“You can determine the strength of a business over time by the amount of agony they go through in raising prices.”– Warren Buffett
I’ve been hearing a lot from my clients and friends in the agency business about the erosion of their margins for years now. What Mr. Buffett alludes to as it relates to agency services is that if you’re not creating real value for your clients, and figuring out how to charge for that value, you’re never going to grow your margins. Many are wondering how we got into this mess in the first place, and how we’re ever going to get out of it.
My friend and colleague Ed Klein, who’s sat on all three sides of the table as an Advertising Director and VP Marketing at Coca-Cola; Principal at Hauser Group and 22squared; and as a search consultant has some insight to help us continue the migration away from the hours based fee structure.
Ed: “Thanks Mike. There’s an evolution in our industry that’s taking place right now. It can become a revolution if everyone gets on board and starts changing the conversation with the client community. The good news, clients are open to and wanting the change! They didn’t get into Marketing to manage an agency’s profitability. The only reason they ask to see proposals in the form of FTE’s, blended rates, overhead and profit is that we trained them to do it that way. Think about it, what other business opens the kimono so wide that their customers can calculate not only the costs behind your operation, but right down to the salary of many employees.”
Palma: “How do we get out of this?”
Ed: “The big headline is pricing deliverables based on the value created. I love the
Warren Buffett quote because the best agencies in the world right now are more profitable than at any time since the days of massive commissions on media. It’s because they understand that the value they’re creating isn’t related to their time, it’s directly correlated to the value they’re creating for their clients, and no one has trouble paying for that.”
Palma: “How should agencies go about determining the value they’re creating, and how do they price from there?”
Ed: “The best news in the movement to what economists refer to as value based pricing is that from the outset of any engagement, you’ll be discussing your client’s goals and objectives, not your overhead and profit margin. Agency’s need to understand the value they’re creating to set a price. That conversation will lead to a deepening of their understanding of their client’s business, and their client’s belief that goals and objectives will be aligned. From there, agencies will calculate their costs, (not for client consumption), to build Pricing proposals, (not fee proposals), that protect and grow their margins. There is an element of art as well as science in pricing, as we can all understand when we think a little harder about what we pay for clothes, food, and other professional services. The strongest proposals will always come with options, so that all negotiations will be based on the pricing structure you’ve presented, not the slashing of your FTE’s, overhead, blended rate and all the other drivers of your profit margins.”
As Jack Torrance said to the bartender in The Shining, “Words of wisdom, Lloyd…words of wisdom.” By the way, Ed and I will be launching a major initiative next year, disrupting the new business model and revolutionizing the agency search process, so stay tuned to mikepalma.com.