• Introduction
  
• Background
  
• Profitability: What is Fair?
  
• Guidelines for Effective Advertiser/Agency Remuneration
  
• Review of Current Remuneration Methods
  
• The Commission System
  
• The Fee System
  
• Variation of Commission and Fee Systems
  
• Media Services Remuneration Methods
  
• Some Closing Thoughts
  
• Further Reading
  
• Exhibit I: Defining the Scope of Work For Agency Remuneration
  
• Exhibit II - Sample Agency Performance Review
  
• Exhibit III - Sample Advertiser/Agency Remuneration Agreement
  
• Exhibit IV - Other Types of Actual Remuneration Systems
  

Introduction

The process of deciding which remuneration system is best for an advertiser and agency can be difficult. This booklet has been prepared to help this process by:
· reviewing the current trends
· addressing the issue of agency profit
· providing information on media-only services remuneration
The Association of Canadian Advertisers (ACA) and the Institute of Communications & Advertising (ICA) have produced this booklet to address this topic. The information should shorten remuneration discussions and ensure focus on the more important advertiser/agency relationship.

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Acknowledgements

Special acknowledgement and thanks are given to those members of the Remuneration Task Force and others whose help and wisdom have led to the publication of these guidelines.

Ann Boden - McKim Media Services
Erwin Buck - MacLaren McCann Canada Inc.
Christine Coleman - Hershey Canada Inc.
Joan Curran - Association of Canadian Advertisers
Yvan Garceau - Dairy Farmers of Canada
David Haan - FCB Canada Ltd.
David Harrison - Harrison, Young, Pesonen & Newell Inc.
Lowell Lunden - Quaker Oats Co. of Canada
Graham Lute - Nestlé Canada Inc.
Patrick McDougall - Association of Canadian Advertisers
Michael Palmer - Bozell Palmer Bonner
Cam Reston - Harrison, Young, Pesonen & Newell Inc.
Adrian Sark - Media Buying Services Limited
Ian Watson - Nabisco Brands Ltd.

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Background

Advertisers, agencies and media-buying services review their methods of remuneration for different reasons:
- advertisers want to be sure they are getting value for their money;
- agencies and media buying services want to be profitable so they remain viable.

Results from the ACA/ICA "1993 Agency/Client Relationship" study state:
- compensation is the primary area where advertisers/agencies are at odds;
- 52% of advertisers feel "they pay a fair price for services they get" (neutral 28%);
- 32% of agencies do not feel "the client compensates fairly for services required" (neutral 42%);
- 28% ACA members stated the situation had improved over past three years;
- 71% ICA members stated it had worsened.

The U.S. Association of National Advertisers, Inc. (ANA) "Trends in Agency Compensation 1995" asked advertisers their concerns about "current agency compensation practices." In reviewing the general pattern of concerns expressed, a distinct evolution in advertisers' views is apparent:
- in the late 1980's, the dominant concern was with the mechanics and procedures of agency compensation;
- in 1992, this concern shifted to the impact that a compensation system might have on the quality and stability of the advertiser/agency relationship itself;
- in 1995, the sense is that the compensation system itself should actively promote the well being of the advertiser - by motivating the agency to perform at a level that is generally more satisfactory to the advertiser; or by performing in a way that will be reflected in marketplace results; or by performing in a way that maximizes the cost effectiveness of agency service; or all three.

Current practices - based on the ANA Trends in Agency Compensation 1995:
- 14% of advertisers pay full 15% commission in 1995 vs. 33% in 1992;
- 35% of advertisers use a fee system vs. 32% in 1992;
- 45% of advertisers pay a reduced-rate commission vs. 26% in 1992.

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Profitability: What is Fair?

Based on the opinions and experiences of ACA and ICA members, the Association of National Advertisers, Inc. (ANA) and the European Association of Advertising Agencies (EAAA), the consensus is that 15% - 25% operating profit, as a percentage of gross revenue, is "fair agency profitability". This translates to between 2% - 4% of billings on media and production.
The advertising agency business is a service industry and operates under conditions of unusual risk and uncertainty. A 15% - 25% operating profit is in line with comparable businesses, such as lawyers, contractors and accountants.

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Guidelines For Effective Advertiser/Agency Remuneration

1. Define the scope of work required before completing the remuneration agreement. For example, will the agency buy media or just do the planning?*
2. Decide the remuneration system (commission, fees, incentive) that meets your needs.
3. Negotiate remuneration that is beneficial to all parties - win/win. This can be accomplished by understanding what each party wants to achieve, identifying the key issues/concerns, deciding what an acceptable solution is, and discussing options that will achieve the desired solutions.
4. Promote regular review of all aspects of your remuneration.**

* Exhibit I: Defining the Scope of Work For Agency Remuneration
** Exhibit II - Sample Agency Performance Review


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Review of Current Remuneration Methods

The Commission System

Definition: A form of payment in which an agent or agency receives a certain percentage of media and production charges.

Advantages

· Simple to execute. For example, if it costs $100,000 to run a television commercial, the agency commission, historically at 15%, is $15,000. Stated another way, the agency bills the client $100,000 but pays the station $85,000.
· The advertiser benefits from all the agency's services at no additional cost.
· Once the media plan is in place, the advertiser knows what they will be paying their agency and the agency knows what it will be receiving.
· Puts pressure on an agency to keep its costs down.
· When the advertising is cancelled to save money, media remuneration to the agency is also reduced.

Disadvantages

· Unlike a cost-based system, an agency may make profit on some brands while losing money on others.
· Does not allow for 'degree of difficulty' or level of full-service.
· Agency investment front-end loaded-compensation back-end, i.e.: agency is required to invest considerable time developing campaigns prior to earning commission.
· High risk on new product development work.
· Agency recommendations for higher expenditures may be perceived as self-serving.
· The agency's payments are based on the price a medium charges and not on their 'work', i.e.: agencies are not compensated for undoing/revising media buys.

What Happens When The Commission is Lower Than 15%?

In an attempt to reduce expenses when advertisers are looking for a new agency, they may suggest they will pay less than the traditional 15% commission. The rate is negotiated between advertiser and agency. What work will be done by the agency and what will be charged for separately are included in the negotiation. Here are some guidelines:

Included in Commission	Some- times Included	Charged Separ- ately
Analysis of client research	Layouts	Advertising production
Preparation of overall strategy	Telephone	TV production
Creation of advertising	Travel directly related to client contact	Travel unrelated to client contact
Media planning	Alternate campaigns	Shipping
Media buying	Media research	Postage
Payment of Suppliers	Duplicating	Market research
Billing to client		Direct marketing
Research in support of recommend- ations		Public relations
Discounts for prompt payment		Interest for late payment

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The Fee System

The alternate form of compensation is the fee system. This system compares to the means by which advertisers pay their lawyers and accountants. The advertiser and agency agree on an hourly, annual or overall fee. This fee can vary according to the department or levels of salary within a department. In other cases, a flat hourly fee for all work is determined, no matter the salary level of the person doing the work. Charges are also included for out-of-pocket expenses, travel and the items normally charged separately under a commission system. These are charged net, without any markup or commission. All media are billed to the client net of any commission.
How is the agency fee calculated? First, the agency assigns costs for salary, rent, telephone, postage, internal operation, equipment rentals, taxes and other expenses. Second, the agency determines what hourly charge will recover these costs and provide the agency with a profit.
The common rule of thumb in setting a fee is to charge three times the person's annual salary divided by the number of hours that person works on an annual basis (on average, 1,600 hours per year).

Advantages
· Provides for better agency financial planning.
· Advertiser pays only for desired agency services.
· Tends to make advertiser/agency relationship more efficient.

Disadvantages
· Hard to forecast workload, therefore fees to be charged to the advertiser by the agency a year in advance.
· More administrative costs to advertiser and agency.
· Advertisers reluctant to involve agency for fear of 'running up bill.'

Variation of Commission and Fee Systems

1. Minimum Guarantee (Guaranteed Minimum Compensation)
This arrangement involves putting a 'floor' under the agency's compensation. A minimum-income figure, including a profit, is predetermined by making assumptions about the level of service required for a period, usually a year. Payments are customarily made monthly. Commissions are credited against these payments, and the agency keeps the excess of commission over the aggregate payment during the contract year.

2. Hourly Rates
Hourly charges for time-reporting employees are designed to recover agency costs, plus a profit. There are two basic versions: (1) the agency credits all commissions against hourly fees, and (2) the agency retains any commission over the accumulated hourly fees. (The latter version is, in effect, a 'minimum guarantee.')

3. Fixed Fee (Flat Fee, Fixed Compensation)
A predetermined, fixed payment period (usually a year) is based on an anticipated workload, at an assumed level of advertising activity (customarily billed in monthly installments with media and production billed at net).

4. Flat Fee Plus Direct Labour Costs
This is a combination of 'fixed fee' plus 'hourly charges'. There are several varieties. The fixed, or flat amount, can be the agency charge for either: (1) overhead, (2) overhead and profit, or (3) just profit. Correspondingly, the hourly charge would cover either: (1) direct cost and profit, (2) direct cost only, or (3) full cost. Each variety is a way of modifying the 'cost plus' fee arrangement, i.e.: the higher the cost to the advertiser, the greater the profit to the agency.

5. Reduced Commission/Sliding Scale
In this instance, an advertiser pays the agency an amount less than 15% for less than full-service, based on the volume of business being generated. The effect is to find economies of scale based on increased volume.

6. Volume Rebates
These are similar to reduced commissions but entail full-service to an account. This remuneration type works when advertiser billings increase beyond a certain level, without a proportionate increase in agency costs, the advertiser recovers an increasing commission rebate as the billing increases.

7. Cost-Plus-Profit
The cost-plus-profit system is really very much like the hourly rate arrangements, except that the profit factor is negotiated and added to the total annual service cost and usually billed in monthly installments. During the year, or at year's end, the fee is adjusted to compensate for any difference between the estimated and actual cost.

Media Services Remuneration Methods

Media buying services grew substantially in the 1970's. Such specialized agencies, often buying in more markets or in greater quantities than some advertising agencies, may deliver media at greater efficiency. Like full-service agencies, media buying services have a range of remuneration arrangements, depending on the volume of business handled.

Examples are:

Significant economies of scale can be gained the larger the media assignment. Conversely, as the volume decreases or the target group narrows from a demographic, psychographic or geographic perspective, additional fees may be required.

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Some Closing Thoughts

There are no easy solutions to Advertiser/Agency Remuneration. However, there is usually only one answer for an advertiser and that is the remuneration system that best meets the advertiser's needs. Only the advertiser knows how much money the company is prepared to spend on advertising, and how large a part of it will be paid to an advertising agency. Whichever system is chosen, it must be one that includes five elements:

1. It must provide adequate professional service to the advertiser.
2. It must fairly compensate the agency for its work.
3. It must provide an incentive to both the advertiser and the agency.
4. It must be simple to operate.
5. It must be reviewed periodically.

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Further Reading

1. Agency Compensation - A Guidebook - 1989
Association of National Advertisers, Inc.
155 East 44th St.
New York, N.Y. 10017
USA
212-697-5950

2. Rewarding the Advertising Profession - 1991
Institute of Practitioners in Advertising
44 Belgrave Square
London SW1X 8QS
UK
44-171-235-7020

3. The Great Uneven Agency Playing Field: Some Perspectives on Agency Compensation
by H.E. McDonald - 1989

4. Client/Advertising Agency Partnerships - 1994
A fresh look at how to reach the right agreements on remuneration and exclusivity
European Association of Advertising Agencies
3-5, rue Saint Quentin
B-1040 Brussels
BELGIUM
32-2-280-1603

5. Advertising: Principles and Practices, Third Edition
Well, Burnett, Moriarty
Published by Prentice-Hall, 1994

6. Trends in Agency Compensation 1995 - Results of ANA's Triennial Survey
Association of National Advertisers, Inc.
155 East 44th St.
New York, N.Y. 10017
USA
212-697-5950

7. A Client's Guide to Agency Compensation
American Association of Advertising Agencies (Copyright 1994)
666 Third Ave.
New York, N.Y. 10017-4056
USA
212-682-2500

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Exhibit I: Defining the Scope of Work For Agency Remuneration

Critical to the plan of action for agency remuneration is the clear definition of advertising services required - both current and anticipated. It helps agencies forecast the annual workload more precisely.

Here is a list of agency services that may be required. Each category should be considered in detail, before finalizing a remuneration system.

1. Strategic Corporate/Marketing Planning
2. Budgeting
3. Strategic Advertising Planning
4. Strategic Creative Planning
5. Strategic Media Planning
6. Strategic Research Planning
7. Tactical Creative Execution
8. Tactical Media Execution
9. Tactical Research Execution
10. Direct Mail
11. Public Affairs
12. Interactivity
13. Infomercials
14. Newsletters
15. Print & Broadcast Production
16. Data Base Management
17. Event Marketing
18. Special Projects

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Exhibit II: Sample Agency Performance Review

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Exhibit III: Sample Advertiser/Agency Remuneration Agreement

Note: This is an actual system currently being used by an ACA member. This system is based on forecasted hourly fees, a performance bonus and a regular evaluation of the advertiser/agency working relationship.


ADVERTISER/AGENCY REMUNERATION AGREEMENT

Remuneration Principles

No matter what remuneration system is applied, it must provide the agency with a fair remuneration, including a reasonable profit.
This is to protect both the advertiser and the agency. It protects the advertiser from payment of an excessive number of hours and exaggerated profit. It protects the agency from excessive demands from the advertiser and ensures a reasonable profit scaled according to performance.
These principles apply to both a fee system, as well as a commission system and lead to regular reconciliation between costs and revenues.

Remuneration

This agreement covers all aspects of remuneration with agency with the exception of Agency of Record (AOR) functions which are subject to a separate agreement.
The fee arrangement covers all standard agency services. Client will be billed net for all other services, as well as out-of-pocket expenses such as facsimiles, photocopies, travel expenses, long distance and messenger services.

Formula

Agency's total remuneration will be calculated on a fee basis using the following formula to calculate the hourly rates, per individual, working on the account:
(Total actual annual remuneration* + fringes) x 2.75** / 1,500 hours = hourly rate

* Salary + other allocations appearing on T-4 and TP-4.
** Includes direct costs, overheads and a normal pre-tax profit of 18%.

In order to effectively manage this fee arrangement, agency will calculate a uniform average hourly rate that best reflects forecasted revenues and will use this average rate for monthly billing to the advertiser awaiting final year end reconciliation with actual individual rates and actual hours. The average projected hourly rate will be: $xx.xx.
This uniform average hourly rate will be subject to change on (month/day) of every subsequent contractual year and will be used only for billing purposes, as solely the above mentioned formula will validate the actual rates and the actual fees that the agency will be entitled to for any given period.
Agency will also supply the advertiser with estimates of the hours to be spent on the account for any contractual period and after agreement these estimates will be used to set out a monthly installment to be made to agency which will be subject to reconciliation at year end.
Therefore, the monthly installment based on the estimates will be as follows:

Fees and Hours Report

Monthly
Agency will supply to the advertiser, a report showing the hours spent on the account, grouped and detailed by department or by project, depending on the circumstances.
Quarterly
A reconciliation will be performed between the fee billing to date and the actual fee value of the hours worked on the account at the same date. Any difference will be dealt with at this time.
If the average hourly rate needs to be adjusted to a higher or lower level to better reflect reality, it will be done at this time.
Year End
The fourth quarter reconciliation report will also take into account hours to be billed at half rate (if applicable) as per the clause dealing with surplus hours.
Sub-contractors
All sub-contractors that agency mandate on behalf of the advertiser (e.g. specialists, promotion specialists, production houses and public relations firms) will be billed net to the advertiser. Any pre-approved administration costs, based on a submitted quote, will be handled on a case-by-case basis.
Temporary Personnel
If agency requires temporary personnel, it must respect the spirit of the present agreement. The rate rebilled to the advertiser should correspond to the calculation specified above by using the actual fee and billable hours worked by temporary personnel while ensuring that the specified rate would not surpass the maximum rate that regular agency employees performing similar tasks would normally charge.
Rate For Surplus Hours
The hourly rate used will be as follows:
a) 1,500 hours to be paid at full rate;
b) the balance to be paid at half rate.

For individuals who have logged more than 1,500 hours during a given year, and logged at least 750 hours on advertiser business, the rate structure will be as follows:
a) determination of actual hours attributed to advertiser;
b) determination of actual hours worked over the 1,500 hours limit (excess hours);
c) determination of % of hours worked over the 1,500 hours limit (excess hours);
d) application of % to advertiser hours resulting in excess advertiser hours to be billed at half rate;
e) remaining advertiser hours to be billed at full rate.

Example:
Individuals have logged 2,000 hours in total, 1,000 attributable to the advertiser:
excess hours = 500 hours or 25% of total hours worked
therefore 1,000 x 75% = 750 hours (full rate)
1,000 x 25% = 250 hours (half rate)

Performance Evaluation Program

As well, agency agrees to a performance evaluation program under which 50% of its normal profit is subject to an annual performance evaluation.
This amount will be calculated as follows:
· actual fees earned by agency after reconciliation for any given year or period x 18% (normal profit,
see above);
· 50% of this amount will be subject to the performance evaluation program.

Example:

The total fee earned after one year is $1,620,000. Profit of 18% is $291,600. Agency accepts to submit 50% of this total ($145,800) to an annual performance evaluation program. How much of this $145,800 will remain with the agency will depend on the evaluation.
The formula used for this purpose will be part of a separate agreement between the advertiser and the agency at the beginning of the fiscal year. (This agreement could include the possibility of an incentive package for exceptional performance.)

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Exhibit IV - Other Types of Actual Remuneration Systems

Event Bonus
The agency is paid a bonus above the fixed fee, if the attendance goal for an event is exceeded.
Media Savings
The agency receives a share of the media savings it achieved versus the previous agency.
Agency Guarantee
Based on forecasted hours, a percentage of an agency's fixed expenses (overhead) and profit are added to form the Agency Guarantee.
A 'blended' hourly variable rate is developed based on the direct labour cost of people assigned to the business. This blended amount, based on the annual forecast, is then added to the Agency Guarantee to reach the annual fee which is then billed in equal monthly installments.
NOTE: Variable rate excludes fixed costs and profit, as this is covered in the Agency Guarantee. Should needs exceed ongoing hours estimate, additional hours are charged at the variable rate. Conversely, if actual usage is below estimate, unused hours are credited back at the same variable rate.
Forecasting System
Fee system based on expected hours required to service the advertiser. Monthly summaries are prepared to monitor actual versus forecasted fees. Adjusted as required. No surprises at end of fiscal.
Unit Sales Incentive
Base fee and payment for unit sales over target.
Extra Performance Incentive
A). A bonus system based on extra performance. An agreed benchmark is established and a bonus is awarded, if the agency can exceed that mark.
B). Base fee (which equals a commission % on gross) plus a performance bonus against:
1) quantitative advertiser dollar volume objectives;
2) qualitative assessment of added-value business-building ideas.
C). A basic 13% commission on all advertiser spending. The advertiser then uses a variety of criteria to evaluate agency at the end of the year:

Full-Service - Excluding AOR

Based on gross media billings, the agencies are paid 11.2%, the AOR 1.8%, and 2% is held in bonus reserve. Agencies receive a commission of 15.29% of net commissionable production costs (i.e.: 13% of actual gross billings). 2.71% of net is held in bonus reserve. At year end, each agency is evaluated on their performance for their assigned brands and dependent upon the grade, they are paid a bonus based on total media and production billings. The bonus payment is calculated at 3% for Grade A, 1% for Grade B and no payment for Grade C.


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