Which Advertising Agency Compensation Structure Is Better For Me? Part 1 of 3
There are a myriad of ways in which advertising agencies can be compensated. For full-service shops, it typically consists of some form of hourly billing, media commission and/or production commission. While there are standard industry norms, it is common practice to engage in negotiations specifically tailored to the unique needs of each client. Finding an agreement that is fair and mutually beneficial is the foundation to building a successful long-term partnership.
Part 1 of this series is going to solely focus on non-commission forms of compensation. This is generally the foundation of the agreement. Media and production commission will be explored in parts 2 and 3, respectively.
What are “hours”? Ad agencies sell ideas – along with the expertise and strategy to execute them. The tangible product is a written communications plan, creative concepts, and finally, the advertising assets that go to market. As it is impossible to inscribe a sku number on an idea, it gets translated into the amount of “time” it took to develop it.
It’s often a vague concept to dissect, but billable hours are the core of most shops in one facet or another. To be operational in any capacity, the agency has to cover salaries, internal resources and all overhead expenses. Thus, the agency exists by compensation for invested time. However, this “time” should not simply be thought of as the clockwise journey of the minute-hand – as it encompasses the knowledge, experience, education and collective wisdom of specialized “idea makers” and “problem solvers”.
How are hourly rates established? Agencies take into consideration the total cost of running the agency and divide that by the number of billable hours available from all non-administrative employees. Comparable to any other business, revenue, minus cost of goods/service sold (adjusted gross income) must exceed total expenses for the business to be profitable. Overhead / total billable hours = hourly rate.
Typically, hours are compensated in one of two ways: monthly retainers or per-project estimates. There are pros and cons to both structures. Here is an overview to help determine which option is better suited for your needs.
A monthly retainer is an agreement to purchase a preset amount of hours every month. You do not have to determine what the specific details of each project will be in advance, although the initial hours were predicated on a basic assessment of overall needs. In other words, retainers are calculated based on a scope of work coupled with estimates of man-hours and staffing needs for that scope of work (based on past experience). From this, a monthly fee is arrived at and proposed.
Each month you get one (1) invoice for the exact same amount. That invoice covers a specific block of agency hours at a blended rate across all departments (copywriting, graphic design, account management, etc.). Under the right conditions, a retainer can be advantageous. For example, a retainer can work well if you require long-term strategic planning and an ongoing partnership that works in a proactive capacity.
- Consistent billing for both parties.
- Allows for ongoing proactive solutions.
- Clients can more accurately forecast an annual marketing budget.
- Retainer clients are often the priority in the agency.
- The hourly rate for a retainer structure is typically lower than its per-project counterpart.
- Projects can start immediately after being requested, there is no additional paperwork required (pending it is within the scope of the retainer).
- Retainers can lead to liberally requested assignments that often eat up hours.
- Often time, the amount of hours needed to complete the full scope of work in a given month is underestimated. This means that the client must be able to prioritize projects and work within the allotted hours.
- Neither party wants to hear “over hours”, but an agency can lose major resources if it consistently gives away hours. Time can’t be resold or recouped. Everyone must agree on the hour allotment and work within that parameter.
- With a retainer structure, there is no set amount of changes to any particular project. Unfocused rounds of revisions are often the culprit of hours usage. On estimated projects, a change order estimate is generated after three rounds of revisions. This can lead to a more tightly focused approach.
A per-project estimate is an agreement to a predetermined amount of hours to complete one specific project. This works best when you know exactly what you both need and want. “Need” is relative to your target audience. If you don’t know what you need in order to stimulate action among them, then it is important to take a step back and focus on a strategic plan first. “Want” is relative to knowing what the end product must achieve to gain approval in your organization. If you don’t know, the agency certainly doesn’t know.
Estimates are based on past experience. It’s a culmination of collective wisdom from the agency for the development of a similar type project. Typically, ad agencies will develop two to three design options for client review. One option will be further revised for final execution. The estimate assumes there will be a set number of client revisions to the chosen concept. Additional revisions that cause an overage of quoted hours typically results in a change order estimate prior to commencement of new work. The client should notified of approaching hours at 70% completion.
- Working on a per-project estimate has a higher perceived workload visibility and transparency.
- There is no ongoing payment for the client.
- If you need reactionary solutions, this is a better option.
- The review process is often more tightly focused, as the estimate allots for a finite number of revisions.
- No work can commence until a formal estimate is approved. Estimates generally take 48-72 hours to create. This means projects cannot start immediately upon request.
- This structure does not allow for ongoing proactive solutions, it simply covers the exact task requested.
- It is hard for an agency to staff based on project work because there is no clear determination when projects will come in or how large they will be.
- The hourly rate is often higher than what retainer accounts receive.
The success of a good agency/client financial relationship is based on having a clear understanding of the project up front. Expectations of both parties must be defined prior to the commencement of any work. 99% of billing issues are a result of poor planning or faulty communication.
It is important to truly evaluate both compensation models to best determine what will meet your needs. It’s also important to understand that there is no perfect science to estimating hours. Just ask yourself, how much will a new kitchen cost? Every single project is unique and there is no way to predetermine the exact amount of time needed to create the exact design a client will love. Because design is subjective, the agency could hit a home run with the first concept or it could go to ten rounds of revisions because of a multi-person approval process. It’s truly in the client’s hands.
Q: My retainer covers 200 hours per month. My agency is telling me I used up 150 in the first week. How is that possible?
This is the most common reason for client dissolution with the retainer structure. First, it’s very important to prioritize project needs. You can’t expect to have a fully-dedicated agency team for the entire month without considering it is 8 hours per day for each staff member working on your projects. Often times, client’s think of 40 possible hours in a workweek. However, if multiple people (Account executive, Art Director, Copywriter) are all working on your projects at the same time, you have to consider the total hours of everyone. If you have a retainer of 200 hours per month, that roughly translates to 15 hours per week of Account Management, 15 hours of copywriting and another 15 hours of graphic design. That’s less than 2 days a week of service among all the departments.
Q: How will I be able to keep track of hours?
For retainer accounts, your Account Manager will keep you informed of hours used every week. As the month progresses, the client can decide which jobs to hold until the following month and which will take priority. On estimated projects, you will be notified of hours only when it gets to a 70% completion. If more time is needed than what is remaining on the original quote, an addendum estimate is created. There should be no surprises with hours, once you understand how they work.
Q: What does “out of scope” mean?
These three dreaded words affect both parties. Out-of-scope means the project has shifted to include more deliverables than what was originally quoted. For example, let’s say you have started a print ad project and the estimate covers one full-page layout. Then, it is later revealed that you will need it resized to both a full page and ½ page, and you need a full color version as well as black and white. If those mandatories were not specifically line-itemed on the original estimate, a change order estimate will be generated to cover the additional scope of work. Simply put, the agency did not allocate enough hours to complete the additional needs of the project.
Q: What do I do if my agency can’t complete all my needs in my allotted monthly retainer?
There are several options for this situation. The most common is to have a rate negotiated with your agency that is billed hourly once you are in excess of your retainer allotment. For instance, if you have 200 hours in your retainer, but you need an additional 50 for the month in order to complete your needs, then you can simply purchase them. The client is in control of this situation and can determine if those projects truly warrant the purchase of additional hours or if they can be postponed to the following month. If you experience the need for more hours on a continual basis, then you should consider renegotiating the contract. It can be disparaging for both the agency and client to run out of hours every month. Your agency should be able to provide audited time sheets so you can see exactly where your hours are going and how much time is needed in a given month to cover the totality of requests.
Q: None of the initial concepts resonated with me, do I still have to pay for the work?
Ad agencies are not set up to do selective selling. Meaning, hours start accruing at the conceptual stage, which may require several rounds of revisions before it meets a client’s needs. No matter how much research goes into the creative brief before concepting, the end product will always be “subjective” to the approver. The important thing to remember is that you shouldn’t solely focus on it resonating with you; instead, look at it from your target audience’s perspective. Ask your agency why they chose that image, headline, etc. If you simply don’t like it, be as specific as possible as to what you don’t like about it to help them achieve success in the next proof.