Ignorance of Pricing is Ruining Ad Agencies

Let's keep it simple.  Creative agencies do not sell Big Ideas, creativity, Cannes award-wins or brand building any more than General Motors sells transportation, Apple sells communications or Bain sells analytics.  Creative agencies sell ads, or more broadly, content in the form of deliverables. Bundled with the deliverables are strategic insights, of course, just as iPhones are bundled with high value functionalities.  Agencies are in the deliverables business.  The business is expected to deliver results.  Prices should be high enough to reflect anticipated results.  The number of deliverables is high and growing.  Price is income divided by deliverables.  Price per deliverable(with deliverables normalized by size) is the relevant pricing metric.

Research for my book Madison Avenue Manslaughter shows that deliverables have been growing and fees have been falling for decades. Consequently, price has fallen dramatically,and there is nothing in management's toolbox to manage or stop it. Price (in constant dollars) is now 70% below what it was in 1992.  Since 2004, which was the last year that price and deliverables were in balance, price has fallen by 42% and has been below the level required for appropriate agency staffing.  Falling prices stretch agency resources, reduce quality, create client dissatisfaction and limit holding company growth.  Agency CEOs are on the hook for this adverse performance.  They've responded, wrongly, by focusing on cost reductions, downsizing since 2004, cutting out creative, analytical and senior muscle instead of seeking better and more logical prices for their growing deliverable workloads.  Worse, they blame procurement for their predicament.

Source: Farmer & Company client data.
Price is calculated 'per ScopeMetric® Unit (SMU),' our normalized unit of agency work

Agencies confuse "how they are paid" with "what they are selling."  Just because agency costs are the basis for calculating fees does not mean that agencies are selling costs or that clients are buying man-hours.  A hot dog seller in Yankee Stadium could calculate prices on daily attendance: $2.00 on "low capacity days" (below 30,000 fans), $3.00 on "average capacity days" (30,000-35,000 fans) and $4.00 on "high capacity days" (above 35,000 fans), just like the airlines.  The vendor is still selling hot dogs, whatever the price, not the day's attendance level. Get 'em while they're hot!

Agencies act as if they have no control over income.  They've abdicated pricing to their clients, who determine what the agency costs are (through benchmarking), what the fee levels will be (through zero-based budgeting) and what the Scopes of Work will involve (more work than last year).

Agencies do not systematically use Scope of Work deliverables to establish their prices and calculate their fees, even though deliverables are the foundation of what they sell.  Deliverables are not documented, tracked or negotiated in a consistent way.  This is crazy, because deliverables are growing, and remuneration based on deliverables could grow rather than decline.

There is a gap between how much agencies are being paid and how much work they are doing.  How big is the gap?  It is now about 24%, I estimate.  This gap could be viewed as "unrealized income" for agencies and their holding company owners, or as 24% too much work, with agency staffs stretched to carry it out.

If half of this surplus work is unnecessary for the brands, and can be cut out, then the agency fee gap is 12% or so -- still a very considerable amount.  The fee gap represents "agency underperformance" from an income and profitability standpoint.

Agencies are not realizing all the income that they could.

Agencies need to take control of pricing.  First, they need to acknowledge that they have a price problem, not a cost problem. (Since they do not measure their deliverables or work, though, they cannot measure price, so this is a separate problem that needs to be solved.)  Second, they need to recognize that future pricing must be handled on a per-deliverable basis.  Third, they need to ensure that the work they plan and carry out adds value -- enhancing client brand growth and profitability.  Otherwise, their efforts to improve pricing will fail, since they will remain in a commodity business, competing against other commodity-like agencies.

Agency CEOs need to take control of pricing as their most important strategic priority.  What could be more critical for the long-term success of their clients, their employees and their owners?

Cartoon credit: Leo Cullum, The New Yorker, The Cartoon Bank. With permission.

Click the social buttons above or below to share this story with your friends and colleagues.

The opinions and points of view expressed in this content are exclusively the views of the author and/or subject(s) and do not necessarily represent the views of MediaVillage.com/MyersBizNet, Inc. management or associated writers.