Agency Management Agency Compensation

6. AGENCY COMPENSATION
INTRODUCTION:
The advertising agency can be compensated in a variety of ways. Till the 19 th century,
advertising agencies were earning money by selling space for the media. Thereafter, they
were represented by the media companies & advertisers paid for booking slots in the media.
Sometimes advertisers even paid for agency agents to create an advertisement for them.
Today, an advertising agency’s revenues come from two streams – media commissions &
client billings. Media commissions come from various advertising media such as print &
electronic. Client bills include fees, mark ups & incentive based compensation. In India,
advertising agencies are paid fees as well as commissions.
MODES OF AGENCY COMPENSATION:
Like any other business organization, ad agency operates to earn profit. Following are the
various sources of income for the advertising Agency:
1. Commissions from Media:
The traditional method of compensating agencies is through a commission system, where the
agency receives a specified commission (usually 15 percent) from the media on any
advertising time or space it purchase for its clients.
Example: Assume an agency prepares a full-page magazine ad and arranges to place the ad
on the back cover of a magazine at a cost of 100,000.The agency places the order for the
space and delivers the ad to the magazine. Once the ad is run, the magazine will bill the
agency for 100,000 less the 15 percent ( 15,000) commission. In this the agency earns
15,000 as compensation. The media might also offer a 2 percent cash discount for early
payment, which the agency may pass along to the client. The agency will bill the client 100,
000, less 2 % cash discount on the net amount, or a total of 98,000.The 15,000 commission
represents the agency’s commission for its services, i.e., commission is on the actual amount
& not the discounted amount.
Advantages of Commission system:
1. Traditional and well understood.
2. Simple and easy to operate.
3. Inspite of its conceptual imperfections it worked well in most cases.
Disadvantages of Commission system:
1. The efforts required by the Agency may bear no relationship to the 15 percent commission.
2. Big account subsidies smaller account.
3. Profitable accounts subsidies less profitable accounts.
4. There is temptation for an Agency to recommend an increase in advertising budget in order
to boost Agency income.
5. The commission system leads to a lack of objectivity in Agency media recommendations
and to discriminate against recommending below the-line activity.
6. Agencies on the 15 percent commission tend to expand their services as their revenue
increases whether or not their clients want extra services, the final result being that many
clients are paying for services they do not want.
2. Fee Arrangement:
Under the fee structure, the client and the ad agency negotiate a flat sum to be paid to the
agency for all the work done. The agency estimates the cost (including out of pocket
expenses) of servicing the client who either accepts or negotiates for a lesser amount.
Negotiations continue until an agreement is reached.
There are two basic types of fee arrangement systems –
(a) Straight or Fixed Fee method &
(b) Fee-Commission method.

Page 1 of 5
Agency Management Agency Compensation

(a) Straight or Fixed Fee Method: In the straight or fixed-fee method, the agency charges
basic monthly charges for all of its services. Advertising agencies opting for the fee structure
should be good at estimating the total costs that would be incurred to serve the client for a
particular period of time (month). The agency should also add its profit margin to the cost,
before arriving at the actual fee. The agency & the advertiser sit together to decide on the
kind of work that will be done by the agency & the fixed monthly fee to be paid for the
services. The media commissions earned are returned to the advertisers or they are credited
against the fee. If the media commissions are less then the agreed fee, the advertiser has to
pay the difference.
The arguments (Disadvantages) against the fee system were listed as:
1. The fee system is basically a cost-plus system which breeds inefficiencies; the commission
system is a discipline on the Agency to keep down costs.
2. The fee system could lead to a price war between agencies and thus of a skimping of
services to clients; it could also lead to a deterioration in the standards of advertising.
3. The fee system is complicated to administer and needs to be constantly reviewed.
4. The settling of fees can lead to friction between agencies and their clients
Commission or fee-which works best
The fee-based system no doubt ensures a fair compensation to cover an agency's direct salary,
overheads and profit margins, but agency also want to earn an incentive if its campaign works
well and delivers the desired impact in the market.
The commission-based system also pays back to the agency in terms of royalty for the
intellectual value that it sells its client in the form of a successful campaign, but the fee-based
system has no mechanisms for this element of compensation.
The agencies feel advertisers want to switch to the fee-based system mostly to cut costs, but
in the long run are compromising with the passion and equity an agency shares with a brand.
On the other hand, there is a segment which feels that the fee-based system is a much more
professional and efficient way of doing business. Agency gets paid for the services it
provides, not based purely on the amount spent in media. It's a more open and clear way of
paying the agencies. It's still in its infancy, but should settle down to being the most common
method of remuneration.
By and large most Indian companies prefer a commission system, whereas the big spenders
among multinationals prefer a fee system which is either mandated by their global
headquarters or want to follow what is practiced at their headquarters. Indian companies
prefer a commission system as they believe paying their agency in proportion to their spends
(which in some way is equated to the work the agency does) is fair.
This debate is relevant only to a few top advertisers of the total of about 3,500-4,000
advertisers in the country. Therefore, the Advertising Agencies Association of India also
believes that the relevant system for the country is the 15 per cent agency commission
system, so do the Indian Newspaper Society and the Indian Broadcasting Foundation. It is
simple, direct, and easy to compute and does not lead to discussion, negotiation, dispute or
misunderstanding.
(b) Fee-commission combination:
In this method, the agency charges a fixed monthly fee for the services it offers to its clients.
The media commissions earned are retained by the agency, & act as extra source of income
from the clients account. Agency is given commission for media buying & services rendered
in terms of creating campaign, its production & so on.
Both types of fee arrangements require that the agency carefully assess its costs of serving the
client for the specified period, or for the project, plus its desired profit margin. To avoid any

Page 2 of 5
Agency Management Agency Compensation

later disagreement, a fee arrangement should specify exactly what services the agency is
expected to perform for the client.
The ‘commission system’ and the ‘fee system’ is developed side by side. Some people have
always argued that the fee system was the most rational and fair commission system.
3. Cost plus agreement:
The cost-plus system is generally used when the media billings are relatively low and a great
deal of agency service is required by the client. This happens most often with industrial
products, new product introductions etc. that require disproportionate amount of agency help
in preparing brochures, catalogues and other non- commissionable marketing activities.
Under a cost-plus system, the client agrees to pay the agency a fee based on the costs of its
work plus some agreed-on profit margin (Often a percentage of total costs).This system
requires that the agency keep detailed records of the costs it incurs in working on the clients
account. Direct costs (personnel time and out-of-pocket expenses) plus an allocation for
overhead and a mark up for profits determine the amount the agency bills.
4. Incentive-Based Compensation/ Performance Based Compensation:
It is also known as performance based compensation. It is a combination of the commissions
& fee systems. Many clients these days are demanding more accountability from their
agencies and tying agency compensation to performance through some type of incentive-
based system. The amount to be paid to the advertising agency is decided based on the
effectiveness of the ad campaign. If the campaign is effective, the agency gets more money, if
it is ineffective it ends up with less. The effectiveness of the campaign is measured in terms
of advertising goals or other factors determined by both the parties. The campaign is deemed
effective if the goals are met. In case of compensation system, the advertising agency asks for
more control over the process.
5. Percentage charges/ Mark Up:
Another way to compensate an agency is by adding a mark up of percentage charges to
various services the agency purchases from outside providers. These may include market
research, artwork, printing, photography, and other services or material. Mark ups usually
range from 17.65 to 20 percent and are added to the clients overall bill. Since suppliers of
these services do not allow the agency a commission, percentage charges cover
administrative costs while allowing a reasonable profit for the agency’s efforts. Example: if
the advertising agencies pay
X to the service provider, the client is billed X +PX, where P is mark up or percentage.
Suppose the agency hires a research agency to conduct research & pays the research agency
1,00,000 (X), in such case the client is billed as follows: 1,00,000 + 17.65% of
1,00,000= 1,17,650.
EXPENDITURE HEADS OF THE AGENCY:
Expenditure heads of an agency means aggregate costs or expenses that agency has to bear in
the process of rendering its services. The expenditure can be calculated in form of:
i. Direct Cost
ii. Indirect Cost
i. Direct Cost: is the cost that can be identified with & allocated to cost units (here service
rendered). Following are the activities that involve direct cost:
 Salary of various departments like account planning, creative, production, media planning
& buying, those are directly responsible for development & execution of the advertising
plan
 Printing & stationery
 Media Bills

Page 3 of 5
Agency Management Agency Compensation

ii. Indirect Cost: is the cost that cannot be allocated, but which can be absorbed by the costs
units (here service rendered). The indirect costs involved in agency business is –
 Office Rent
 Salaries of administrative staff
 Electricity bills
 Telephone expenses
 Maintenance etc
FINANCIAL PLANNING OF LEADING AD AGENCIES:
Financial planning of every business organization including advertising agency
consists of several stages such as:
 Identifying current financial condition
 Analysis of cash inflow & outflow
 Forecasting & planning of financial future of a firm
 Estimating a financial requirement of the agency business depending upon the
type of agency and service it offers.
 Based on financial requirement, financial goals to be developed.
 Planning the course of action to achieve goals.
 Gathering funds from various sources such as retained earnings, term loans,
borrowed funds etc.
 Proper allocation and optimum utilization of funds.
 Evaluation of financial plan, comparing the expected financial outcome and the
actual one.
AAAA REGULATION:
Following are few guidelines compensation led down by American Association of
Advertising Agencies (AAAA) and the Association of National Advertisers inc. (ANA). The
best compensation programs:
1. Are simple to understand and easy to administer:
Advertisers hire agencies to help create and execute business building advertising ideas and
marketing programs. All the supporting processes including agency compensation need to be
geared towards that goal. Accordingly, it's imperative that a compensation program be simple
and clear enough for all involved to understand and execute.
2. Are fair to both advertiser and agency:
An advertiser should expect to pay and an agency should earn fair compensation, including a
fair and competitive profit. A frank, open and up-front discussion of both advertiser and
agency compensation expectations, including profit expectations and value to be delivered, is
important to avoiding contentious misunderstandings of what is needed from both sides.
3. Align advertiser and agency interests and priorities:
If the agency and advertiser are to achieve superior results and have an outstanding working
relationship, it is important that the compensation system be designed to align the advertiser's
priorities and interests with the success of the agency.
4. Match compensation with the resources required to do the work:
A thorough understanding of the assignment is critical for the agency to allocate appropriate
resources. A review of the advertiser's detailed scope Of work and the agency's projected
staffing should be a two-way conversation, with both the agency and the advertiser providing
a point of view.
5. Establish clear goals and objectives up front:

Page 4 of 5
Agency Management Agency Compensation

The advertiser and agency should determine and prioritize critical short-term and longer-term
objectives, and since no two marketing assignments are the same, there is a broad range of
possible objectives that could come into consideration.
6. Must be finalized before agency resources are committed:
Time is forever being compressed and there is an urgency to get the things done. Assuming
there is concurrence on the need to match compensation and resources. It is equally important
that this be accomplished before the work is begun.
7. Remain flexible to accommodate change:
It is important that compensation terms remain flexible enough to accommodate significant
changes in scope of services, timing of services, mix of resources, new products being
developed, new and foreign markets and products with limited or erratic spending. Work
being done and expected to be done should periodically be compared to the original scope of
services and service requirements.
8. Can be adapted globally:
With continuing globalization, consideration needs to be given to compensation A global
compensation structure, whether fee or commission based, may need to be adjusted by region
to allow for differences in regional cost structures or custom.
9. Endure over time:
As a result of adopting the guiding principles listed above, both advertiser and agency can
expect a compensation program that endures over time. It is inevitable that an advertiser's
business plans will change, thus impacting the agency's scope of service. Budgets may
increase or decrease and the communications mix may change. Regardless of these business
changes, the objectives of the compensation program should not change

Page 5 of 5