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Following on from my last article exploring ‘percentage of spend’, I now turn my attention to ‘performance based’ agency models.

In essence, any paid search program should be performance based i.e. the agency and client should agree the strategy, objectives and KPIs, of which the agency will then be measured against.

The distinction in this instance is when the remuneration of the agency is directly linked to the financial performance of the paid search campaign.

Overview

From experience, the most common performance metric is revenue. The agency earns a percentage on each sale they generate from the paid search campaign. So for example, the agency generates £10,000 in revenue during a calendar month.

They are paid 15% on that revenue, making the fee £1,500.

As an aside, I have heard of situations where the agency doesn’t just buy the media but actually pays for it.  Effectively, they work as an affiliate, ‘owning’ the account with little client input. I’ve never heard of an instance where this model has proved successful (although I am happy to be corrected!)

Therefore, for the purposes of this article, let’s assume the client is paying for their own media. 

Is this model right for me? Start by working the numbers...

If you hire an agency to manage your paid search campaign, it goes without saying that you will be paying for their time in some form (hey, we have to make a living!)

With percentage of spend and fixed fee models, the math is pretty straightforward. However, with a revenue based performance model, there is a little more to think about.

The direct link between the revenue generated from the campaign and the cheque you hand over to the agency at the end of the month makes working out how much can you afford to ‘give away’ to generate a sale absolutely essential. 

With this in mind, the metrics to hone in on are:

  • Sales volume (the average number of transactions on a monthly basis).
  • Average order value (AOV).
  • Margin.
  • Agency effort (the amount of time actually required to manage the campaign).

A performance based model may not be suitable if:

  • Your transaction volumes are very high. 
  • Your AOV is low.
  • Your margin is small.

Let’s use an example to illustrate the point:

Your AOV is £20. The agency drive 10,000 sales in a month, of which you pay 15% in commission on the total revenue (£200,000). The monthly ‘fee’ is therefore £30,000 (nice work if you can get it by the way!)

But, what if your margin is only 20% to begin with? If so, you’ve just given a pretty large chunk of that away.

Another point to consider is the amount of agency effort required to drive those sales. Let’s say the campaign requires 50 hours per month management time. At £100 per hour, you might be looking at around £5,000 per month working to a flat fee model.

Clearly, your profitability will be negatively impacted to a much greater degree by ‘giving away’ £30,000 per month compared to paying for the time actually invested by the agency.  

This is both purposely simplistic and extreme but illustrates a key point: you must know your numbers in the first instance (I’m amazed at how many businesses don’t) and then work them… hard.

The agency should be part of this process. Not only does this help assess the viability of the entire model, but will also allow you to negotiate a fair rate of commission should both parties agree pay-on-performance is the most appropriate way forward. 

Other things to look out for

Some of the considerations raised in my last post are also relevant to pay on performance models (see the comments around set up fees, ‘set it and forget it’ and brand term bidding). However there are also some other considerations specific to pay on performance that come to mind, as follows:

Attribution

In almost any sector, but especially retail, consumers use multiple channels to research, compare and ultimately make their purchase.

Therefore, for a pay on performance model to be fair to both parties, the following needs to be in place:

  1. An agreed attribution model. For example, if somebody visits your site initially via an organic listing but converts on a paid search ad, who gets the sale? In turn, do you pay the agency commission on this? Or do you pay part-commission?
  2. Appropriate tools and processes to track the above… with as much accuracy as possible.

The attribution model and commercial arrangements need to be set in stone from the outset. This ensures that the role PPC has played in generating sales is fairly rewarded (or, on the other hand, not rewarded). 

Driving traffic is just the start

Buying traffic via Adwords or Bing is very easy to do, almost too easy in fact (I refer to the actual act of creating an account and handing over your credit card details, not the significant amount of skill required to actually drive a return). 

However, turning that traffic into revenue is an altogether different challenge. 

Whilst it should always be in both parties interest to ensure as much of the traffic driven from the paid search program converts, the interest is understandably heightened from the agency’s side with a pay on performance model employed.

Therefore, there needs to be a clear focus on the entire customer journey and a clear commitment to conversion optimisation. 

If this isn’t clearly outlined and agreed from the outset it can inevitably lead to frustration for both sides later on. A poor user-experience and low conversion rate undermine the paid search campaign, no matter how well thought out it is. 

Ownership of the account

The issue of who ‘owns’ the paid search account(s), client or agency, isn’t restricted to pay on performance models. However, it is something that I come across more frequently when a pay on performance model is employed.

Recently, we took on a client where their previous agency had complete control over the Adwords account in terms of strategy, structure, keywords, messaging and so on. The client had virtually no input and certainly no access to the account.

At the end of each month, the client was billed for media, plus 20% on any sales generated (needless to say, this was not a great deal due to the non-collaborative approach).

Worse still, when it came to a parting of ways, the agency claimed ownership of the account citing that it was their intellectual property. The client had to start again from scratch.

Take note; just because the agency knows PPC, it does not mean they know your business better than you. Therefore, don’t ‘hand the keys over’ and simply let the agency get on with it. Not only does this run the risk of a poor performing campaign but if things do go wrong you might find valuable Adwords data is lost because you didn’t read the small print. 

When does this model work best?

As I cite above, the success of this model boils down to the numbers. Therefore, as a buyer, you need to be willing to share sales volumes, AOV, margin and other key financial metrics with an agency.

If you don’t know them or don’t have enough historical data, it may prove difficult for the agency to make an informed decision on the viability of the model from their side.

An appropriate amount of analysis, scoping, due-diligence and forecasting is therefore required prior to contracts being signed. Jumping in blind to this kind of arrangement is dangerous for both agency and client.

It then comes down to the size of the carrot you are willing to dangle in front of the agency. Assuming a set-up fee is not being charged, you are asking the agency to invest their time and energy to determine the strategy, create the account and then manage it on an ongoing basis.

There needs to be enough of a financial incentive to have the agency go the extra mile. Without it, corners will inevitably be cut. Ultimately, this will come at your expense.

In some cases, this model may be more appropriate a few months into the relationship when there is greater understanding of the business and trust has been developed between agency and client. 

Issues such as stock availability also come into play with the model. Out of stock items limit the agency’s opportunity to generate sales. More widely, it could be argued that a general failure to put the customer first will undermine not just PPC (and this model in particular) but all marketing efforts. 

Lastly, flexibility in media spend – nothing will be more frustrating for the agency if market demand exists but there is not the adequate media budget to realise it (and in turn, earn their commission).

Two models down, one to go

Next time, fixed fee comes under scrutiny. 

In the meantime, please share your own experiences of pay on performance models. Have you come across any weird and wonderful variations to a revenue based approach?

What worked? What didn’t?

Image courtesy of opensource.com
Ben Potter

Published 19 November, 2013 by Ben Potter

Ben Potter is Commercial Director at Leapfrogg Digital Marketing and a contributor to Econsultancy. You can follow Ben on Twitter and Google+.

18 more posts from this author

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James Gurd

James Gurd, Owner at Digital JugglerSmall Business Multi-user

Hi Ben,

Great blog, thanks for sharing your thoughts.

Performance based models definitely require a lot of thought and number crunching from both sides.

From the agency perspective, you have to be convinced that the website is fit for purpose and has an effective conversion funnel + the Client is committed to continuous improvements to drive conversion e.g. landing page optimisation, content creation etc. Otherwise you can create an epic account structure and brilliant campaigns but fall at the last hurdle as people abandon the site.

I've seen this model crash because the Client expects the agency to do all the work as their risk is reduced but if the ROI isn't there, no incentive for the agency to hang around. Or it crashes if the agency focuses purely on converting as many clicks as possible without thinking about the overall value proposition e.g. focus on highest converting keywords, ramp up brand ppc, encourage client to discount heavily to drive CTR etc. This can play havoc with attribution revenue as often it's the non/low converting search terms that drive assisted conversion.

In my experience, performance based models work best when there is true collaboration, a genuine partnership rather than 'me agency, you client' (in my head that was said in Tarzan style!). And that requires strategic input from both sides - the Client to set expectations and define goals/objectives etc; the agency to influence strategy and execution based on their deep knowledge.

Often i find there's a hybrid model that comes out on top - a base line fixed fee to cover the core agency costs, then performance based on targets to incentivise over-achieving and delivery outstanding value. As you say, if you don't know the numbers, it's almost impossible to define a sensible commercial agreement.

Thanks again for an interesting read.
james

almost 3 years ago

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webmoghuls

Hi Ben.. Such a great blog.. really enjoyed reading it..the content is so crisp and exact.

almost 3 years ago

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Luke Judge

@Ben - excellent 2nd article in your series. Thank you.

You explain the model well, albeit with some extremities in your examples [15% commission on revenue generated, when the client is paying the media spend, would be a stretch].

We have 10years experience working on all 3 of the models, including the "affiliate2 based performance model. I would note that:

- No two clients are on the same commercial model. Every situation requires a bespoke approach that both agency and client need to work through collaboratively. Exactly as you call out.

- James is spot on regarding the success of hybrid fee models, where a fixed fee [minimum] covers the basic effort and hours; and a performance fee incentivise the agency to maximise return on as spend.

- The "affiliate" based commercial model [the situations where the agency pays for the media spend, owns the account, and is paid a commission], can be very successful. We have worked on this basis with numerous well-known brands for many years. The secret to making it work - being clear on the pros and cons right at the very start. It can be a very successful model if both client and agency are clear on the terms right from the start.

One of the major benefits we have found in the affiliate-based model - it offers clients the flexibility to test and prove new opportunities, when their Paid Search budget is otherwise fixed for the year [the curse of the finance department]. The affiliate budget is typically, but not always, more flexible.

All in all, great article. Looking forward to the next one.

almost 3 years ago

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John McElborough, MD at Inbound360

Nice intro to this subject Ben

As you've hinted at, the reality of performance based pricing is far less appealing for agencies or clients than it would seem on the surface. In my experience its rare that the model makes sense for both parties. We'd love to do more performance based projects but whenever I've looked at them there's always ended up being too many variables to make it practical.

Years ago I took over a campaign similar to the one you've mentioned. This was an agency who specialised in these "affiliate" style contracts where they charged the client a cost per sale they generated but they retained all the data and used their own landing pages so the client never saw the referring keywords. As you'd expect the only keywords we ever found evidence of them bidding on were brand terms!

almost 3 years ago

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Ovie Oba

Good article in general. Very informative.

As a performance based search agency we come across this dilemma all the time. Ie to go % of ad spend, performance or pure performance (where we pay for the media cost).

I usually go for your key option here. That is the client pays for media, but we get paid based on hitting certain targets.

However, we have number of great accounts that we own and spend our own money on. Then charge the client on a cost per lead basis. This can work, but the agency has to know the market very well or they could end up losing out, as you mentioned.

Keep the good articles coming!

Ovie @ FirstClick Digital

almost 3 years ago

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Ian

Hi

The % based model is only really going to work when you run PPC for ecommerce websites.

If you were running a PPC campaign for a home improvements firm for example Anglian Home or Everest a PPC performance based model will only work on a lead generation basis.

Then it's gets difficult working out what the cost of the lead would be and if they ever convert into a sale further down the sales funnel? As someone enquiring about a 25k orangery is totally different to another customer who just wants her misted window replaced.

almost 3 years ago

Ben Potter

Ben Potter, Commercial Director at LeapfroggSmall Business

Hi Guys,

Thank you for your comments.

Broadly speaking, I agree with all the points raised. I think the absolute key to making this model work is agency / client collaboration, as @James you point out.

Without a clearly defined strategy, fair commercials, a commitment to CTR and transparency in reporting, both parties are subject to risk.

@Luke - good point re every situation being unique and therefore a bespoke model required for each client. As I've made the point in a previous article on SEO payment models, 'off the shelf' packages just don't work - the same is true for PPC.

It's also good to hear that in the right situation the affiliate style model can work. I hereby stand corrected!

@Ian - my article does have a slight bias towards ecommerce as that it my world. However, I do think that performance based models can work in lead generation so long as tracking and reporting along the full sales cycle is robust.

almost 3 years ago

Heledd Jones

Heledd Jones, Head of Search Marketing at Confused.com

Interesting article Ben, I couldn't believe my eyes when I read this as I'm a real advocate in clients owning their work and results...
'Worse still, when it came to a parting of ways, the agency claimed ownership of the account citing that it was their intellectual property. The client had to start again from scratch.'

As a client with a very hands-on team, one of the issues I've always had with performance-related pay for agencies is the grey area where the in-house team has recommended an idea, implemented by the agency which has then improved results... or when a different part of the (client-side) business like IT has improved the process which has increased conversion rates which the agency would then benefit from in terms of fees....

almost 3 years ago

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