How Do Marketing Agencies Get Paid?
Have you ever wondered how do marketing agencies get paid? Do all agencies charge their client the same way? If you’ve been in or around the advertising business for a while, you have probably heard stories of major clients bringing their advertising agencies to task for not being very transparent about their pricing. Advertising agencies in the 1990s got a bad reputation for “padding the hours” or otherwise not being very accountable with their clients’ marketing dollars. A similar issue has been brought up in more recent years with Internet marketing agencies, especially SEO agencies. Generally speaking, there tends to be confusion about how marketing agencies charge their clients.
If you’ve worked with marketing agencies in the past, you’ve probably encountered several different pricing models. It’s important to understand the various ways agencies charge in order to make an educated comparison between them. It’s also important to understand the true costs involved with the different pricing models. Each model has its pros and cons and they can make a significant difference in the performance of the agency.
Here’s a brief tour with some pros and cons of the most common agency pricing models. This is by no means an in-depth look but rather a general guide.
Charging an Hourly Rate
Charging by the hour is the original method advertising agencies used with their clients. The agency to charges a fixed hourly price and keeps track of the amount of work-ours required to complete the project. The profit is built into the hourly rate, and the client is usually charged after the work has been completed. Another variation may be that the agency quotes a certain number hours and the client pays them in advance with overages invoiced after the project is completed.
For example, if the agency’s rate is $50/hr, and a project takes 100 hours, the overall cost will be $50/hr x 100 = $5000.
Hourly pricing has become less common with modern advertising and marketing agencies.
Pros of Hourly Pricing
- Profitable for the agency – Charging the client based on exactly how many hours a project takes to complete ensures the agency will always make a profit. This is especially useful when the scope is still unclear, or you don’t know how big a project will.
- There is little mystery – Or at least there shouldn’t be. Assuming the estimated time to complete a project is accurate, both agency and client can have a good idea what any project is going to cost.
Cons of Hourly Pricing
- No benefits for efficiency – An agency employing an hourly rate gains no benefit from working faster or more efficiently. This is obvious to clients, which can cause them to become suspicious of how long a project takes, even if the agency is taking a fair time for a project.
- Not all billable hours aren’t created equal – The client has to pay just as much for the hour the agency spent composing and sending a project-related email as they do for the hour spent coming up with the killer strategy that will bring in thousands of dollars of new business. Many clients see this as unfair and not representing true value.
- Undervalues work – If a marketing strategy that has the potential to bring in hundreds of thousands (or millions) of dollars takes just a few hours to create, the agency risks being significantly underpaid for the value they provided. The agency is then faced with two options, neither of which is ideal: they can either accept being underpaid for the value they have created or pad their hours dishonestly.
Another traditional method of charging clients involves the agencies receiving a fixed percentage of the money the client spends on media as a fee. This is called the “Agency Discount” which averages 15% of the media budget and is essentially a commission.
For example, if the client wishes to spend $10,000 on a radio campaign, and the agency discount is 15%, then the radio station charges $8500 and the agency keeps $1500 as commission.
Commission-based pricing is still very common and is often a part of a hybrid model of pricing, or possibly one of many options an agency might offer a client.
Pros of Commission-Based Pricing
- Predictable – With a commission, the agency always knows it will receive money for running a campaign.
- Advertiser doesn’t pay the commission – Like a real estate transaction, the advertiser (buyer) does not pay the commission. The radio station (the seller) pays the commission to the advertising agency (the broker). If the advertiser were to purchase the radio spots directly from the radio station, they would pay the same amount that they would’ve paid to an agency.
Cons of Commission-Based Pricing
- Conflict of Interest – A commission-based model encourages agencies to maximize the amount of media in the project. This is not always in the best interests of the client so the agency must choose between offering good advice and making more profit.
- Not Suitable for Small Projects – A low media budget produces very small commission fees. Agencies are reluctant to exclusively use this model with smaller clients because the amount of commissions will not likely pay for the costs of creating the campaign.
A retainer means the client pays the agency a fixed amount every month, quarter, or year to manage their marketing efforts. This fee is the equivalent of paying a consultant or a business coach on a monthly basis to help you with your business, etc.
For example, an agency may charge a fixed amount, say between $500 and $5000 a month to manage a company’s advertising efforts, depending upon the size of the company and their marketing budget. Or, they may charge a fixed percentage of the overall marketing budget as the retainer fee. The fixed percentage fee is paid in addition to the marketing budget.
The retainer-based model is still common and is sometimes used as part of a hybrid model in combination with another pricing model such as commissions, etc.
Pros of a Retainer-Based Model
- Predictable Payments – Both the client and the agency can budget for the retainer, helping both to have a clear cash flow.
- More bang for the buck – Just as salaried employees generally tend to work longer hours with less restrictions on their time, agencies on retainers often have to spend much more time and effort to accomplish the advertising goals. So the advertiser may be getting more for their money than with an hourly model.
Cons of a Retainer-Based Model
- Must manage expectations – Unless used as part of a hybrid model, a retainer is a fixed cost charge. The agency must manage the client’s expectations to ensure the scope of the project doesn’t make it unprofitable.
- Less bang for the buck – If a client changes their strategy and needs less from their agency, they still pay the same retainer. This may result in the client paying an agency for advertising services that are never rendered, hence they’re getting less for their money.
Fixed-Pricing (Project-Based Pricing)
Fixed-pricing, or project-based pricing, refers to a pricing model where the agency charges the client a fixed price for a specific advertising campaign. By charging a fixed price, the agency estimates the amount of time, effort and other costs necessary to accomplish the campaign. They factor in a profit margin and then sets the price. For example, if a client has $1000 for a print campaign, the agency runs that campaign and must manage all their costs and the costs of the campaign within that $1000 budget, or lose money on the campaign.
Fixed-pricing is very common with limited-scope advertising campaigns or projects such as website development, etc.
Pros of Charging a Fixed Price
- Transparent for Client – The client understands what they are going to receive and exactly what it will cost. This removes much of the risk and makes it easier for them to budget for the project.
- Predictable for Agency – The agency knows exactly how much revenue they will receive for the project.
Cons of Charging a Fixed Price
- High Risk for Agency – The agency takes on all of the risk for managing the costs of the campaign. If the project costs more than expected, the agency will pay for the overage and possibly lose money.
Value-Based Pricing Models
All of the above pricing models are traditional cost-based pricing models which involve calculating the costs of the project and adding margins to calculate the price you charge.
A value-based is different in that it calculates the value of the campaign based on benefits that a client receives in terms of its own profitability. The price is determined by the potential success of the project and the overall benefits to the client. These benefits can be numerically tangible and/or intangible in nature.
There are a couple ways of creating a value-based pricing model. A results-based, or performance-based model involves the client paying the agency only for predetermined results. For example, the agency may agree to receive a certain amount per sale that results from the performance-based campaign.
Another way of determining the value is to look at either the Life Time Value (LTV) or the client’s Current Marketing Cost of Acquisition (COA). Based on one of these criteria, the agency and advertiser negotiate how much the client is willing to invest to acquire a certain number of clients and that is the fee for the advertising campaign. This is a slight over-simplification, but hopefully you get the idea.
An intangible value may be something like “brand recognition” or “customer goodwill” that is difficult to quantify and measure, but still considered valid.
For example, the lifetime value of a retail client may be $3000: $250 in initial product purchases and then an average of $2750 in purchases over the next several years. The client may be willing to invest 40% of the average customer’s LTV, or $1200 per customer. The advertising campaign goal may be 10 customers per month, or $12,000. That would determine the value-pricing. The agency would take the $12,000 and create an advertising campaign that would generate 10 sales and still be profitable to the agency. Also, the agency may negotiate a certain amount for any sales generated above the stated metric.
Pros of Value-Based Pricing
- Pay for Results – The client only pays for results or the overall value they receive. Since this is mutually-negotiated between the agency and the advertiser, the expectations are very clear.
- Incentive – The agency is incentivized for producing great results. The more results, the more the agency makes. Also, the happier the client.
Cons of Value-Based Pricing
- High Risk for Agencies – For the agency, this model does account for unexpectedly high costs for producing sales (poorer-than-expected results). Also, the time required to achieve the results may be longer than expected, resulting in higher costs for the agency and lower profitability.
Hybrid Payment Methods
A hybrid method uses two or more of the previous methods in conjunction. Since many of the aforementioned payment methods are more advantageous to either the client or the agency, using a hybrid model can allow for a balanced agreement.
A common way to do this is to take a value-based pricing model, a very popular choice for clients and combine it with one of the other methods to reduce the risk for the agency.
For example, I often use a project-based model in conjunction with a commission-based model. I’ll create several online properties for a client and a TV commercial at a fixed price. Then, I will receive a 15% commission for the TV campaign that uses the commercial and drives traffic to the online properties.
Another way my agency uses a hybrid model is by charging a monthly retainer for advertising management and then project-based pricing for websites, commercials etc. Also in these situations, I might waive the agency discount I receive from the media outlet and pass that savings on to the client, since I am already receiving a retainer.
Pros of Hybrid Models
- Extremely Flexible – A hybrid model can be made to suit the circumstances of the project and the needs of both the client and agency. If done right it can be suitable for almost any project.
- Mutually beneficial – A hybrid model can be designed to ensure the client and the agency receive maximum transparency and value.
Cons of Hybrid Models
- Can Be Complicated – Both sides must fully understand how the agreement works and under what circumstances a payment is triggered. A failure to understand the fine details can result in disagreements later on.
Which Advertising Agency Pricing Model is “Best”?
In my personal opinion, a hybrid payment model offers the best of both worlds, ensuring both the client and the agency have a fair deal. None of the cost-based methods (hourly-based, commission-based, retainer-based and fixed-price) are intrinsically bad in themselves. Nor does the value-based model work in all situations. However, a combination of a value-based model and a cost-based model provides the “best of both worlds”, as it were, and allows the agency to make money while being incentivized to perform well while minimizing the risk to the client.
Do you have a favorite agency pricing model? Please leave your comments below.