How agencies are punished for efficiency 91% of the time

The inefficiency of digital media buying is well-known. Tools and methods to improve workflow and efficiency have been developed over the years, but they’ve not been widely adopted. Could it be that agencies aren’t properly rewarded for being efficient? Or, worse yet, could it be that agencies are actually punished for being more efficient?

Let’s take a look at the economics of efficiency at an advertising agency.

Starting around 1990, agencies have moved from media commission models to hourly (or “cost plus”) pricing models. This movement has been accelerated by shift of advertising spending to relatively inefficient digital advertising. According to the 4A’s Labor Billing Survey Report, 91% of proposals today are priced based on hourly rates (despite scoring lowest among alternatives on the Grossman Grid).

Imagine a new technology has been just been developed that doubles staff productivity through automation. In other words, this automation would enable you get the same amount of work done at the same level of quality with half the number of people. Furthermore, this technology costs only 5% of the value created. In other words, it would only cost $5,000 for every $100,000 saved.

Purchasing and installing this new technology would normally be a “no brainer” decision. However, for the typical agency using hourly rates (or “cost-plus”) it’s not so simple. Consider the following before and after comparison above.

As you see, the technology would enable the agency to serve the same 10 clients with half the number of people. It would reduce personnel costs by 50% saving the agency $2,000,000 per year while costing only $100,000 per year. That’s fantastic ROI on this new technology!

How would the agency be rewarded for this breakthrough? Since this agency uses hourly billing, there is no reward. In fact, there’s a huge punishment: the agency’s revenue would get cut in half, there would be a painful round of layoffs, and (assuming the agency can’t pass through the cost of productivity technology) the agency would suffer a 65.5% decline in profits. Not cool.

If you were making the decision, would you advocate this technology be purchased and installed? Given these numbers, that would be risky. Doing so would be what I call a CLM – a “career limiting move.”

The best argument to install this technology would be to gain a competitive advantage to win new business. But that would be a big bet. You’d have to more than double your business to make up for lost profits with existing clients.

Or you could change your compensation model to a value-based model, which would be a difficult transition. Would that be worth the risk?

This over-simplified example makes the point: digital media buying wants to be inefficient because of hourly compensation models. Until compensation move away from time-based models, there’s not much motivation to be more efficient.

By | 2017-12-26T15:35:07+00:00 May 29th, 2012|