Hogeschool-Universiteit Brussel

Campus Stormstraat Stormstraat 2 1000 Brussel

Faculty of Economics & Management Commercial Sciences & Management Field of Study Master of International Business Economics & Management Degree Programme

A contemporary business model for advertising agencies.

Does outcome based compensation provide a better alternative to the current behavior based compensation?

Master Thesis by
Kasper VANDEN BUSSCHE

Submitted for the Degree of Master of International Business Economics and Management Supervisor: Stijn Kelchtermans Academic Year 2011 - 2012

Abstract
The compensation model of full-service agencies hasnt changed significantly in more than eighty years, while almost everything else in the communication landscape has been transformed dramatically. Technology changes, with the internet as the main driver, have led to increased advertising clutter, audience fragmentation and increased advertising avoidance. These changes have over the years redefined the role of the advertising agency. From a supplier of print, TV and radio ads, to an increasingly more involved partner of the advertiser. Yet the agency still gets compensated based on hourly fees and production costs regardless of the effects of the campaigns they produce. This thesis investigates whether outcome based compensation is a better alternative to the currently used behavior based compensation. Funded on extensive academic and practitioner literature research, this thesis concludes that if performance based compensation is correctly applied, it does provide a better alternative, for both the advertiser and the advertising agency.

Table Of Content
Abstract Table of content Overview of graphs, tables and charts Introduction 1 Advertising compensation models, an overview 1.1 Definition 1.2 Criteria for a good compensation model 1.3 Current types of compensation models and their origin 1.3.1 Commission based compensation (Percentage on media space) 1.3.2 Labor based compensation 1.3.3 Outcome based compensation 2 Context outline: Current challenges for advertising agencies 2.1 Changes in consumer behavior 2.1.1 Audience fragmentation 2.1.2 Abandonment of the advertising grid 2.1.3 Time-shifted viewing 2.1.4 Opt-outs versus on-demanders 2.1.5 Banner-blindness 2.2 Changes in media 2.2.1 Advertising clutter 2.3 Changes in technology 2.4 Changes in campaign measurability and agency accountability 2.4.1 Accountability of advertising agencies over time 2.4.2 A shift from selling audience to selling behavior 2.5 Role of the full-service advertising agency 2.6 Conclusions in regards to the compensation model 3. Brief evolution analysis of compensation model usage 3.1 Demise of commission based compensation 3.2 Domination of labor based compensation 3.3 Rise of outcome based compensation 4. Comparison of labor based and outcome based compensation 4.1 Side by side comparison 4.2 Labor based compensation in depth 4.2.1 Lack of incentive for agencies to pursue more effective campaigns 4.2.2 Discontent on both the agency and the advertisers side 5 Outcome based compensation in depth 5.1 The principal-agent theory: a short overview 5.2 Advantages of outcome based compensation 5.2.1 Overcome information asymmetry 5.2.2 Aligning incentives 5.2.3 More autonomy for the agency 3 5 7 9 12 12 13 14 14 15 16 17 17 17 17 18 19 21 22 24 25 25 25 27 27 31 32 33 33 34 35 35 36 37 38 40 40 42 42 42 44

5.2.4 Longer term relationships 5.2.5 More sincereness from the agencies 5.3 Downsides to outcome based compensation 5.3.1 Risk 5.3.2 Costs 5.3.3 Lack of standards 6 Outcome based compensation in practice 6.1 Coca Cola makes the switch 6.1.1 How Coke's new compensation system works 6.1.2 Interview with VP marketing of Coca Cola 6.1.3 Current Coca Cola Inc. contracts in Belgium 6.2 Change at Procter & Gamble 7 How to apply outcome based compensation 7.1 Defining agency goals 7.2 Defining campaign goals 7.3 Measuring goals 7.4 Allocating appropriate compensation General Conclusions Reference list Appendices 1 Agency performance questionnaire sample 2 Example of an agency gap analysis 3 Metrics list

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Overview of graphs and figures

1.1 Agency profit margins vs. advertiser profit margins 1.2 Comparison of Labor based (Fee) compensation vs. commission based 2.1 Simultaneous usage of tablets and television. 2.2 Penetration rate of DVR within TV households in the US, France and the UK 2.3 Video content viewing behavior in 2009 2.4 Video content viewing of On-demanders per medium 2.5 Eye movement depending on internet usage 2.6 Advertising revenue market share by media 2005-2011 2.7 Advertising revenue market share by media 2011 2.8 US online ad spending 2.9 US TV vs. online ad spending 2.10 Accumulated turnover of Belgian advertising agencies 2000 - 2009 2.11 Yearly turnover of Ogilvy & Mather 2000 - 2009 2.12 Yearly turnover of McCann Erickson 2000 2009 2.13 Yearly turnover of TBWA\Brussels 2000 2009 2.14 Yearly turnover of Duval Guillaume 2000 2009 2.15 Yearly turnover of Famous 2000 2009 3.1 Trends in compensation program usage 1982 2003 4.1 Comparison of agency compensation methods 1 4.2 Comparison of agency compensation methods 2 4.3 Agency profit expectations vs. reality and the advertisers view 4.4 ACC virtual strike 5.1 The impact of the interaction between reliance on an incentive-based compensation scheme and information asymmetry 5.2 Indicative Switching Costs 7.1 Questionnaire to uncover dualities 7.2 Seven pitfalls that lead to counterproductive metrics 7.3 Allocation of profit 14 16 18 19 20 20 21 22 23 23 24 28 28 29 29 30 30 32 35 36 38 39

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Introduction
This thesis departs from the assumption that since the introduction of behavior based contracts in advertising, almost everything has changed in the communication world except the compensation model of full service advertising agencies. This thesis will investigate whether that assumption is right and if so, whether performance based compensation could be a better alternative to the currently domination labor based compensation model. After a brief history of the advertising compensation model, the current behavior based model is discussed in more detail, and the downsides to this model are explained. To create a context to better understand the relevance of a new compensation model, the current state of the communication landscape is laid out. This with particular focus on recent changes in technology, media and consumer behavior that make it more challenging today for both the advertiser and the advertising agency to effectively reach consumers. Once this is clear, this thesis looks at the evolution of the role of the advertising agency. From here an in depth look is provided on the performance based compensation model. What its underlying mechanics are, its strengths and weaknesses, and how it is currently applied by Coca Cola Inc. One of the first global advertisers to use the model in practice. Derived from literature on both theory and practice a general outline is provided on the requirements to apply performance based compensation. Including selecting campaign goals, measuring how these goals are met, with which metrics and how to allocate appropriate compensation to the campaign goals. At this point all aspects of both the context and the model itself will have been discussed, thus a comprehensive overview of advantages and disadvantages of the performance based compensation model is provided. After which the general conclusions are formulated. But first the scope of the research and some specifications are needed on to be clear on what is meant by advertising agency and its compensation model. When brands want to communicate to their users they can employ the services of different kinds of companies. These are four types of advertising agencies that are relevant for this thesis:

Full service agencies: A full service agency is what is the typical advertising agency most people know. They offer their clients a wide range of marketing, communications, and promotion services. Their core activity is creating and producing of advertising campaigns. These Full service agencies are the focal point of this thesis and will also be referred to as advertising agency or just agency. The clients of this agency will in this thesis also be referred to as clients, advertisers or brands. Media buying agencies: Media buying agencies are the intermediaries between advertising creators (a.o. Full service agencies) and media channels like TV networks, newspapers, radio stations, etc. Historically the media buying companies started off as space brokers. They bought large amounts of space for a discount in newspapers and sold this to advertisers with a markup. In essence this is still the core business, but as the media landscape has grown more complex, these agencies have specialized in a niche of specializing in analysis and purchase of advertising space and time. Specialty agencies: This type of agencies have specialized in a specific aspect of advertising. A specialty agency may for instance focus on just social media, product placement, promotional events or the development of mobile applications. These agencies are subcontracted by both full service agencies and brands themselves. Online media agencies: They are specialized in displaying online ads that are related to the surrounding content on a particular website. Examples are: Google Adwords, Yahoo Advertising solutions, Microsoft adCenter, etc. These are typically owned by technology companies who own a search engine or a platform on which they sell advertising space. For instance Microsoft adCenter schedules ads on the Microsoft search engine Bing, and the in-app advertisements on phones who run Windows mobile. Or Apples iAd service, which provides ad space in applications on iOS devices. The main difference between these type of agencies and the classic media buying agency is the difference in track ability. Almost all of these companies have a strong technological and or online background, and are therefore in a pioneering position in terms of visitor tracking methods. Especially compared to analog media like newspapers and street billboards which gauge their reached audiences based on number of papers sold and estimates of people passing by. As we will see in the next chapter not all these agencies are the product of the same history. Which to this day makes for big differences as to how communication is approached. For instance the full service agency has historically never been held completely accountable for its results as they were often hard to prove. Contrary to search engine agencies which have sprung from digital and online companies who have made their living of good analytics and intelligent algorithms to deliver the best 10

search results. In this thesis we will see that the latter are a driving influence in the transition to outcome based compensation. It has to be made clear that performance based compensation, value based compensation and outcome based compensation, are one and the same and will be used interchangeably and may sometimes be referred to as, the new model. Contrary to behavior based, which might also be called the old or current model. As said, this thesis focuses on the full service agency and its relationship with clients. Also often referred to as advertisers. To provide some context the next chapter will briefly discuss the history of this relationship.

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1 Advertising compensation models, an overview

1.1 Definition
A compensation model determines how, in this case, advertising agencies are rewarded for the efforts they put forward for their clients, the advertisers. The world knows many different compensation models. Someone whos selling a good, may charge his clients for the item itself, for the service of providing it, give it free, but charge for the additionally needed features, or for the maintenance of the good and even for not using the good. In the book Free by Chris Anderson (2009) there is an example of fitness centers in Denmark who charge nothing to their members as long as they show up once a week. If they skip a week they have to pay the full month fee. This compensation model is specially designed to motivate people to fitness more. This goes to show that a compensation model isnt only a tool for fair reward, but can also be a determining factor to incentivize certain behavior. In their book: Agency Compensation: A Guidbook David Beals and Stanley Beals (2001) distinguish between three categories of advertising agency compensation models: Commission based (or billing) agreements: This is the oldest model which has almost universally been used trough most of the past century. Under this approach, the agencys compensation is based on commissions or markups the agency takes on the cost of media, production and or third-party services. This percentage was on media has long been 15%, but currently this rate varies and is often lower. (Beals & Beals 2001, p3) Labor based (or cost based) fee agreements: With this model the agency bills the advertiser based on the cost it incurs for servicing the client, plus a markup for profit. (Beals & Beals 2001, p3) Incentive based compensation agreements: In incentive based models the agency is compensated based on the attainment of pre-negotiated performance goals. These key performance indicators (KPIs) can be any measurable metric like, sales, changes in audience attitudes or perceptions, reach of a campaign, etc In addition the agencys work may also be subjectively evaluated by the client management. Incentive based models are currently never used uniquely, but combined with cost based agreements. Payments of incentive models can take the form of supplemental fees or commissions. (Beals & Beals 2001, p3)

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1.2 Criteria for a good compensation model

Beals & Beals also put forward five criteria for a good compensation model in the context of the advertising world. Equitability (fairness): The price/value ratio of the contributions made and services provided by the agency, to the compensation it receives. Adaptability: The degree to which a compensation agreement is applicable to a range of different agency services. Administrative simplicity: The relative ease (or difficulty) with which a compensation agreement can be administered. Reward: Motivation for both client and agency to encourage greater efficiency and productivity in the relationship. Predictability: Assurance to each party in the relationship that its individual and mutual goals are attainable. From Agency Compensation: A Guidbook (Beals & Beals, 2001, p7) All of the above are of course somewhat vague terms open to interpretation by both parties. Therefore Beals & Beals (2001) try to provide some more clarification. For instance based on research of the American Association of Advertising Agencies (4As) they determined that 12% to 15% percent profit margin for agencies is acceptable (p8). Another study of the 4As however shows that profit margins of agencies are structurally smaller than the ones from their clients. Which if it comes to applying outcome based compensation (the focal point of this thesis) this might generate some irritations because outcome based compensation requires more transparency from both parties about financial situations (Mc Bride & Associates, 2004, p4).

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Figure 1.1: Agency profit margins vs. advertiser profit margins. Retrieved from: Agency Compensation Task Force Profit a 4As presentation by Perry & Weiss (2012)

As the five criteria of Beals & Beals are still open for interpretation, we will in chapter 4 & 5 compare and analyze the compensation models to determine which one is the most appropriate in current times.

1.3 Current types of compensation models and their origin

1.3.1 Commission based compensation (Percentage on media space) In 1842 when print advertising was just emerging, Volney B. Palmer started buying large amounts of space in various newspapers at a discounted rate, then resold the spaces at higher rates to advertisers. The actual advertisement with copy, layout, and artwork, was still prepared by the company seeking to advertise. In essence, Palmer was a space broker. The company is generally considered the first advertising agency (Tungate, 2007, p14). Back then advertising agents were no more than middlemen who bought advertising space from newspapers and resold it at a profit to a company seeking to place an advertisement.

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In 1869 George P. Rowell, a Boston based advertising agent created the first ever media directory. A guide including the circulation- and advertisement rates of 5000 newspapers (Tungate, 2007, p14). This was an important step in the transparency of advertising, on which Francis Wayland Ayer further improved. The latter was the founder of N.M. Ayer & Sons, a Philadelphia based advertising firm. He offered its customers an open contract under which Ayer would be the company's sole advertising agent and, in exchange, would price advertising space at cost plus a fixedrate commission on the media space. He used a fixed fee of 12.5 per cent, and later 15 per cent. Which became the industry standard for many years to come (Tungate, 2007, p15). Currently this rate has been replaced by varying, and often lower rates (Beals & Beals, 2001, p3). This percentage on media model implied that an advertising agency makes more profit if it sells more media to its clients regardless of its necessity or effectiveness. Secondly it also doesnt account for the costs incurred by the agency to produce the advertisement. Whether or not a campaign is production intensive, thus expensive, the agency doesnt earn more. 1.3.2 Labor based compensation Unlike the percentage on media system, labor based agreements dont charge advertisers based on how much media they buy, but on the effort the agency has to put in to fulfill the advertisers demand. The agency charges the production cost plus a markup for profit (Beals & Beals, 2001). These kind of agreements emerged as advertising agencies started to hire copywriters, and art directors. Also, around the early thirties, with the introduction of radio and TV, the production process of advertising got more complex and expensive which led advertising agencies to expand the commission model with the labor based fee or simply a negotiated amount based on work load and resources allocated to execute that work. These labor based fees were often combined with the commission model (Beals & Beals, 2001). From the survey numbers of the Association of National Advertisers (ANA) we learn that both labor based and the percentage on media models are still in use. But in the past decade, the commission based model is in decline in favor of the labor based model.

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Figure 1.2: Comparison of Labor based (Fee) compensation vs. commission based. (Association of National Advertisers, 2003)

1.3.3 Outcome Based compensation The third and most recent compensation model is outcome based contracts. These tie the agency compensation to pre-defined, measurable performance targets. These targets can be based on sales, profits or market share, or by meeting standards for key communication effects on such dimensions as brand equity (Davies & Prince, 2010). Outcome based compensation is often referred to as value based compensation or performance based compensation. Beals & Beals (2001) point out in their Compensation: A Guidebook, that most agencies currently combine several of the above compensation models and this in many different forms. Outcome based compensation is now often used as an additional incentive system on top of a labor based agreement (Beals & Beals 2001). The last openly published survey of ANA in 2003 shows that labor based is the most often used compensation model. Additional research, which will be discussed in chapter 3, shows that this is still true today. Of course labor based compensation is not the predominant model by accident. For a long time it has been the most efficient way for advertisers to reward agencies for their work (McBride & Associations, 2004, p3). This for two reasons: It has long been too difficult to accurately appraise the added value of an agencies work (Beals, 2010). And secondly, the media landscape has long been fairly straightforward. (i.e. newspapers, magazines, television radio and billboards) Which means that the production process of ads was also reasonably straightforward and predictable. Making it easy to monitor and use as a billing basis. However, as we will discover in the next chapter, these two factors have radically changed in the last few decades, which according to many industry professionals calls for a reevaluation of the compensation models.

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2 Context outline: Current challenges for advertising agencies

Evolutions in technology have often influenced consumer behavior and subsequently how advertisers communicate with their consumers. As already mentioned, the introduction of radio and television was a tipping point for agencies to rethink the way they charged advertisers. Since then technological innovations have rapidly pilled on, which brings us to today in a complex communication landscape scattered with media and devices and an increasingly assertive consumer. This chapter is an attempt to list the most important changes and challenges for the advertising industry of the past two decades. A list that may quickly be outdated.

2.1 Changes in consumer behavior

2.1.1 Audience fragmentation Large audience sizes are declining as more channels and vehicles emerge and audiences are spread more thinly across different media opportunities. For the advertiser, this means that it is more difficult to reach a specific audience, especially in a coordinated fashion (McPhillips & Merlo, 2008, p293). Rosenberg, a researcher who studies media usage came to the same conclusion. His findings and a more detailed version of these behavior changes are explained in this next part: Changes in media. 2.1.2 Abandonment of the advertising grid In the same article Matt Rosenberg (2010) explains how more and more people are going off the advertising grid, using time shifted viewing, online streaming, or other advertising avoidance tools. According to him, cord-cutting for cable network executives is going from a bad dream, to a waking nightmare. In the third quarter of 2010 the large cable operator, Comcast alone would have lost 275.000 subscribers and 600.000 over the first three quarters. Another phenomenon contributing to the abandonment or at least ignoring of the advertising grid is people spreading their attention over different devices. Nielsen Company (2012) held a media usage survey and asked what tablet users do while watching television. Turns out a majority of tablet owners checks their mail and surfs the web for unrelated information. As tablet and smartphone sales soar, this new habit will most likely gain more ground (Holman, 2012).

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Figure 2.1.2.1: Simultaneous usage of tablets and television. Retrieved from State of the media: consumer usage report 2011 (Nielsen Company, 2012)

2.1.3 Time-shifted viewing An important part of the abandonment of the advertising grid is time-shifted viewing (iDate, 2010). Time-shifted viewing means, not watching programs on television while theyre aired, but on some other time. Something people can do since the introduction of the VCR, but which has grown exponentially since the introduction of the digital video recorder (DVR). Now there are many different solutions to view TV programs at a different moment than their normal broadcasting. Both with digital recording devices as with online services like Tivo, MyFreeview and MySky (Nielsen 2011). Most of these devices allow ad skipping and or fast forwarding (iDate, 2010). To illustrate this new trend we look at the penetration of DVRs within US households.

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Figure 2.2: Penetration rate of DVR within TV households in the US, France and the UK (IDATE report 2010)

2.1.4 Opt-outs versus on-demanders These two types of content viewers are according to Rosenberg (2010) a growing group of people who are very apt at skipping and avoiding advertising. In theory an "Opt-out" watches no live TV, while streaming an average of at least 4 hours of video content a week. These people are also called cord-cutters. Although 90 percent of them own televisions (Rosenberg, 2010). "on-demanders," on the contrary still watch live TV, but watch more time-shifted and stream and less (Rosenberg 2010). Altogether this group would already represent a third of the online 18 and older audience. According to a Comscore study which Rosenberg bases his study on, this amounts to 56 million people in the US. Both these groups are fairly young. Among the 18 to 24 year range, 30% would be an opt-outer. While on-demanders are a bit older and are more likely to have graduated college (Rosenberg 2010). Both groups are highly digital and know how to find programming online (Rosenberg 2010). Below is a graphical representation of the content viewing behavior of both groups.

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Figure 2.3: Video content viewing behavior in 2009. (Rosenberg 2010)

According to Rosenberg, these peoples viewing behavior is no longer led by whats on and more by whats available. One of the few things that still drive on demanders to live television is live TV sports (Rosenberg 2010).

Figure 2.4: Video content viewing of On-demanders per medium. (Rosenberg 2010)

The big theme in the research of Rosenberg was that the off-the-grid population is using technology to bring greater efficiency into their lives. He argues that one can

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view four hours worth of programming in three hours. This by either fast forwarding, skipping or opening a new browser tab during pre-roll advertising. These people value their time more than the message of the advertiser. According to Rosenbergs data ondemanders are much negative towards advertising than any other group. This also strengthens the argument made in the chapter above on media. That while brands advertise more, user tolerance and attention goes down. Therefore the modern marketer will have to do things much differently than in the past. Rosenberg says that the ways in which marketers have to be different will not make life easier for them. 2.1.5 Banner-blindness Banner blindness is a phenomenon that has been studied for years by many researchers. This is a short explanation of the issue compiled from research of Burke, Hornof, Nilsen and Gorman (2005); Benway and Lane (2005); Drze and Hussherr (2003). Consumers are getting better and better at avoiding advertising both when it comes to the classical media and certainly the internet. The above mentioned studies show that experienced internet users just dont look at classic banners anymore. The picture below shows the eye movement on a website of an experienced and an inexperienced web user. The box on top of the website is a banner advertisement. The study showed that the experienced user didnt even look at the banner. This phenomenon is called banner blindness. As more and more people are getting used to browsing the internet beginners disappear and click trough rates of banners drop (Drze and Hussherr, 2003).

Figure 2.5: Eye movement depending on internet usage. (Drze and Hussherr, 2003)

Banners would still have some long term impact as we unconsciously notice them in our peripheral sight. But for people who want banners completely out of their sight, developers have made browser add-ons that disable banner advertisements. Adblock Plus for instance will do that both for Firefox and Chrome.

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2.2 Changes in Media

Data from The Nielsen Company, a global market research company, shows that overall media spending in 2011 went up by 8% in the United States, compared to the same period in 2010. Unlike what one would think reading this thesis, TV advertising is still the most important and cost-effective advertising medium. Ad spending on television went up by 12% from 2010 to 2011. Radio and magazines follow television, but at a slower rate, respectively 8,5% and 6.4%. This study of Nielsen doesnt mention online spending, therefore we look at articles and studies from IAB (2012), Forbes (2011), Forrester (2011) and eMarketer (2012). These studies show the same picture of strong television and weak newspaper revenues. But it also shows rapid and steadily growing advertising revenues for internet. The IAB internet advertising revenue report (2012) shows internet at a second place behind broadcast television, and before cable television. Of course it must be pointed out, that it depends on whether it is deemed fair to split up television in those two categories or not. If put together, television is still on an all time high. Advertising revenue market share by media 2005-2011

Figure 2.6: Advertising revenue market share by media 2005-2011. Retrieved from the Internet Advertising Revenue Report (IAB, 2012, p20) * Broadcast Television includes Network, Syndicated and Spot television advertising revenue. ** Cable Television includes National Cable Networks and Local Cable television advertising revenue.

Advertising revenue market share by media 2011 (In Billions)

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Figure 2.7: Advertising revenue market share by media 2011. Retrieved from The Internet Advertising Revenue Report (IAB, 2012, p19)

Nevertheless, internet is rising and may overtake all other media by 2016. At least if the forecasts of Forrester (2011) and eMarketer (2012) are correct. Their two separate studies came to more or less the same conclusion that by 2016 internet advertising spending will rise above television as a whole. US online ad spending, 2011-2016 (Billions and % change)

Figure 2.8: US online ad spending. retrieved from US online ad spend to close in on $40 billion. (eMarketer, 2012) Note: eMarketer benchmarks its US online ad spending projections against the IAB/PwC data, for which the last full year measured was 2010.

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Figure 2.9: US TV vs. online ad spending. retrieved from US online ad spend to close in on $40 billion. (eMarketer, 2012) Note: eMarketer benchmarks its US online ad spending projections against the IAB/PwC data, for which the last full year measured was 2010.

2.2.1 Advertising clutter The described changes in media mean two important things for the working of advertising agencies. First, as overall advertising spending is going up, this means that more advertisers are placing more ads. In Rosenbergs (2010) article on Why no one is watching your ads he estimates that the average American consumer sees up to 1000 commercial messages a day. On an increasing number of media and devices. (i.e. Smart phones, tablets) Rosenberg argues that this advertising clutter diminishes the effect of many of these ads greatly. Which ironically in turn drives advertisers to spend more on more advertising in even more unexpected places. A second important factor for the way agencies work is the rise of the internet as an advertising medium. This both has a negative and a possible positive side. Negative because internet, unlike TV, Radio or print, isnt a one way communication tool and it is technically much more complex than any of the before mentioned media. The fact that internet communication is a two way process is a major opportunity for brands to interact with their consumers, but brings along a certain cost for maintaining that conversation. This in the form of conversation managers, additional creative work, etc The internet is also technically much more challenging than any old medium. On TV one can put product placement and commercials, and that is about it. While any internet campaign will likely include a campaign website, a banner campaign (with banners in many different shapes and forms), a social media part, context aware text ads on search engines, maybe an online game and accompanying mobile application, etc All of these are very production intensive. This not only makes campaigns more expensive, it makes it more difficult for agencies and advertisers alike to estimate the workload up front.

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2.3 Changes in technology

Throughout the history of advertising changes in technology have played a major role in the way agencies communicate their advertising to people. Today the days of the holy trinity, radio, print and TV are long behind us. Every year technology innovations create new opportunities for advertising, but also make it increasingly difficult for advertisers to stay ahead. To name a few of these recent technologies or applications: iOS & Flash support. The mobile operating system of Apple which runs on all iPhones, iPod touches and iPads does not support Flash. While almost all banner advertisements are made in Adobe Flash, and thus are not seen by any IOS user. According to AdMob (2010), (The mobile advertising unit of Google) Apples mobile operating system held in may 2010 still the largest market share of 40% worldwide and 73% in Western Europe. Android, Googles operating system comes in second with 26% worldwide and 16% in Western Europe. Thus a vast amount of mobile surfers never see any regular banner. HTML5 HTML 5 is a fairly new coding language which allows developers to make Flash like animations, and is supported on every device (also on Apple devices). This means that it could become the new language to develop internet advertisements. Yet, like regular html, it is not displayed the same in every browser. This means that objects and animations may appear slightly different in Firefox, Chrome, Safari or Internet Explorer. For developers and agencies it requires time and budget to adopt to this new way of working. As it is not the goal of this thesis to get too technical about every single issue that makes advertising more difficult, it is needed to give some impression of the current issues, and show that the media landscape is not likely to become less cluttered or less difficult to work in.

2.4 Changes in campaign measurability and agency accountability

2.4.1 Accountability of advertising agencies over time. Up until the 1930s effectiveness of advertising was rarely measured. In the beginning of the 20th century there were only a few people like Albert Lasker, a copywriter fond of facts and proper product research (Tungate, 2007, p20). He meticulously kept track of product sales to determine the effectiveness of his ads. But as he was a full time copywriter, this research was not a proper occupation within the agency. Nor in any other agency (Tungate, 2007, p20-23). It took until the 1950s for Mr. Rubicam from

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Young & Rubicam, one of the leading agencies at the time, to hire a full time researcher. George Gallup, a professor of advertising and journalism, was hired to examine the effects of their campaigns. His research showed that the hard fact magazine ads that were popular at the time, were less effective than the ones that pushed the right buttons with the readers concerning quality, vanity and sex-appeal (Tungate, 2007, p31). The research proved so useful that after a few years over 400 people at Y&R were full time employed to analyze the effects of their advertising. The agency invited listeners panels from church groups and womens clubs to rate radio ads, using devices uniquely designed by General Electric for this purpose (Tungate, 2007, p32). After a few years George Gallup broke away from Y&R to found his own advertising and media research firm. Today there are several world wide and local companies and organizations involved in extensively researching the state of advertising, consumers and media. Often this research is ordered by their clients which may be both advertisers and agencies. Some of the best known whos research is also used in this thesis are: The Nielsen Company, The Interactive Advertising Bureau (IAB), eMarketer, Forrester and The Association of National Advertisers (ANA). However if it comes to agency level research of campaign effectiveness, there is still serious room for improvement. Rosser Reeves a successful advertising executive and half owner of the Ted Bates agency wrote in his book Reality in Advertising (1961): Advertising started as an art, and many advertising men want it to stay that way, a never-never land where they can say: This is right because we feel its right. This illustrates a point also made in Tungates Ad Land (2007). He describes it as a constant tug war between two schools: the creatives, who believe art inspires consumers to buy, and the pragmatists, who sell based on facts and come with reams of research. With internet on the rise as an advertising medium which is very measurable in terms of numbers of clicks, time spent on websites, click trough rates, blog mentions or a simple Facebook fan count, advertisers start demanding more and more accountability of their agencies (Elliot, 2007; Bruell, 2012; Husain, 2012). In 2007 New York Times advertising columnist Stuart Elliott wrote in Pushing the industry to learn how to count: If the 20th century was known in marketing circles as the advertising century, the 21st may be the advertising measurement century. Marketers are increasingly focused on the effectiveness of their pitches, trying to figure out the return on investment for ad spending The ability of newer Digital media to provide more precise data has also led traditional media like television, radio, magazines and newspapers to try upgrading the ways they count consumers. Digital has clearly changed the game. (Stuart, 2007)

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This statement reflects the general sentiment towards accountability of agencies well. In a later chapter on how to apply outcome based compensation we have a closer look at the current possibilities of metrics and the remaining barriers around them. 2.4.2 A shift from selling audience to selling behavior After looking at the changes in technology and consumer behavior it becomes clear that there is an attitude change in how advertisers appraise the efforts of their agencies. Thinkmetrics CEO, Brandt Dainow (2009) explains how in print and broadcast, advertising rates are largely determined by the number of people who will be exposed to the ad also called reach. Traditionally media agencies provide an estimate of the reach of an ad expressed in Gross Rating Points (GRP). It is calculated as a percentage of the target audience multiplied by the frequency that consumers will see a given ad. Yet GRP doesnt ensure a specific amount of views. As explained before, people may not be paying attention, can have the TV sound muted, or simply not be in the room. Since most marketers are aware of the opt-outers and on-demanders, banner blindness and people multitasking or ignoring their advertisements, they can no longer be satisfied with the promise that people will see their advertisements just because they bought the media. This represents a shift from selling audience to selling behavior. Agencies and media companies alike need to increasingly be more convincing about the effects of their work and media space.

2.5 The role of the full-service advertising agency

With the rise of every new major technology the role of the advertising agency has and is continuously changing (Davies and Prince 2010). Of course at the basis the agencies are today just as much as in the past expected to persuade consumers to buy products, but range of individual services offered keeps expanding. In the past advertising was largely divided in above the line and below the line advertising. Above the line, being: Television, billboards, radio, print advertising, etc an below the line was everything from direct mails, trade fair advertising, promotional methods, in store advertising, etc Later, trough the line was coined as a new buzzword, for campaigns that combined both sides of the line, later agencies rushed to claim they created 360 campaigns covering the whole media spectrum. Also agency creative had to adapt. Where in the past they had to come up with a print campaign and or a television ad, they are now pushed to come up with media neutral ideas that can be easily adopted to any medium. This buzzword frenzy alone already shows how agencies have been, and are

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being forced to adapt and progress. To their praise many of them have done so with great success. In fact data shows that the advertising sector in Belgium still grows year over year. Below a graph of the cumulated turnover of all Belgian listed advertising agencies with over 10 employees.

Figure 2.10: Accumulated turnover of all Belgian advertising agencies with more than 10 employees, listed in Bel-FIRST index. 2000-2009 (Bel-FIRST 2011) Of course media agencies, online agencies, direct marketing agencies and even some PR agencies are listed under advertising agency as well. Once we dig in to the data to find specifics on full service advertising agencies, the picture is slightly different. Many agencies do good and increase their turnover year by year, but several dont. Ogilvy&Mather and Mc Cann Erickson for instance are Belgian branches of world wide networks and their turnover is decreasing at least for the last ten years. So on the surface it could look like there is a downward trend for local branches of international network, but that is not completely true. Saatchi & Saatchi and TBWA have grown over the last ten years.

Figure 2.11: Yearly turnover of Ogilvy & Mather 2000 - 2009. (Bel-FIRST 2011) 28

Figure 2.12: Yearly turnover of McCann Erickson 2000 - 2009. (Bel-FIRST 2011)

Figure 2.13: Yearly turnover of TBWA\Brussels 2000 - 2009. (Bel-FIRST 2011) Then Duval Guillaume for instance shows a huge dip from 2005 to 2007, it is unclear whether this is due to the loss of some clients or if something else was going on. Duval Guillaume was purchased by the Publicis Group in 2006. Shortly after they opened an agency in New York which was closed 2 years after due to the financial crisis. Famous, another Belgium based independent advertising agency, does increase its turnover at approximately the same rate as the industry. And then there are several other independent full service agencies that are not listed. (i.e. Happiness, Mortierbrigade and Boondoggle are not listed or with too few data available.)

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Figure 2.14: Yearly turnover of Duval Guillaume 2000 - 2009. (Bel-FIRST 2011)

Figure 2.15: Yearly turnover of Famous 2000 - 2009. (Bel-FIRST 2011) So, except for the fact that the industry as a whole grows, it is hard to draw any other conclusions related to the challenges described before. Although it is at least odd that a business with so much trouble ahead still enjoys such growth, but literally all literature that was read for this thesis, both academics as practitioners, all agree on the previous challenges that were discussed. The fact remains that a solution is needed for the difficulties of communication in this hyper-connected world. Only the timing may not be as urgent as some claim. But since the climate, at least in Belgium, is still good it may be a good time for agencies to investigate a possible future without a deadly recession breathing down their neck.

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2.6 Conclusions in regards to the compensation model

After the introduction of radio and television came many more new technologies, platforms and thus advertising opportunities. Of those innovations the most important one for advertisers in the past few decades is the internet. Not only as a new possible place to advertise for the agencies, but also a way for the consumers to avoid commercials and ads. And even apart from the invention of the internet, the lives of people are increasingly cluttered with advertising, which ironically makes it harder for the advertisers to stand out or get their message across. From early on advertisers are aware that not all their ads are read, viewed or listened to with as much attention as they would hope. John Wanamaker, an advertiser in the turn of the 19th century, is attributed for having famously proclaimed: Half the money I spend on advertising is wasted; the trouble is I dont know which half. Derived from all the above, it is clear the communication world is fundamentally and rapidly changing. These changes already have altered the way agencies produce their campaigns, but what are the conclusions that need to be drawn in terms of the compensation model for agencies? As far as billing based or percentage on media compensation goes, it is obvious that the cluttered media landscape and the subsequent increased production cost of campaigns make it very hard to attain a fair compensation based on an arbitrary percentage. Then again, the next chapter on the evolution of compensation use, indeed shows a steady decline for this model. For labor vs. performance based models these are the main factors at play: Increasingly more difficult to reach consumer. Too much advertising on too many media. Higher production costs of advertising. Which makes the commission based model less useful. Production is becoming more and more complex. Which makes it harder to track costs, thus to compensate based on labor. It is becoming easier to measure the effects of advertising. Which makes performance based compensation more realistic.

Since all the above described changes did not occur yesterday, but have been evolving over at least the last decade, we should already see some changes in the usage of different compensation models.

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3. Brief evolution analysis of compensation model usage

Since 1982 the Association of National Advertisers from Detroit has conducted a triennial survey among advertising agencies in the USA. In the table below the trends show a steady decline in commission based compensation. Meaning the percentage on media practice is losing significant ground. Meanwhile the labor-based compensation has risen from 8% tot 74% over two decades. The other compensation methods of which Incentive-based agreements is one, has since 85 risen, but was in 2003 still only at 16%. Compensation program usage (1982-2000)

Figure 3.1: Trends in compensation program usage 1982 2003. Compiled from Beals & Beals (2001, p4) and Mc Bride & Associates (2004, p3)

David Beals, an authority on compensation models and the author of the ANA reports, wrote together with Stanley Beals the book: Agency Compensation: A Guidbook (2001). In which they analyze the ANA numbers and make some side notes. For instance they point out that most agencies dont use one compensation method for all their clients, in fact their research shows that most agencies even apply different billing systems for one client. For instance the above and below the line advertising for a client can be billed separately. As the above the line, meaning classic media like newspaper, radio, TV and billboards may still perfectly be compensated trough the percentage on media agreement, while below the line advertising, like guerilla, direct mail, events, etc are harder to measure in media usage and are often more labor intensive for the agency. In the next chapter we have a closer look at the changing media landscape and behavioral changes in how people consume media, which is the reason for this change in billing agreements.

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3.1 Demise of commission based compensation

McBride & Associations, a Marketing Communications consulting firm analyzed the ANA survey of 2003 and combined their findings and bundled this in their paper: A Second Opinion: Compensation Trends (2004). According to them, when commission based compensation was still prevailing, it almost always resulted in either over or under payment of the agency. Large advertisers mostly over paid their agencies as they bought large amounts of media, to which the production work of the agency wasnt necessarily in proportion. Smaller advertisers on the other hand often didnt buy so much media, which resulted in an underpayment of the agency. So within the agency this might balance out, but especially for the large advertisers this wasnt completely fair. According to McBride & Associations (2004) media costs started to hyper-inflate in the late eighties, which led large advertisers to question the commission system. At first this led to a reduction of the 15% rule to 10% or less. But the globalization of firms and their subsequent public trade status required a steady and predictable earning stream for their stakeholders. So fees based on labor cost became a preferable solution for both parties (McBride & Associates, 2004). As a result we can see a continuing demise in the usage of commission based compensation from 71% in 1982 to a mere 10% in 2003. Even though the latest publicly available ANA study dates back to 2003, literature about the increased complexity of the media landscape indicates that this downward trend is continuing today (See chapter 2). Therefore from here on this thesis will focus on only labor based and outcome based compensation.

3.2 Domination of labor based compensation

The ANA survey of 2003 clearly shows a prevailing labor based compensation model with 74%, to which it has risen from 8% in 1982. Which is almost the exact opposite trend of billing based compensation. But of course for this thesis we are interested in more recent years as outcome based performance, the supposed new competitor, is currently a hot topic among marketers. The most recent and 15th ANA triennial survey from 2010 is not publicly available, but the association did publish a press release with their key findings. The most important one is the title: ANA survey finds fees persist as dominant method of agency compensation, even with emergence of other models. By fees they mean labor based compensation. Unfortunately, no exact percentage is given. What is given is a steep decline in commission use, from 16% in 2006 to 3% in 2010, with the added remark that these lost commission models are replaced by labor based and sales based models. (Sales based being one of the possible outcome based compensation agreements.) Further articles of 2012 from among others David Beals, the author of 33

the ANA reports, mention no excessive rise in outcome based compensation in the last two years. Thus we conclude that today labor based compensation is still the domination model.

3.3 Rise of outcome based compensation

Despite the dominance of labor based compensation there is a steady rise of performance based compensation. The ANA survey of 2003 does still categorize this model under the general term: Other compensations. These other compensations have risen from 0% in 1985 to 16% in 2003. This is an indication of progress, but a shady one. Luckily the 2010 ANA press release gives more detail. In 2010, 46% of respondents used performance incentives. One must note that like Beals & Beals (2001) pointed out, many of these agencies may combine the incentive model with a labor based one. From 2006 to 2010 ANA reports a particular rise in performance based use with large marketers. This might be due to the 2009 announcement of Coca Cola to switch to the new model (see chapter 6.1). Of those marketers who spend over $30 million annually, 70% employ performance incentives with at least three of their agencies (ANA, 2010). Smaller advertisers under $30 million annually, only 8% uses performance compensation. Of those advertisers applying incentives, 78% use agency performance reviews, 72% use sales goals, 24% use market share goals. One might conclude that although labor based is the current dominator, performance based models are on the rise and are being tried and tested in parallel with the more familiar models.

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4 Comparison of labor based and outcome based compensation.

4.1 Side by side comparison
Since the second chapter laid out a context of new realities for the agency world and the third showed how agencies are being compensated today, we can have a more in depth look at the mechanisms behind the compensation models to determine the defining pro and contra arguments and asses how these can be offset or put to work. To assess whether it is appropriate to move away from commission and labor based models, in favor of the incentive based ones we will look at the pro and contra arguments made by advertising professionals on both the client and agency side, and also examine how the usage of the different models has changed over time. Mc Bride & Association, a consulting firm specialized in helping agencies and advertisers to optimize their performance, has compared the three models in terms of need for cost-monitoring, degree of risk and importance of measurability.

Figure 4.1: Comparison of agency compensation methods 1. Retrieved from: A Second Opinion: Compensation Trends (McBride & Associates 2004, p2)

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Figure 4.2: Comparison of agency compensation methods 2. Retrieved from: A Second Opinion: Compensation Trends (Mc Bride & Association, 2004, p2)

As seen in the chapter two, the increased diversity in media make advertising more production intensive and more difficult to monitor costs. Which is particularly important for behavior or labor based compensation. Outcome based compensation on the other hand does not require any monitoring of costs, as the advertiser can rely on the self-interest of the agency to reach the set goals. A more in depth explanation about the incentive mechanisms will be provided in the principle-agent theory. However the advantage of this freedom for agencies is countered by the higher risk. Outcome based compensation is much less predictable in terms of profit for the agency. This because environmental factors, not controlled by the agency, may influence the outcome of a campaign. In the chapter on defining campaign goals and selecting metrics, Hauser & Katz (1998) provide some advice on how to select the right metrics in order to avoid these factors. In both compensation models however there is a need for measurability. Which of course is of much higher importance in outcome based compensation. Also in chapter seven a step plan is suggested on how to install a good measurement system.

4.2 Labor based compensation in depth

The major part of the job of an agency is to come up with creative ideas and solutions to make the advertising of the client stand out and appeal to the right audience. In Advertising agency compensation, client evaluation and switching costs: An extension of agency theory, Davies and Prince (2010, p15) state that creativity is the most popular reason for hiring an agency. However as creativity is no exact science it is hard to measure. Therefore, unless the client and the agency can agree on how creative output should be measured, it may be preferable to resort to labor based compensation (Davies & Prince, 2020, p16). This can avoid perceptions of unfairness about reward and allocation.

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4.2.1 Lack of incentive for agencies to pursue more effective campaigns One of the main downsides to behavior based compensation is that it doesnt or almost doesnt take the success of the campaign into count. As said before the behavior based compensation structure does not push agencies to strive for more effective campaigns. This way of compensation only pushes agencies to do good enough so clients wouldnt turn away. As the compensation of agencies has long not been dependent on the success or failure of a campaign, agencies have long not had a incentive to consistently gather data on campaign success and failure. Yet this doesnt mean that agencies dont push the envelope of their creations. A look at winning campaigns at the annual advertising festivals like Cannes Lions, Clio Awards, Eurobest, CCB awards, D&AD and the likes, will prove the opposite. Advertising creatives will also testify that winning awards will in most cases result in a pay raise. So it is safe to conclude that the industry is able to incentivize creatives to make more creative campaigns, but not so much more effective campaigns. Although there is a trend in that direction. As six years ago the Cannes advertising festival introduced a new category: The Titanium Lions. As stated on the Cannes Lions website, these lions are awarded to game changing creative campaigns who have proven to be effective. It was the first category at the festival that explicitly implied effectiveness. And in 2011 another category was added, the creative effectiveness lions, for campaigns that won the year before, but have since been proven to be highly effective. This is in line with the already discussed trend towards more demand for accountability of agencies in the second chapter of this thesis. As for the situation today it remains a fact that advertising agencies do not or not enough consistently study the effectiveness of their work (Beals, 2010). The general tendency is that analytics of campaigns are provided to clients if they explicitly ask for it, or if a campaign is successful enough to enter in award competitions. Hoffman Lewis is a American full service agency that has published a book in 2009 on performance-based advertising in which they bluntly state their view on the matter: Ask the average ad agency person about the fundamental principles behind what she does and you will likely get stunned silence. When she recovers, you will probably hear a series of buzzwords rather than principles, vague statements about cultural conversations or 360-degree touch-points or consumer engagement. The reason ad agency people have a hard time articulating underlying principles is that for the most part they dont have any. Instead they rely on a grab bag of platitudes handed down unchallenged from agency to agency, generation to generation (Hoffman 2009, p53)

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4.2.2 Discontent on both the agency and the advertisers side In the already cited 4As study (2012) on agency compensation, in chapter one we saw a discrepancy in profit margins between advertisers and agencies. Another ANA study which was analyzed by McBride & Association (2004) further elaborates on this. This study also indicated that agencies would like to earn profits of +17% where in reality they often need to be satisfied with an average around 12%.

Figure 4.3: Agency profit expectations vs. reality and the advertisers view. Retrieved from: A Second Opinion: Compensation Trends (McBride & Association, 2004, p5)

From the above we can derive that many agencies believe that they are not adequately compensated but agree to the terms anyway. According to Gideon Spanier (2010), an advertising journalist, agencies agree to the terms because of competitive pressures and fear of the client. Clients on the other side often believe that they are over paying their agencies. One consequence of poor agency compensation and the resultant squeezed margins is the need of agencies to find other ways of making money or at least saving money. The ability to afford top quality talent becomes an issue. This triggers a vicious cycle: sub optimal service to the client, leading to clients unhappiness, leading to a pitch. A pitch is the process of a client selecting a new agency. The advertiser may either invite several agencies, or just post a pitch in the open available for any agency to apply. In recent years, clients tend to do more pitches, open to more agencies. (ACC 2010) As only one agency can win the pitch, each time several agencies lose all the time and resources spent. Plus during the time these agency people were working on the pitch, they werent serving the existing clients. The trend of too many pitches has been on the rise for several years and was brought to a climax with a virtual strike of advertising agencies in Belgium. To express their discontent about this situation, the ACC (Association of Communication Agencies of Belgium) organized a virtual strike in 2010 among 38

advertising agencies. Twenty four Belgian advertising agencies took their website offline for a week and replaced it with a letter addressed to their clients. The letter was divided into twenty-four parts so each website linked trough to another agency site on which the letter continued (ACC 2010). The letter expressed the concern of the agencies and went on to explain how many Belgian advertisers had ignored the industry charter. This charter stipulates that no more than three agencies should be invited to a pitch. This strike got worldwide acclaim and resonated with many agencies over the world, eventually it won a silver lion at the Cannes advertising festival (Cannes Lions 2010). The results were, According to the ACC and Famous, the advertising agency that created the campaign, that one year later the violations of the code of conduct were brought down from 37% to 5%. As a result uncompensated hours declined by 26% (Famous 2011).

Figure 4.4: ACC virtual strike. Opening of the letter of complaint that was displayed on the websites of 24 Belgian advertising agencies during one week in 2010.

After discussing these two major arguments above, agencies and advertisers alike need to ask the question whether labor based compensation is still the preferable model for compensation. The possible alternative being outcome based compensation.

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5 Outcome based compensation in depth

Advertising is not the first domain in which incentive based compensation would be implemented. For years it has been successfully and less successfully applied in fields such as medical care and sports and real estate. To fully understand the underlying motives behind the model it is needed to look at the principal-agent theory. This theory explains the underlying mechanism of incentives in a principal-agent relationship. In our case, advertiser-agency relationship.

5.1 The principal-agent theory: a short overview

In their book The theory of incentives: the principal-agent model., Laffont and Martimort (2002) explain the basis of the theory. Principal-agent relationships arise whenever one party relies on the efforts of another to attain a goal set by the first party. This making the hiring person dependent on the others action. The hiring person being the principal, in this case the advertiser, and the person acting on behalf of the principal is the agent, in this case the agency. In this relationship several problems may occur. For instance delegation of a task to an agent with different objectives can be problematic, especially when information about the agent is imperfect (Laffont & Martimort, 2002, p2). The theory has two basic assumptions: Both parties are self interested, utility-maximizing actors (Heubeck & Scheuer, 2002, p4). The agent is risk-avers, while the principal is risk-neutral or at least less risk avers than the agent (Heubeck & Scheuer, 2002, p4). This means that the agent doesnt always necessarily acts in the best interest of the principal. Principal-agent theory studies this phenomenon and tries to provide solutions to this problem by proposing several contracts designed to align the incentives of the agent with those of the principal (Heubeck & Scheuer, 2002, p4). According to the theory, the output of the agents action is usually positively correlated with the revenue of the principal. Meaning, the more effort the agent puts in, the higher the revenue of the principal. This is also the case in advertising. Unfortunately the agent does not always have complete power over the output of his efforts. Other variables may influence the outcome in a positive or negative way, these are also called exogenous factors. In advertising outside factors influencing the outcome of the agent can range from competitors action, interest rate changes, shortages of critical parts or ingredients, bad weather, to unforeseen fashion trends (McBride & Associations, 2004, p7). All of

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these can be positive or negative. In The Tipping Point Malcolm Gladwell (2000, p3-4) describes how the shoe brand Hush Puppies experienced a revival. Seemingly out of nowhere some New York fashonistas had decided the un-coolness of the shoe made them particularly cool to wear. Apparently others were soon convinced and in little over a year sales rose from 30.000 pairs to 430.000. All this time the executives at Hush Puppies had no idea what happened, and could only try and surf the wave of their success (Gladwell, 2000, p3-4). This is a rather extreme example but illustrates that not all outcomes of campaigns (positive or negative) can be attributed to the agency, unless of course a direct link can be proven. More on this in the chapter about implementing outcome based compensation. Nevertheless, when these exogenous factors can be more or less neutralized or be left out of the equation, principal-agent theory states that the best solution for the principal to attain the optimal level of effort is to base the salary of the agent, directly on his effort (Heubeck & Scheuer, 2002). Thus, outcome or performance based compensation. The principal knows which amount of effort maximizes his own revenue, setting the compensation function so, that the agent self-interestedly chooses the optimal effort (Heubeck & Scheuer, 2002). This very logical theory is held back by the fact that the principal needs to be able to perfectly and cheaply monitor the efforts of the agent (Heubeck & Scheuer, 2002). Unfortunately there usually is information asymmetry between the principal and the agent, this for two reasons: The agent has better knowledge about the decisions he is taking on behalf of the principal (hidden information). The principal is not able to observe exactly how much effort the agent really puts forth, because monitoring is costly and precise measures of the agents behavior are not available, i.e. only the agent himself knows if he acted in the best interest of the principal and how much effort he put forth (hidden action).
From incentive contracts in team sports theory and practice. (Heubeck & Scheuer, 2002, p5)

Because of this hidden information and hidden action, the agent can put forth low effort without the principals knowing. Again to overcome this, the principal can base the compensation of the agent entirely on the output of his efforts. However, the greater the before mentioned exogenous factors, the weaker the correlation between the output and the efforts of the agent (Heubeck & Scheuer 2002, p5). This in turn exposes the agent to risk. As he will be compensated based on a variable he can not completely control. According to Heubeck & Scheuer this is not socially optimal for the principal agent relationship.

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Hence, in the case of advertising the principal has to make a tradeoff between the benefits of setting incentives for the agent and the cost of exposing him to risk.

5.2 Advantages of outcome based compensation

As seen in previous chapters there are a good number of reasons for adopting outcome based compensation, but there are also some reservations. In this chapter they are comprehensibly listed and discussed in more detail. 5.2.1 Overcome information asymmetry One of the reasons for advocating outcome based compensation is when behavior is difficult to observe (Davies & Prince, 2010, p17). This is the case in advertising, argue Davies & Prince, as creative staff is often withheld from direct contact with clients, which makes observing effort and creativity difficult. Also the increased complexity of campaign production as was described in chapter two, makes it even harder for advertisers to truly follow up efforts. As we saw in the comparison model of agency compensation by Mc Bride & Associations (2004, p2) in the previous chapter, there is no need to monitor labor in an outcome based compensation model. This entirely takes away the problem of information asymmetry as the advertiser can rely on the agencies self-interest to reach or exceed the pre determined goals. On the other hand, the agent-principal theory that was just explained, does say that exogenous factors may influence an outcome and thus generate risk for the agent. However, with the rise of the internet as an advertising medium (see chapter 2) a whole new set of metrics are now available which can help draw more accurate conclusions regarding certain consumer behavior. Although we should not pretend that better metrics can exclude exogenous factors. Therefore, Beals (2010) pleads for exchange of experience and learning from outcome based compensation, so advertisers and agencies can learn from each other, and can eventually neutralize the risks of outside variables. 5.2.2 Aligning incentives Since several advertisers and subsequently agencies have made the shift towards outcome based, we can hear first hand from advertising professionals how incentives change with the model. For instance a quote from Jeff Hicks, CEO of Crispin Porter + Bogusky, an world renowned and highly creative agency: There isnt a correlation between hourly billing and better results. Our incentive was to work more hours and work slower. The clients incentive was to sell more stuff. From Bloomberg article: P&Gs ending billable hours forces Grey to show chips ads work. (Schweizer, 2009)

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This is exactly what the agent-principal theory stands for. When both parties agree on the same goals, and both parties earn more relative to the attainment of these goals, the self-interestedness of the agent and the advertiser pushes them towards the fulfillment of those goals. To optimally profit from the freshly aligned incentives, Chong and Eggleton (2007) make a case for extending the compensation model to managers and executives. They made a study on how the performance of managers in both outcome based and performance based models evolved. The study examined the effects of information asymmetry and organizational commitment on the relation between the extent of reliance on incentive-based compensation schemes and managerial performance. The results are based on the responses of 109 managers, drawn from a cross-section of Australian manufacturing companies. The results provide evidence of higher managerial performance for managers in incentive-based compensation schemes in high information asymmetry situations (Chong and Eggleton, 2007). Which as we saw in the previous part on information asymmetry, does apply to advertising agencies.

Figure 5.1: The impact of the interaction between reliance on an incentive-based compensation scheme and information asymmetry on managerial performancelow value dimension of organizational commitment sub-sample.(Chong and Eggleton 2007, p326)

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5.2.3 More autonomy for the agency Once the advertiser is convinced the agency has his best interest at hearth, because of the shared goals, he will no longer be concerned about how the agency spends his time and resources, which will results in more autonomy for the agency. According to journalist Kirsten Schweizer (2009), the advertiser and agency develop more of a partnership role, which leads to more client trust and willingness to take risks. Schweizer goes on to quote Gaston Legorburu, worldwide creative director at Sapient Corp.: "The client is much more likely to give you a seat at the adults' table and talk about strategy if you have some skin in the game," (Schweizer, 2009) 5.2.4 Longer term relationships With more autonomy comes a closer partnership between the advertiser and the agency. As Davies and Prince (2010) have proven, the more the agency and client are involved, the higher the switching costs for the advertiser. It becomes more expensive and more time consuming for advertisers to switch agencies and get the new agency back on the same involvement level as the previous agency was. This due to the time it takes for an agency to master the business of the advertiser (Davies and Prince 2010). The graph below illustrates the evolution of costs as the relationship progresses. It shows high set-up costs at the beginning of relationships which decrease over time. While exit costs, start low and increase over time as the advertiser and agencies relationship becomes more mature, the advertiser grows more dependent on the agency. Leading to a relationship with low setup costs, and a high level of trust.

Figure 5.2: Indicative Switching Costs Over Tie-in Age of a Typical Client-ad Agency Relationship (t), (not to scale). Set-up costs treated as average costs per year from the beginning of the focal relationships that gradually erode either economically as they become sunk or written off, or emotionally (as they are dismissed as unimportant or forgotten). (Davies and Prince 2010)

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5.2.5 More sincereness from the agencies Not only will advertising agencies have to put more effort in, clients as well will have to step up their game. In interviews with advertising professionals about outcome compensation and what they think about it, a lot of what if questions came up. These are some examples of the concerns from a several creative and account personnel of Belgian advertising agencies. For obvious reasons they rather not have their name or agency mentioned. What if we make an amazingly good working campaign, but the website of the client is a monster that has no usability at all? What if clients turn down our greatest idea and make us execute yet another emptyheaded campaign with toothpaste smiles? What if we run a successful campaign that lures people to the shops, but the client didnt ramp up its supplies, so they miss out on sales? What is interesting about these questions is, up until now, advertising agencies in most cases dont make a huge point out of the weaknesses of their clients. There is not much to gain except the possibility of upsetting your moneymaker. As one strategist said. But this also suggest that once the advertising people do have a real bone in the fight for consumers, clients might be getting a lot more honest and sometimes hard to swallow feedback from their agencies. Thus marketing managers on the advertiser side should be aware of the often luxurious position they have had so far. To summarize the above, performance based compensation offers creative freedom and authority for agencies. Whereas labor based compensation requires the advertiser to closely monitor every move of the agency to determine whether his money is well spent, without a promise of success. Therefore, one would expect agencies to generally prefer performance based compensation over labor based (Davies and Prince 2010, p17). Unfortunately there is a flipside to the medal. In the next part we will discuss the downsides to performance based compensation.

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5.3 Downsides to outcome based compensation

The chapter on performance based compensation in practice already touched on some downsides of the model. The following are the main downsides.

5.3.1 Risk This thesis already discussed the possible negative risk of exogenous factors influencing the outcome of campaigns. But we also saw the Hush Puppies example how these factors can have a positive impact. And more so like David Beals (2010 argued in his Adage article, that these risks should be studied and shared by the industry as a whole to learn how to offset them. But next to this there is also the risk attached to being the first in trying new things. This is also the case with trying a new business model. Even though a lot of studies and several examples are at hand from practice, there are still a lot of uncertainties. On top of this advertising agencies are like Dana Perry and David Weiss (2012) from 4As argue, are fragile enterprises. These are the reasons: Agencies are often the first to feel the impact of pending economic declines. Agencies are often one of the last sectors to turnaround in an economic recovery. If the Agency isnt able to sell its time, it loses the opportunity cost. In a relationship based business, major client contracts are mandatory for clients and discretionary for agencies: o Typically cancelable on 90 days notice in spite of investments made on behalf of the client in people, technology and real estate.
Retrieved from: Agency compensation task force operations management education. (Perry & Weiss, 2012, p11)

David Beals (2010) argues in an Adage article that most agencies, especially the publicly-held ones, would rather steer clear of these risks inherent to performance based compensation. Because despite all the flaws of the labor based system, it is something that gives the agencies a certain level of assurance of getting planned revenue and a reasonable profit. While performance based compensation may give them a shot at a higher profit, they are not willing to take the risk of losing the entire profit altogether (Beals, 2010). Which might say something about the confidence level of some agencies about the effects of their advertising. Nevertheless these risks are the dominant reason why agencies might not jump into a new compensation model willing, nilling.

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5.3.2 Costs According to Heubeck and Scheuer (2002, p25), implementing new incentive systems based on unfamiliar performance measures is always costly for both paries. These are the costs they foresee for a compensation model shift: Cost of finding a correct mechanism o Cost of research for the right performance measures. o Cost of staff training in selecting and appraising measurements. o Cost of failure when using the wrong measures. Transaction costs of bargaining between the two parties.

Yet there is also a perspective gain, as since the effects of campaigns are measured, media will be better targeted, which should result in lower media spending. (Burton 2009, p6). As for the agency there is the perspective of gaining more profit than would be possible with labor based compensation when goals are reached or exceeded. 5.3.3 Lack of standards Just like it took the agencies in the early 20th century some time to come to the 15% rule on media and like it took agencies and advertisers in the eighties several years to establish their prices, it will take the industry some years of learning before they can all agree on some unifying compensation standards for pre defined goals. In the following chapter on implementing outcome based compensation an overview of available measures is provided. This vast list alone illustrates the minefield of metrics that is being entered. In this a large role is to be played by the current consulting firms and advertisers associations. McBride & Associations is one of the many that provides clients with survey templates for both advertisers and agencies to come to terms on campaign goals. They also provide indications on how to compensate depending on the level of goal achievement. These studies are of course too expensive for smaller advertisers and agencies, but David Beals (2004) wrote in Adage he believes the same will happen as when the industry switched from commissions to labor-fees. The compensation method of the larger advertisers gravitated to the smaller ones. Which brings us to the next chapter: Outcome based compensation in practice where well see how two of the largest advertisers in the world are making the switch.

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6 Outcome based compensation in practice

6.1 Coca Cola makes the switch
In 2009 Coca-Cola Co. announced it would adopt an output based compensation model (Mullman 2009). Their model promises agencies nothing more than fair compensation for the production costs if they don't perform, but profit markups as high as 23% if their work hits top targets. Coke disclosed its plans at the Association of National Advertisers (ANA) Financial Management Conference in Phoenix on April 20 of 2009, saying it wanted to nudge the industry into adopting value-based models as a standard practice. If it succeeds, agencies accustomed to being able to book profits long before they deliver work won't have that sort of certainty anymore. Cokes director of worldwide media and communication operations, Sarah Armstrong who is the driver behind this initiative stated: "We want our agencies to earn their profitability, but it's not guaranteed. We need them to be profitable and healthy, but they have to earn it through performance". Coke's shift from paying a flat fee based on hours worked began in five markets last year. According to the press statement of Coke, the model would roll out in 2009 in at least 35 markets and will include all of the company's ad- and media-agency relationships by 2011. Jeremy Mullman (2009), journalist at Advertising Age, who wrote an article about Coca Cola entering the outcome based compensation era, says that until 2009 many marketers have discussed and claimed to be in favor of the new model, but few have attempted to apply it. According to him Procter & Gamble has long been the pioneer in this, but only uses it on twelve of its brands. At the ANA Financial management Conference, Ms. Armstrong pointed out that the process involved considerable give and take with agencies that were briefed on Coke's plans and were given opportunities to voice concerns. "There were some pointed questions," she said. "But our agencies read the trades, and they know what P&G did. They knew at some point someone would take this path; they just didn't know it would be us." At the conference Mullman spoke to some of the agency executives of Coca Cola to hear their take on the new model. Coke worldwide employs dozens of agencies, among which are some of the most creative in the industry, including Wieden & Kennedy, Crispin Porter & Bogusky, Starcom MediaVest Group and Mother, to name a few. According to Mullman some agency executives, speaking privately, said they

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couldn't argue with the theory behind the shift, but had concerns about how it might work in practice (Mullman 2009). He quoted one senior executive at one of Cokes agencies saying: "Look, if you're talking about getting paid more because you're adding value to a project, I think that's terrific, the tricky part is how you define value." 6.1.1 How Coke's new compensation system works In the same article, Mullman (2009) describes how the new model of Coke determines the value of the agencies work. This is done on the basis of a range of factors. Among those are: the strategic importance of the work, the talent involved and whether the work can easily be duplicated by other agencies. (This is important to Coca Cola as one campaign will need to be adopted in many countries by many agencies.) Once those factors are set, the value for the attainment of each is set. Coke pays some upfront costs and later they determine how much, if anything, the agency receives on top (Mullman 2009). If all targets are met the agency can reach a profit margin of 23% which is well above the industry average of 12% to 15% (Beals & Beals, 2001, p8). If on the other hand all targets are missed, the agency dos not make any profit, and is only compensated for the costs incurred (Mullman 2009). Jeremy Mullman summarized the approach as follows: Before: Agencies and Coke negotiate in advance how much profit the former will see on a given project. After: Agency is guaranteed only recouped costs, with any profit coming only if certain targets are met. Before: Agency decides what Coke should pay for a project based on the time it expects to expend on it. After: Coke tells agencies how valuable a project is based on strategic importance, whether other agencies could deliver the same outcome, and other factors. From Adage article Coke pushes pay-for-performance model (Mullman, 2009)

Although Coca Cola announce the shift in the economic downturn of 2009, Ms. Armstrong denied the switch was made to save costs. According to Armstrong, the shift started in 2006. Whether or not Coke had saved costs with the new model in the first five test markets, she didnt declined to reveal (Mullman 2009). Asked if agencies will take the same creative risk as they used to, in the new model, Ms Armstrong said: "That has not been a concern, I have a fundamental belief that

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our agencies are competitive enough that they are going to bring their A-games no matter what." 6.1.2 Interview with marketing VP of Coca Cola After the announcement in 2009 Coca Cola hasnt release reports on the results yet, but in 2010 they did extend their view on compensation to their marketing research suppliers. Saying, if it works for our creative agencies, it can work marketing research too. After announcing this news the marketing VP if Coca Cola gave an interview on the subject to Brian Tarran of Research Live. This is the transcript: For the benefit of those not in attendance, can you recap what you said relating to pay-for-performance? What I said is that nobody should take profit for guaranteed. Brand marketers dont take profit for guaranteed. If your product doesnt meet expectations you get penalized. We cant go out and tell our consumers: Look, I spent so much money on buying this ingredient and that ingredient, and I spent so much money on marketing I deserve a profit. Why shouldnt it be the same all the way down the value chain? Thats the thinking behind it. Yes, it is going to be an uncomfortable journey for us and our agencies but we genuinely believe it is required. We have done it with our creative agencies, and if it can work with creative agencies, why not with research agencies? The key is to define what performance is. If you link it to profit and volume and share and so on, that might be a bit unfair to the agencies, because there is a lot that goes on between what an agency delivers and what happens in the marketplace, so you cant be holding them responsible for a poor [market] outcome. So, the definition of performance is very crucial, and when we start working with people in this way well define that in a way that is comfortable to us both. So no examples as yet? No, this is a journey we have just started on. Weve spoken to a couple of our partners and they are on board, but its going to take some time. I can quite understand the benefits of this model to the end-client, companies such as yours. But would you say there are advantages here for suppliers? Absolutely. They can make much more money if they do a really good job. What prompted you to go down this road? Is it purely a cost/return thing? No, no. In the context of the whole presentation, the focus was all about change. The reality is I cannot change if my agencies dont change. I cannot change if my agencies dont support me. I cannot go and tell my people internally that I have changed 50

without a proper backup system. So unless everyone raises their game we will not be the change agents within the company. Whats in it for [agencies] today to change the game? Practically nothing. No risk, no reward. If they do a fabulous job they still get the same money same as if they do a piss-poor job. But if they now realise they can make more money they will suddenly put different calibre talent it will attract different kinds of people, so this will hopefully act as a trigger for a bigger change. What was the audiences reaction like when you broached this subject? I think they were probably a bit surprised and shocked, but I didnt stay long enough to listen to all the feedback. As I said, I know that it is uncomfortable but is it required? Absolutely. So accept it and lets move on. Is this something you will be pushing the whole industry to follow or is Coca-Cola happy to do it by itself? It might be easier if it becomes an industry-wide initiative, but then I also recognize that anything that has to be industry-wide can also become quite time-consuming as everyone brings their own point of view. It could take forever. While I would be very happy to play an industry-wide role on this, the train has already left the station for us. We will be going ahead and doing this. 6.1.3 Current Coca Cola Inc. contracts in Belgium An in informal interview with Bernard Pollet (2011), an employee of the current agency of Coca Colas activation in Belgium, Square Mellon, says they have so far not received a renegotiation on existing contracts. On the contrary, the previous contract was being extended into the future. This current contract is behavior based with bonus clauses if certain KPIs are met. Key Process Indicators are specifically described goals for the campaign. In case of activation advertising, KPIs range from sampling cans of Fanta with a smile, over making sure the sampled drinks are perfectly served at the right temperature, to defining how many units should be distributed among which age groups, etc These KPIs only apply to how a campaign is executed, not to the success rate of the campaign. 6.2 Change at Procter & Gamble Even before Coca Cola, Procter & Gamble started experimenting with outcome based compensation. In an article in Adage, Jeremy Mullman (2009) tells the story. P&G is adopting a system in which one agency is appointed as lead contractor of one P&G brand. As Grey is brand agency leader (BAL) for Pringles chips (Schweizer, 2009). Being a P&G brand agency leader includes maintaining control over hiring, budgets and payments for other agencies (Mullman, 2009). In 2009 this system was being applied on 12 brands which was 5 more than 2008. In media spending this system accounts for 3.1 billion, which is 26% P&Gs media budget. Among these 12 51

brands are eight of P&Gs 21 billion dollar brands (Mullman 2009). The article quotes P&G spokeswoman Martha Depenbrock saying: I wouldn't be surprised if more brands adopt this. It's not a corporate mandate, but it appears to be working well. The system fosters better collaboration and holistic-marketing plans, and it's more cost-effective for P&G and agencies. Ms. Depenbrock further explains: A BAL or Brand agency leader, gets pay for performance, based on negotiated value of the work to the brand rather than the hours worked. This fee increases or decreases based on brand sales, market share and agency evaluation.

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7 How to apply outcome based compensation

After discussing all the up and down sides of outcome based compensation, and seeing how large advertisers are seemingly happy with the outcome and plan on extending to more brands, one might want to set the next step and also try it in ones own company. But how to start?

7.1 Defining Agency Goals

From previous mentioned ANA (2003, 2010) studies we know companies try to gradually slide in to the new system, by applying it in parallel with more familiar models. And we know what performance measures are currently most popular among the incentive programs. Agency performance reviews (78%), sales goals (72%) and market share goals (34%) (ANA, 2010). David Beals, the outcome based compensation evangelist and author of the ANA reports, and Agency compensation: A Guidebook wrote a hard hitting article in Adage (2010) in which he gives some clear uncut advice to advertisers and agencies who are considering the switch, but are overwhelmed by the perceived challenge. These are his recommendations in a nutshell compiled with guidance material from consulting firm McBride & Associates (2004: Beals (2010) advices both marketers and agencies to start by leaving compensation off the table, but to engage in a serious talk in which both parties try to find common ground on the definition of measurement and what the added value of the agency to the clients business is expected to be. According to Beals this is a conversation far to few advertisers have with their agency. He argues that regardless of the compensation method, a clear understanding of objectives and role, will always lead to better work and improved agency profitability. McBride & Associates have like many consultancy firms templates ready to help streamline the discussion and focus on the right priorities. In this case it constitutes of a survey of 40 questions, specially designed to uncover dualities in the relationship (McBride & Associates, 2004, p10). These are a few of the questions:

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Figure 7.1: Questionnaire to uncover dualities. Retrieved from: Carrot vs. Stick: Incentive Compensation. (McBride & Associates, 2004, p10)

Meanwhile Beals (2010) goes on to give some direct advice to marketers and agencies separately: Marketers: Try to focus on the outputs of the agency rather than the inputs that go into the work. Treat your agency's work as an investment to grow your business rather than just as a cost. This outlook will better inform the most basic laborbased fee discussion and is crucial for a serious discussion of value-based compensation. From Adage article: Why Value-Based Compensation Is Going Nowhere Fast. (Beals, 2010) Agencies: You need to focus your attention on the "value" your clients will find most important, and be willing to put your money where your mouth is by putting some significant skin in the game. Few marketers, and certainly very few of their procurement professionals, will be interested in paying more because your ad ran in more countries or won some awards. A focus on significant and measurable results (e.g, sales, improvement in brand preference, qualified

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lead generation, etc.) and a compensation proposal structured on a "you pay for results" basis will get more serious attention from most clients. From Adage article: Why Value-Based Compensation Is Going Nowhere Fast. (Beals, 2010)

7.2 Defining campaign goals

Once the advertiser and the agency are clear on what the added value of the latter should be, they can move on and set objectives for specific campaigns. In their paper on advertising effectiveness, Hairong and Leckenby (2004) give some explanation on the different functions goals and objectives serve (p4). First they provide direction for both parties, and secondly they serve as means by which results can be evaluated. As to how well a campaign worked, goals define the well. Does a campaign succeed if it generates profit for the advertiser, or when brand awareness among the target audience increases? And like Beals also said, Hairong and Leckenby define the most important role of objectives as a means to force those involved into gaining a deeper understanding of the task at hand and the underlying campaign problems (p4). Taking all opinions in account, also with respect to principle-agent theory, campaign goals should be set as follows: Campaign goals should be set in agreement with both parties. Metrics that quantify the attainment of these goals correctly should be selected. Multiple metrics are better for the reliability of the measurements. Metrics should be transparent and accessible for both advertiser and agency. This to avoid information asymmetry. The accuracy with which these goals are set will can or brake the compensation based model. In Freakonomics (2009, p68-70), the bestseller book of Steven Levitt and Stephen Dubner about incentives, an example is provided from the world of real estate. In which agents get paid with the incentive system of a percentage on the selling price of houses. Despite this seemingly appropriate outcome based compensation that is, brokers in the research didnt sell the houses on the highest price possible, but rather tried to make their client settle on the first decent offer that came about. Levitt and Dubners research showed that brokers did wait longer for a higher bid when they were selling their own houses. This discrepancy in effort when it comes to selling their own house, versus the one of a client can be found in their incentive. First of all, a 6 percent commission is typically split between the seller's agent and the buyer's. Each agent then kicks back half of her take to her agency. Which means that only 1.5 percent of the purchase

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price goes directly into the agent's pocket. Thus, the higher the house is sold the more the real estate agent earns. A schoolbook example of performance based compensation. On the sale of a $300,000 house, the agents personal take of the $18,000 commission is $4,500. This seems like a decent amount. But what if the house was worth more than $300,000? What if, with a little more effort and patience, the agent could have sold it for $310,000? After the commission, that puts an additional $9,400 in the clients pocket. Yet the agent's additional share, the personal 1.5 percent, is a mere $150. The extra money that is supposed to incentivize the agent, is after al not so convincing to put up with the extra time and energy that is needed, for a mere $150. Levitt and Dunbar go on to explain about the difference between home brokers selling their own houses compared to those sold for clients, but the short answer is: The additional $150 doesnt give the broker enough incentive to push for a higher selling price. As the agent-principal theory about incentives applies the same to broker-clients as to agency-advertiser, this could happen in advertising just as much as in any field where this theory of incentives applies. Therefore it will be crucial for the industry to find the right incentives.

7.3 Measuring goals

As explained before, choosing the right metrics is the key to success and will ultimately influence every decision being made. This is well explained in the much referenced 1998 paper by Hauser & Katz: Metrics: You are what you measure!. If a firm measures a, b, and c, but not x, y, and z, then managers begin to pay more attention to a, b, and c. Soon those managers who do well on a, b, and c are promoted or are given more responsibilities. Increased pay and bonuses follow. Recognizing these rewards, managers start asking their employees to make decisions and take actions that improve the metrics. (Often, they dont even need to ask!) Soon the entire organization is focused on ways to improve the metrics. The firm gains core strengths in producing a, b, and c. The firm becomes what it measures. From Metrics: You are what you measure! (Hauser & Katz, 1998, p1) That said, Hauser & Katz go on to determine seven pitfalls that lead to counter productive metrics. It is important to note that the research of Hauser & Katz is regarded as very important and is used as reference by many researchers, however their field of expertise lies in manager-employee relationships and incentive programs within firms. So not all their recommendations apply to the advertiser-agency relationship. This short summary attempts to filter out the relevant parts for this

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thesis. Below are the seven pitfalls of Hauzer & Katz, some are self-explanatory while others need some elaboration.

Figure 7.2: Seven pitfalls that lead to counterproductive metrics. Retrieved from: Metrics: You are what you measure! (Hauser & Katz, 1998, p24)

Delaying rewards departs from the assumption that employees and managers, change jobs and might not be around when the result of their work comes in. Therefore Houser & Katz recommend to use metrics that are measurable today, but impact the future goals (p3). Making metrics hard to control builds further on the first point, meaning that one should choose metrics that are directly affected by, in this case, the campaign (p5). A car safety campaign, may not directly reduce the number of accidents, but from consumer calls to an info line one could possibly determine a rise in awareness. Losing sight of the goal is fairly self-explanatory. Hauzer & Katz give the example of a research department that rewarded employees on the number of ideas generated, which created a culture where the researchers were no longer open to ideas from the outside world. To counter this not-invented here-syndrome they should switch to a culture that values all ideas no matter their source (p6). According to Houser & Katz, choosing metrics that are precisely wrong is a mistake often made by managers desire to precisely measure things. But precision can be misleading. It is more important to Measure what is truly important, not what is easy to measure. Vaguely right is better than precisely wrong! (p9). Thinking narrowly is about what advertising people would probably call: out of the box thinking. Houser & Katz give the example of Scott Cook, president of Inuit software, who, instead of optimizing their service center by improving waiting times etc, tried to make the service center dispensable as a whole. This by measuring the return rate of questions. If a question was called in, the employees had to bring it to the appropriate department, which had to solve the problem. If the question didnt come up again, they had succeeded. Thus, instead of trying to improve the answers to questions, they tried to prevent questions altogether (p10-11). 57

Building on the research of Houser & Katz, Jorge Garcia (2012) developed six guidelines for good metrics: Listen to your users. The driver for the metric is the business. Listen to what your stakeholders have to say and understand what they want to achieve. Knowing how the stakeholders work will not only help you define the goal, but also lead you to their expectations. Compare your metric against these expectations. Prioritize elements for major effect. Consider for your metrics those components that will have greater impact on your metrics and that will you be able to affect or improve. Stick to your objective. Always keep your goal in mind and refer to your stakeholders to keep you on track. Keep informed and solicit their feedback. Establish your initial expectations. When defining metrics, try to define your expectations as well. Perhaps a reasonable value is already known, or you can estimate a value based on experience. Avoid uncertainty. As much as possible, define metrics based on your available facts. Establish your calculations based on data that is available and under your control. Test and improve. Test your metric against your expectations and take your stakeholders opinion into account. Make it possible for your users to contribute to evolving your metrics. From Make sure metrics dont kill your business (Jorge Garcia, 2012) After these pitfalls of selecting metrics, it is time to look at the currently most popular evaluation metrics in advertising: Agency performance reviews (78%), sales goals (72%) and market share goals (ANA, 2010). Agency performance reviews are not based on actual results of a campaign, but on how the agency and the advertiser perceive the effort and outcome of the agencys work. McBride & Associates (2002) have created a template for such agency evaluations, of which a sample is presented below. The general idea is to have both parties fill out and appraise the other in a predefined measurement system. This tells the one party how he is perceived by the other. This exposes weaknesses or strengths of both the advertiser and the agency, which can either be fixed or exploited. In appendix 1 are two small samples of such questionnaire. The first for the advertiser, the second for the agency. McBride & Associates (2002, p12) present in their Judging excellence paper an additional Gap analysis, which provides further insight on problem areas in the client-agency relationship. In this analysis both parties need to answer questions on

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the success-level of the agency on different aspects of their work. Each aspect is given a weight for importance. The attainment of these aspects is mapped on an Action matrix against their importance. The Action matrix is designed to show the satisfaction gap between success-levels and importance of the different aspects of the agencys work. The result is a clear representation of the gaps between performance and importance, of problem areas. (See appendix 2) Next to agency appraisal there are many, more quantifiable metrics. As already mentioned, the two other most used incentive triggers: sales goals and market share goals (ANA 2010). But next to those there is a plethora of metrics available to track almost every aspect of a campaign. Especially for online, measurements and tools to measure are available in abundance. To give a list of all the available options would be almost impossible and this list would probably be outdated by the time this thesis is read. Tools like Google analytics keep improving and add new possibilities. For instance last October (2011) Google Analytics added real time tracking, which makes it possible to see exactly how many people from which cities, using which browsers, etc are visiting which particular part of your site at this very second. (Cowley, 2011). However to give an impression of what aspects can be measured David Berkowitz (2009) compiled a list of 100 Ways To Measure Social media. This list is aimed at social media campaigns but many of these metrics may just as well be used to track other campaign parts. (See appendix 3) As impressive as the Berkowitz list may seem, it is far from complete. To give a quick example, Bounce rate is not on the list. It is a measure that shows the amount of people that leave your website without clicking through to other pages and just leave almost immediately. It is an important measure as it can show that the website does not provide the content people expect, or that the website is listed under the wrong categories, which make it show up to people who are not interested. Bounce rates are closely linked to conversion rates. A conversion rate shows how many of a websites visitors clicked through and executed a desired action (i.e. buying in a web shop, sharing something on their Facebook, ). Thus a high bounce rate will make the conversion rate look like a failure, which might not be true. This is just a rough example to illustrate that a lot of knowledge will be needed at both the advertiser and the agencys side, to have meaningful discussions about these metrics and be sure they are measuring the right things and are interpreting the results correctly.

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7.4 Allocating appropriate compensation

Once both parties have decided on goals and measurements it is time to determine the actual compensation of the agency. These type of numbers however are mostly kept between the advertiser and the agency. So not much indication is publicly available. However Coca Cola did disclose, they give their agencies a 30% profit markup over their initial costs an a given project. This comes down to a profit margin for the agency of 23% (Mullman, 2009). Compared to the current industry average of 12% to 15% (Beals & Beals, 2001, p8) that is huge. Some more guidance on how to distribute profit can be found in material from McBride & Associates (2004, p12). They advice to base profit on more than one criteria and to include some measure of actual advertising effectiveness. (i.e. Brand equity, awareness) These criteria should be given an importance rating that determine the profit percentages (see below). M & A do warn that incentives should not substitute fair pay, but be a reward for above average performance. Experience has learned M & A that agencies prefer cash rewards with no strings attached. However stocks or warrants to buy stocks at a fixed price could also be used, but then the agency should be free to sell the stock whenever and how much they please (Mcbride & Associates, 2004, p12). The model below represents the allocation of profit split between three equally important criteria. The circle below represent the entire possible profit of the agency. Even though the criteria are equally important, for incentive reasons, each has its own levels of qualification. For example if in this case the agency is not able to reach the sales goals, but raises equity by 16% and exceeds most expectations on agency evaluation, its profit would be the following: Nothing for the sales goals, 67% of the equity profit and 100% for agency evaluation. Meaning the agency would in this case have reached 55% of the total possible profit.

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Figure 7.3: Allocation of profit. Retrieved from: Carrot vs. Stick: Incentive Compensation. (McBride & Associates, 2004, p12)

This is just one example of the many possible. The general advice seems to be to experiment. Tim Williams president of Ignition Consulting Group and promoter of value based compensation, wrote that the leaders of creative agencies who have adopted the new model, Apply as much creativity to pricing as they do to client business. (Williams 2007)

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General Conclusions
This thesis started off with the observation that the compensation model of fullservice agencies hasnt changed significantly in more than eighty years, while almost everything else in the communication landscape has been transformed dramatically. Technology and media changes, with the internet as the main driver, have led to increased advertising clutter, audience fragmentation and increased advertising avoidance. These changes have over the years redefined the role of the advertising agency. From a supplier of print, TV and radio ads, to an increasingly more involved partner for the advertiser. From the analysis of these changes we derived four import conclusions in respect to the compensation model: Increasingly more difficult to reach consumer. Too much advertising on too many media. Higher production costs of advertising. Which makes the commission based model less useful. Production is becoming more and more complex. Which makes it harder to track costs, thus to compensate based on labor. It is becoming easier to measure the effects of advertising. Which makes performance based compensation more realistic.

As these conclusions seemed to create the right context for a compensation model shift we looked at the usage trends of compensation models over the past two decades. These show that despite the many factors in favor of outcome based compensation, agencies still get compensated largely based on hourly fees and production costs regardless of the effects of the campaigns they produce. Although in more recent years more and more advertisers have started add incentive compensation to their existing models. To determine clear pros and contras, behavior based and performance based compensation were compared and discussed in detail. Behavior based compensations largest downside is the lack of incentive for the agency to produce more effective campaigns. These non aligned incentives of the advertiser and agency lead to distrust and frustration on both sides, as illustrated with the ACC strike in Belgium and the discrepancy between agency profit expectations and reality. The new contender to the old model, performance based compensation, has as largest advantage that it aligns incentives of advertisers and their agencies. Analysis of the principle-agent theory and literature from advertising practitioners prove outcome

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based compensation to be the best way to overcome these incentive issues and make information asymmetry irrelevant. Which would further result in more autonomy for the agency and longer lasting relationships with their clients. The advantages for both the agency and the advertiser are: Information asymmetry becomes less important, as the agency now has the same incentive as the advertiser to produce the most effective campaign. The advertising agency gains more autonomy to create campaigns. Since the profit of the agency is at stake, the advertiser can trust that the advise of the agency is in his best interest, and not a way of the agency to work more hours on the assignment. The new model will create longer term relationships between advertiser and agency, which is beneficiary for both parties. Researchers Davies and Prince have found that performance based contracts lead to closer partnerships between principal and agent, which result in higher switching costs for the principal in case he would want to switch agents. If the advertising agency is able to create effective campaigns and reaches the set goals, he will gain much higher profits. And in return the advertiser evidently profits from more effective campaigns for his brand or product.

After analyzing the upsides, the downsides were considered: Financial risk for advertising agencies if they are not able to produce successful campaigns. Cost of both switching of models as the costs of experimenting with different metrics and reward allocation bases. Current lack of standards. Which is a cause of the experimentation costs. Performance based compensation can work counter productive if it is not applied right. This conclusion is derived on the premise that the agentprincipal theory that applies to home brokers, applies the same to advertising agencies. The case of Levitt and Dunbar showed that home brokers, despite the apparent performance based model, did not sell the houses of their clients at the highest possible price.

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Of these disadvantages the last three will diminish over time as more knowledge is gained and passed on trough the industry. We saw two of the worlds largest advertisers take up this pioneering role: Procter & Gamble and Coca Cola. The case of Coca Cola and its advertising agencies showed that the model seems to be a success as the company expands this approach to their marketing research agencies. Results and data are scares, but interviews with practitioners suggest positive results. The toughest part however remains actually making the switch. Therefore advice from several sources but particularly from David Beals and McBride & Associates was compiled to give some insight in how to take those first steps. Start by trying outcome based compensation in parallel with older models. Define agency goals: Both advertiser and agency need to engage in a serious conversation of what value needs to be added. Define campaign goals based on multiple metrics that are transparent and accessible for both parties. Metrics should quantify the attainment of these goals and be affected directly by the campaign output. Allocate the right profit to the selected criteria. Reevaluate the compensation model on a regular basis

Based on the above research this thesis concludes that performance based compensation, if applied correct, is a better alternative to behavior based compensation for the full service advertising agencies of today. Once one starts to investigate outcome based compensation, and looks at the current state of advertising and the downsides to labor based compensation it becomes very hard not to see how outcome based compensation can provide the answer. If agencies are truly convinced about the value they create for their clients, they stand to make much higher profits and have longer more sincere relationships with their clients. Advertisers on the other hand will get more reassurance about their goals being met and can put much more trust in their agencies as they will also have some of their skin in the game. As a consequence of course advertisers will truly need to know up front what they want their agencies to achieve, and agencies will truly have to be serious about the effectiveness of their advertising.

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Certainly before reaching this utopic state of efficiency, much work needs to be done and many times the model will have to fail before reaching maturity. But in the long run this price might well be worth it for both parties. And like David Beals reasons, if this switch of compensation models is anything like the previous switch in the eighties, than the first phase is already happening. Back then it were also the large advertisers that lead the dance. Right now several large advertisers are already using it. Therefore this thesis concludes that outcome based compensation is well on its way. For some not fast enough, for others too fast, but it is merely a question of when it will arrive at Belgian agencies rather than whether it will.

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Reference list
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http://www.marketingprofs.com/articles/2004/1250/evolve-or-die-the-changing-model-of-theadvertising-agency Wilson, F. (2009, November 29th) How to make money around free content. Wired Magazine [Weblog] Retrieved from: http://howto.wired.com/wiki/Make_Money_Around_Free_Content Wright, T. (2007, June 4) Setting Campaign Goals and Metrics for Success. Search Engine Watch [Weblog] Retrieved from: http://searchenginewatch.com/article/2065114/Setting-CampaignGoals-and-Metrics-for-Success

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Appendices
Appendix 1: Agency performance questionnaire sample
Retrieved from: Judging excellence: Agency Appraisel (McBride&Associates, 2002, p9-10 Questionnaire for the advertiser:

Questionnaire for the agency:

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Appendix 2: Example of an agency gap analysis

Retrieved from Judging excellence: Agency appraisals (McBride & Associates, 2002, p11-12) The Gap Analysis is based on a two dimensional appraisal of an advertising agencys performance. It can be either a one-way or two-way process (i.e. the agency evaluates the advertisers management too). What makes this tool unique and more actionable than conventional processes is the fact that the respondents assign an importance rating to each attribute as well as a performance score. By determining where the largest gaps are between importance and performance, it is possible to establish a hierarchical ranking of the most sensitive areas of both strength and weakness in the relationship.

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The top chart shows some hypothetical scores from the questionnaire on the preceding page. Since most of the scores fall in the upper right quadrant one might conclude that the Agency is performing quite well. However that would be mistake as the Action Matrix in the bottom chart shows. When you focus on the Satisfaction Gaps, its clear that the Agency needs to take some remedial action in five of the six areas being appraised.

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Appendix 3: Metrics list

Retrieved from 100 Ways To Measure Social Media (David Berkowitz, 2009): 1. 2. 3. 4. 5. 6. 7. 8. 9. Volume of consumer-created buzz for a brand based on number of posts Amount of buzz based on number of impressions Shift in buzz over time Buzz by time of day / daypart Seasonality of buzz Competitive buzz Buzz by category / topic Buzz by social channel (forums, social networks, blogs, Twitter, etc) Buzz by stage in purchase funnel (e.g., researching vs. completing transaction vs. post-purchase) 10. Asset popularity (e.g., if several videos are available to embed, which is used more) 11. Mainstream media mentions 12. Fans 13. Followers 14. Friends 15. Growth rate of fans, followers, and friends 16. Rate of virality / pass-along 17. Change in virality rates over time 18. Second-degree reach (connections to fans, followers, and friends exposed - by people or impressions) 19. Embeds / Installs 20. Downloads 21. Uploads 22. User-initiated views (e.g., for videos) 23. Ratio of embeds or favoriting to views 24. Likes / favorites 25. Comments 26. Ratings 27. Social bookmarks 28. Subscriptions (RSS, podcasts, video series) 29. Pageviews (for blogs, microsites, etc) 30. Effective CPM based on spend per impressions received 31. Change in search engine rankings for the site linked to through social media 32. Change in search engine share of voice for all social sites promoting the brand 33. Increase in searches due to social activity 34. Percentage of buzz containing links 35. Links ranked by influence of publishers 36. Percentage of buzz containing multimedia (images, video, audio)

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37. Share of voice on social sites when running earned and paid media in same environment 38. Influence of consumers reached 39. Influence of publishers reached (e.g., blogs) 40. Influence of brands participating in social channels 41. Demographics of target audience engaged with social channels 42. Demographics of audience reached through social media 43. Social media habits/interests of target audience 44. Geography of participating consumers 45. Sentiment by volume of posts 46. Sentiment by volume of impressions 47. Shift in sentiment before, during, and after social marketing programs 48. Languages spoken by participating consumers 49. Time spent with distributed content 50. Time spent on site through social media referrals 51. Method of content discovery (search, pass-along, discovery engines, etc) 52. Clicks 53. Percentage of traffic generated from earned media 54. View-throughs 55. Number of interactions 56. Interaction/engagement rate 57. Frequency of social interactions per consumer 58. Percentage of videos viewed 59. Polls taken / votes received 60. Brand association 61. Purchase consideration 62. Number of user-generated submissions received 63. Exposures of virtual gifts 64. Number of virtual gifts given 65. Relative popularity of content 66. Tags added 67. Attributes of tags (e.g., how well they match the brand's perception of itself) 68. Registrations from third-party social logins (e.g., Facebook Connect, Twitter OAuth) 69. Registrations by channel (e.g., Web, desktop application, mobile application, SMS, etc) 70. Contest entries 71. Number of chat room participants 72. Wiki contributors 73. Impact of offline marketing/events on social marketing programs or buzz 74. User-generated content created that can be used by the marketer in other channels 75. Customers assisted

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76. Savings per customer assisted through direct social media interactions compared to other channels (e.g., call centers, in-store) 77. Savings generated by enabling customers to connect with each other 78. Impact on first contact resolution (FCR) (hat tip to Forrester Research for that one) 79. Customer satisfaction 80. Volume of customer feedback generated 81. Research & development time saved based on feedback from social media 82. Suggestions implemented from social feedback 83. Costs saved from not spending on traditional research 84. Impact on online sales 85. Impact on offline sales 86. Discount redemption rate 87. Impact on other offline behavior (e.g., TV tune-in) 88. Leads generated 89. Products sampled 90. Visits to store locator pages 91. Conversion change due to user ratings, reviews 92. Rate of customer/visitor retention 93. Impact on customer lifetime value 94. Customer acquisition / retention costs through social media 95. Change in market share 96. Earned media's impact on results from paid media 97. Responses to socially posted events 98. Attendance generated at in-person events 99. Employees reached (for internal programs) 100. Job applications received

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