There's a long history behind how agencies are compensated for their efforts, but that doesn't mean that everybody is satisfied with agency compensation.
At one time, agencies were typically paid a commission. Clients didn't like that. Today they're generally paid by the hour, something that both agencies and clients alike find reason to complain about.
On the client side, paying for an agency by the hour comes with risk. As agency veteran and marketing consultant Avi Dan points out in a Forbes.com guest piece, "the biggest problem with hourly fees is that they do not separate the sheep from the goats."
...by letting input dictate the worth of an agency’s output, Advertisers in essence reward a bad idea equally as a good idea. In fact, In an Alice of Wonderland world, because it takes more billable hours to get a bad idea revised before it is brought up front to customers, Advertisers actually reward an agency more when it comes up with a bad idea.
So what's the solution? Dan suggests that there's an obvious one: pay-for-performance.
On the surface, pay-for-performance seems to provide a means to align the interests of agencies and their clients. Agencies want to make money, and clients want to make money. In theory, if an agency does its job well, its client will reap the rewards, so tying agency compensation to client success makes sense.
Obviously, the metrics by which success is measured are all important. Dan believes there are numerous options here, and he favors "brand advocacy, efficiency, and continuous gains in profitable sales...because they relate to shareholder value creation." Obviously, the metrics used and the expectations around them are likely to be points of contention, but Dan believes that eventually "Advertisers will seek partners who are comfortable with accountability, and partners who are willing to share in the risk and the reward."
So why hasn't there been more movement to a pay-for-performance model?
Can an agency really make it rain?
The answer is simple: agencies are not rainmakers. The best agencies can provide high-quality services and deliver stellar work product, but that doesn't guarantee outcomes. Great ideas don't always produce success, and great work product developed for a concept that is even slightly off the mark can fail to deliver results.
Naturally, the metrics clients would be most interested in using to determine pay-for-performance compensation will be based on outcomes, not quality of service and work product, which means the interests of agency and client aren't really aligned. Even worse: such a model implies that agencies alone are responsible for outcomes. If they do a good job, clients can sit back and watch the money roll in.
The best model: stop-paying-for-poor-performance
That's simply not the case. At the end of the day, clients are ultimately responsible for their own success and making sure that all the pieces required for success are in place. An agency, for instance, could create a wonderful ad campaign for an internet brand, but if the brand's website isn't optimized for conversion, the ad campaign probably won't drive sales.
And therein lies the rub: agencies rarely have control of product, customer experience and the last mile of the sale. Without control of these things, seeking to compensate them on performance seems incredibly misguided.
That, obviously, doesn't answer the question, "Is there a better way than the billable hour?" If pay-for-performance isn't a viable approach to agency compensation, there is a simple way clients can minimize the amount paid for unsatisfactory work: stop paying for poor performance.
If you hire a web developer who can't build a functioning website, or a designer who can't create a quality visual experience, you don't continue to pay them. You find another web developer or designer who can get the job done. Why should the dynamic be any different with agencies? The answer: it shouldn't be.
The good news is that, as pointed out by MediaPost's Steve McClellan, talk of pay-for-performance hasn't translated into real demand for it. But frustration over compensation is real and until less-than-satisfied clients start to think critically about what they expect from their agencies, don't expect the frustration to go away any time soon.