow requirements, making it simpler for Marketing Procurement to manage and easier for marketing budget allocation.
The fee is typically based on the scope of work agreed between the agency and the brand.
The most common downside of a fee-based agency compensation model is that incentives aren’t aligned if the agency falls short of expected results. It can be perceived that there is less motivation for the agency to go above-and-beyond.
Marketing Procurement teams will often only consider a fee-based agency compensation model for simple, commoditised services or smaller, tactical campaigns.
Commission or Percentage Agency Compensation Model
A popular agency compensation model, where the agency takes either a percentage or commission on the media dollars being spent on their client’s behalf. Commission percentages range, but this agency compensation model provides the agency a cut of the total budget they manage.
The main advantage of this compensation model is the alignment of ROI. Incentivising an increased media performance because a better optimisation will translate to more spend and therefore a higher commission.
One of the drawbacks to consider is the encouragement for your agency to focus exclusively on paid media and ignore organic channels which may be more effective.
We also often see an inflation of costs so that the agency earns higher commissions. Therefore, the need for accurate benchmarking, tracking of spend and agency evaluation is crucial for this type of agency compensation.
Performance-Based Pricing Agency Compensation Model
For performance-based pricing, the agency earns fees based on predefined performance metrics and KPIs. Often a small retainer fee will cover base costs, but the majority of the agency fee comes from performance bonuses when milestones are hit.
The agency compensation model most directly tied to ROI, performance based pricing puts marketing results front-and-center. In theory, it helps brands to ensure they get what they pay for. But, it’s vital that Marketing Procurement take a data-driven approach to this model, and ensure that both agency and brand have transparency and clarity around every element of the contract.
The main downside of this approach to agency compensation is that your agency may avoid investing in longer-term brand building because they are focused on short-term performance.
We also often see that communication between all stakeholders can affect this model, simply because KPIs and metrics aren’t shared and measured accurately. It is vital that with performance-based compensation you have absolute clarity around the benchmarks.
The Hybrid Agency Compensation Model
Given the pros and cons of each of these agency compensation models, Marketing Procurement will commonly consider hybrid structures. For example, a retainer fee can cover day-to-day costs, a commission applied for media buying services, and a performance bonus to reward and incentivise ROI.
However, careful consideration should be given in how to split agency compensation across the chosen models and time must be spent defining and agreeing measurable performance targets.
We often find the hybrid compensation model works particularly well when it comes to aligning incentives across a variety of objectives.
Selecting the Right Agency Compensation Model
When it comes to selecting the right agency compensation model, Marketing Procurement should collaborate with their Marketing colleagues to take into consideration brand goals, priorities, resources, and how they will track and measure ROI.
There is certainly no one-size-fits-all approach.
The best agency compensation model depends heavily on the types of services needed, the agency, and the nature of the relationship.
Open dialogue is the key. Clear communication should be part of the ongoing discussions between both parties to decide what works for an agency to stay adequately incentivized while also delivering great results. Transparency and clarity is a two-way street, so it’s important that everyone is on the same page to achieve the best results and ensure the most effective agency compensation model is chosen.