Making PBR Work

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Making PBR Work
By Alan Middleton, Alan Kay, Rick Wolfe
Marketing Magazine - Friday, September 07, 2001


This article is based on a report by the Association of Canadian Advertisers. This press release announced the report.

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The Association of Canadian Advertisers takes a giant step toward putting accountability for advertising dollars into the marketing process and releases the first North American PBR report to its members.

Toronto - April 30, 2001 - The Association of Canadian Advertisers (ACA) today released its groundbreaking report on payment by results (PBR) – the first in North America* to explore the PBR method of compensation as it relates to the marketing communications industry.

“Payment by results is not a new concept and is common practice in other industries and areas of business, for both employees and suppliers,” says ACA President and CEO Ron Lund. “Alternates to fee or straight commission remuneration systems have been a hot topic within the advertising industry for several years, but more so recently as the need for increased effectiveness has continued to put pressure on all areas of business organizations including the marketing communications departments.”

“We wanted to provide our members interested in PBR learning gleaned from other industries as well as some guidance on how it can be implemented to bring that type of accountability to marketing communications in a way that benefits both advertiser and agency.”

The ACA’s proprietary report examines the issues around PBR and guides advertisers through the integration of processes and alignment of goals within client organizations and between clients and agencies that are crucial to the implementation of a PBR system.

The ACA has issued two versions of the report. The first, Improving the Marketing Communications Value Chain, was developed for marketing communications professionals. It discusses the processes that both advertiser and agency must go through before putting a PBR system in place and includes implementation guidelines.

A second shorter version, Improving Marketing Communications Organizational Effectiveness, provides senior corporate executives with an overview of how their organizations can improve the way they work with and reward suppliers/agencies in the marketing communications industry.
Susan Charles, ACA Vice-President, Member Services, says the guidelines in the ACA report, if followed, minimize the conflict that does exist in the client-agency relationship.

“Clients and agencies have inherently conflicting goals in that they have different business motivations. Traditional compensation structures further exaggerate this non-alignment of goals because they reward increased spending or increased hours but do not compensate for wiser spending decisions that enhance the value of the marketing communications efforts.”

Susan Charles stresses, however, that PBR is not a cost-cutting method, a remuneration scheme or just a bonus clause in a contract.

“PBR is part of a broader system linking performance, its measurement and reward. This method of remuneration covers agency costs, agreed minimum level of profit plus PBR, a bonus based on achievement of goals and measures. It is not an easy process to put into place but for clients prepared to implement PBR, the investment in time and resources will pay off.”

Susan Charles adds, “PBR and the general category of how to achieve more productive relationships between clients and their agency partners are in their early days. We do not view our report as the definitive work but rather a starting point – the beginning of a journey for clients and agencies wanting to work together to achieve mutual goals and be rewarded for that work.”

The ACA report was researched and co-authored by Dr. Alan Middleton, Alan Kay and Rick Wolfe of PostStone Corporation. The research conducted covered both marketing and marketing communications customer/supplier relationships as well as customer/supplier relationships in other areas of business organizations. Primary research was conducted with 37 executives representing customers in 16 industries and 35 companies.

*Britain’s Institute of Practitioners in Advertising (IPA) released PBR guidelines late last year.

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Making PBR Work

Marketing departments today are under more pressure than ever to be accountable for and to prove the value of their contribution to owners and shareholders to the overall business success of their companies. Marketers are, in turn, pressing their advertising agencies and other marketing communications services providers for similar proof of value. And one of the tools they are increasingly looking at are so-called payment-by-results methodologies.

Agencies are naturally, and with good cause, wary that PBR is merely a new way for clients to squeeze more work out of them for less money. Marketers, meanwhile, are grappling with the reality that to actually make PBR happen, they are going to have to look at fundamental changes in how they themselves do things.

Late last year, the Association of Canadian Advertisers commissioned Toronto marketing consultants Alan Middleton, Alan Kay and Rick Wolfe to produce a report exploring PBR. That report, titled Improving the Marketing Communications Value Chain: A look at the role of payment by results, was released to ACA members in May.

We are pleased to publish, by permission, edited excerpts from that study.

ACA president Ron Lund, while stressing that the study represents only a start, notes that it is probably the most thorough look at the whys and hows of putting PBR into practice published to date anywhere in the world.

"We have searched for answers where there is yet to be a best practice defined within the marketing communications arena," write Lund and ACA vice-president of member services Susan Charles at the report’s outset. "We have attempted to bring insight into the process so that we can provide a deeper understanding of what it takes to meet the challenge of creating greater value and accountability for your marketing communications investments."

For more information about the ACA PBR study, contact Susan Charles at (416) 964-1538 or scharles@aca-online.com.

Executive Summary

The incentive is, understandably, the most sensitive part of the PBR process. It has to be fair and large enough to motivate the agency. At the same time, it cannot be so large at the peak payout that the client organization comes to regret the agreement. Most importantly, the incentive has to align the agency’s outlook with the client’s corporate outlook and goals.

Payment by results (PBR) is a system of advertising agency remuneration where a fixed or standardized payment of some type is used to cover the agency’s costs and an agreed minimum level of agency profit. This payment is then augmented by a reward based on the degree of achievement of mutually determined goals and their measures. This added reward is usually based on a sliding scale. A customized system of measure designed by the advertiser and agency is used to assess whether goals have been met or not.

However, PBR is not just a remuneration scheme. It is part of a broader system of linking performance, its measurement and reward. At the heart of the concept is knowledge garnered from many other supplier relationships. This learning indicates that the more aligned and clear the objectives and goals of the client, the more integrated the supplier is to these objectives and strategies, and the more the supplier is rewarded based on achievement of the objectives, the more effective and efficient is the work provided by the supplier.

Against this background, this report indicates the following findings:

  • The linking of performance, measurement and remuneration has become practice in a wide range of business activities, particularly in the areas of management and staff remuneration, supplier relationships in manufacturing, IT and other service areas.
  • Remuneration based on pre-set goals and their measures has been found to achieve better alignment of effort, talent and activity, thereby increasing productivity, fostering greater commitment, encouraging better communication and improving the overall quality of work produced.
  • The trend to this style of remuneration has been fuelled by the demand for ongoing improvement in performance and accountability throughout the contemporary business environment.
  • Although in most cases PBR has only recently been adopted in marketing communications, client practitioners tend to be enthusiastic. Frequently, marketing communications firms are also committed supporters. Successful users report that performance and relationship gains are immediately visible.

The principal benefits of PBR are said to be:

  • better mutual understanding of goals and corporate cultures, and then clearer identification of shared interests;
  • greater efficiency and accountability on both sides;
  • increased productivity;
  • increased ability to attract the best agency talent; and, as a result,
  • improved effectiveness of marketing communications product and process. Executives on the client and agency sides, including supporters of PBR, recognize there are situations where the PBR format is not well-suited but that it contains strategically sound ideas that can be adapted.

For PBR to succeed, the following factors must be in place:

  • full support and sponsorship at the most senior levels of the client organization;
  • goal alignment between the marketing department and other parts of the client organization;
  • goal alignment between client and agency;
  • existence of and agreement on measures to be used;
  • understanding of the contribution of marketing communications to the achievement of the client’s business goals;
  • an environment of partnership and trust between the client and the agency;
  • clarity of the roles, responsibilities and accountabilities on both sides;
  • a deep agency understanding of the client’s business and the PBR arrangement;
  • a very broad client understanding of the agency’s business.

Selection of appropriate measures requires analysis, negotiation and testing. Budgets are needed to invest in the measures and process development. The process of developing measures begins with an in-depth discussion of what the business goals are and how marketing communications contributes to achievement of these goals.

The most satisfactory mix of measures seems to be a combination of business performance measures such as sales, share and profits; marketing communications effectiveness measures such as brand awareness, image, trial, repeat purchase rates and advertising awareness; and agency evaluation measures such as project management, timeliness of work, cost management and so on. The specific measures and the combination of the measures have to be determined based on the specific nature of the client and agency organizations, the market conditions and the role of marketing communications in achieving business goals.

The incentive is, understandably, the most sensitive part of the PBR process. It has to be fair and large enough to motivate the agency. At the same time, it cannot be so large at the peak payout that the client organization comes to regret the agreement. Most importantly, the incentive has to align the agency’s outlook with the client’s corporate outlook and goals.

The agency should not be expected to put its financial stability at risk.

Evaluation of a client’s readiness to embark on a PBR arrangement and then to implement it, proceeds in stages. The stages describe a process of readiness. Then, in the implementation period, we outline 10 "phases" of negotiation and activity to be followed.

A successful and effective integration of activity between client and agency requires alignment of the remuneration system. This more integrated relationship may not be for all clients, but for those who commit themselves to making it work, the payoffs in significantly improved marketing communications product and process are substantial.

Preconditions for PBR

Full client/agency integration and a fully functioning PBR scheme is only achievable when a comprehensive set of conditions are in place. Some marketers are ready to launch right into the process of negotiating a PBR agreement. Others will need to gain specific types of experience and adopt certain philosophies before they tackle the commitments and working processes required to successfully implement PBR.

There are four stages of PBR development (see "The Four Stages of PBR" table, below). These stages describe four approaches to the business relationship between clients and their suppliers. In the first stage, there is a fairly cut-and-dried buyer-seller arrangement, and in the fourth, most advanced stage, there are formal shared goals, fully integrated activity and performance-linked remuneration.

The four stages mirror the progress of a relationship. In all circumstances, companies that were in the more advanced stages of the relationship were at that level based on a foundation of experience, skill and business philosophy that made it possible for the more complex relationship to work. In fact, the marketing communications sector has many examples of clients and agencies that have had long-lasting and extraordinarily productive relationships without adopting the specific practices of PBR. As such, these are the companies that are most ready to move immediately into a comprehensive PBR arrangement. Companies with less experience in working in an integrated and intensely interactive fashion with their agency and other parts of their own business will find there are intermediate steps they must take on the way to comprehensive PBR.

There is no automatic progression through these stages. Organizations can plan on getting PBR to fit their needs in Stages 3 and 4 provided they are ready. But an organization can decide to remain at an earlier stage.

If it wishes to remain with a looser agency relationship, then PBR will not fit that organization’s needs. As one respondent stated, it’s all a matter of culture: a company must have the right culture in order to enter into a client-agency integration and PBR relationship.

If the decision is made to progress through the relationship stages to fully implement PBR, then in addition to the specific issues raised in each stage, there are some general preconditions:

Co-ordination between internal client departments runs smoothly. In all organizations, but especially in large ones, different departments tend to operate as separate silos. This interferes with timely sharing of information about strategies and execution. In order to have meaningful sharing of goals and information with the agency, there must be meaningful sharing of information within the client organization first, e.g. product development, sales, marketing plans, etc.

Senior management support. Both clients and agencies felt that the support of top management was critical to the success of PBR. It is for this reason that we have prepared a condensed PBR report as a review of key issues for senior corporate executives. Without the CEO and CFO involvement with the CMO (chief marketing officer) and other senior management, the strategic information sharing necessary for goal-setting could not be guaranteed. Additionally, in the event of conflicts that inevitably arise in any strategic partnership, senior executives of both client and agency companies will need to meet to resolve disputes.

Study participants emphasized that PBR becomes more viable as senior executives start to manage the marketing process and that only when there is a strong commitment at senior levels of both organizations will a PBR relationship succeed.

Partnership. We were told that the success of PBR largely depends on clients and agencies cultivating a relationship based on mutual respect and a strong sense of partnership. We define "partnership" as a relationship that involves close co-operation and interdependence between parties, each of whom have specified rights and responsibilities.

These executives describe two organizations working together to create "win-win" situations:

"You have to recognize that PBR is a partnership. Who do you spend more time with in marketing than your agency?"

"The foundation of the client/agency relationship has to be strong for PBR to have a chance of survival."

"You have to be clear in your mind that an agency relationship is different than a (traditional) client-supplier relationship. If it is not a partnership, you’ll never have a performance-based relationship with them."

A culture of partnership, we were told, has to exist in order for advertisers and agencies to proceed down a path of mutual disclosure. Without this culture of integrating agencies and other suppliers into their strategies and processes as a partner, the task of aligning goals was felt to be overwhelming.

Trust in sharing information and accountability. Openness and trust are seen as crucial preconditions to PBR. We define "trust" as the willingness of one organization to rely on the character, ability, strength and ethical judgment of another organization. Trust was often cited as a key ingredient for bringing the interests of the agency closer to those of the client. At minimum, trust is necessary in the sharing of information. Trust is necessary in assigning accountability and responsibility. Trust is necessary to ensure that each party is treating the other fairly. Respondents believed that if a long-term relationship were desired, it would have to be built on a deep trust.

Clients also said that trust was a key precondition to keeping the best people on the account:

"There has to be a high level of trust. If there is no trust, the agency personnel will change more frequently."

"A client has to trust the work an agency produces. If there is distrust between the agency and client, both sides suffer because good people won’t stay on the account. This is just common sense perhaps. It seems to have less to do with a relationship between an agency and a client than it has to do with relationships period."

Clients and agencies have always relied on a foundation of mutual trust to achieve results under complex conditions. In matters of money, trust is one of the first elements to be strained. PBR agreements can restore trust at all levels of the relationship by aligning rewards to shared goals.

Clarity of objectives, goals, roles and responsibilities. Executives emphasized the importance of clarifying objectives, goals, roles and responsibilities as a precondition. They said that while the process of setting up objectives and measures brings clarity, both parties should enter PBR negotiations with a fairly clear idea of what they want to accomplish and what they see as their contribution to the relationship’s success:

"You have to be clear on what you want to get out of the relationship. You have to articulate what you see as the role of the client and the role of the agency. You have to ask who is in charge of the client. Who is in charge of product development?"

Most organizations have overt written business goals. Explore below the surface of unsatisfactory relationships and many other tacit, unspoken and even contradictory goals are discovered. Expectations of who does what and who is responsible are also often inconsistent. These issues must all be brought to the surface, discussed and resolution sought if the integration of effort and the PBR system is to succeed.

Knowing each other’s business and business model. When elaborating on the precondition of partnership, executives often commented that agencies have to first understand the client’s total business before entering into a PBR relationship.

This understanding has to include more than just an understanding of the end-client. It has to include an understanding of the business model the client has in mind: what makes the client money. This will then drive the objectives and goals that are set. It will also drive the culture of the client organization.

Understanding these issues is essential in building a more integrated relationship:

"An agency can’t be a partner with the client unless it is client-centred."

"With PBR, an agency has to make sure the contract is based on reasonable expectations. Before an agency can do that, they have to know how its client’s business works."

We were also told that it was equally important for the client to become acquainted with the agency’s business. To motivate an agency, the client has to understand what makes an agency tick, how it makes money and how its experience and skills can be best utilized:

"By knowing how the agency’s business operates and its financial perspectives, the client can better avoid placing unrealistic expectations on the agency."

"The more everybody lives in everybody else’s shoes, the more capable they are to do what they’re asked and, moreover, figure out where everybody’s strengths and weaknesses lie. Everybody should experience what it’s like when the page is totally blank, and the clock is ticking, and you have to be brilliant."

Alternatives to PBR

Not all clients will want to work in this extremely integrated relationship. Not all should.

Other working arrangements and remuneration systems seem to work better in the following circumstances:

  • Clients who prefer a more project-by-project bid-based system with their suppliers.
  • Clients who are primarily looking for a way to reduce costs.
  • Client/agency relationships marked by continuous conflict or the tendency for the client to exercise its power as a buyer to run the relationship.
  • Clients for whom marketing communications is considered a minor contribution or investment.
  • Clients for whom the relationship between marketing communications and achievement of its short-term and long-term goals is largely unknown.
  • Clients who put little emphasis on employee and/or supplier relations.
  • Clients for whom global agency contracts actively preclude adoption of a PBR-based system.

The Benefits of PBR

Any initiative that improves organizational effectiveness must be examined seriously. In this era of increasing market complexity and continually rising expectations for financial returns, marketers need all the help they can get to improve the effectiveness of their product, processes and systems.

Effective marketing communications comes from an organization’s ability to focus the highest quality talent available in the marketplace on its brands. As one executive put it, the role of senior management is to get the best people to work on their business rather than their competitor’s business. Of course, selecting the best talent is imperative but it is more than that. In the "talent war" environment of the 2000s, it also means ensuring that this talent is focused on the right issues and then appropriately motivated and rewarded.

Better business results come from stronger brands. Stronger brands come from the selection and then the focusing and rewarding of better people on the right goals. The PBR remuneration system helps to focus the best people on the right goals and rewards their efforts in achieving those goals.

In our primary research, the benefits of PBR were discussed as follows:

PBR encourages greater efficiency and accountability.

By drawing the financial interests of both parties closer together, executives said that PBR brings about greater efficiency and accountability. Performance measures, they claimed, were responsible for getting more focused work, better outcomes and a more streamlined process from their agency (italic copy indicates verbatim comments from key contacts used for this report):

"From our experience, what gets measured gets done."

"We are seeing the incentives deliver results."

"We’ve found the other benefits of PBR (greater mutual understanding, greater trust, better out of the box creativity, more focused work, etc.) to be as important as the economic benefits. We’ve seen increased efficiencies right across the board."

"PBR gets both sides focused on making sure we are working on the right thing...and making choices about what you won’t work on."

"We’ve experienced better outcomes, there’s no question about that. People in our organization are satisfied with PBR even though there is room for improvement. It solidified our relationship with the agency as our partner. It changed the way they do business, it changed their structure in a way that served us better, and helped us meet our objectives."

PBR helps in the achievement of important cost efficiencies.

Although cost reduction is not a necessary outcome of the use of PBR, respondents did see improvements in cost efficiencies and effectiveness:

"PBR brought our business units together. Now the agency has one client, instead of five or six clients all looking for different things. The impact of the measures forced everyone to talk the same language. This made things much easier for us marketers; it also made things much easier for the agency. They are getting a consistent message from us and we are getting consistently good work from them."

"Now that we are one year into PBR, our judgment is that it is a worthwhile experiment, beyond description. It has completely changed our business process. We now enjoy more responsible budget management. Previously we had innumerable conversations saying, ’Why do we have such expensive productions?’ Now, senior agency management seems more engaged in controlling expenses. Measuring performance has really tightened things up."

"Metrics change as the business cycle changes. During tough times it can mean cost savings. When things are going well, it means profitability and good ideas."

PBR improves productivity.

The new efficiencies and accountabilities introduced by PBR’s disciplines can lead to a significant rise in productivity. Marketers told us that PBR has put more discipline into the marketing communications process and helped focus agency and client on the right objectives.

In addition to more work getting done, executives said that the quality of the work was improving. A better standard of work has in turn led them to have higher expectations for agencies. Furthermore, agencies were not only delivering on these expectations, but also exceeding them, thanks to PBR.

PBR removes the barriers of self-interest.

Performance measures and incentives help motivate the agency to perform actions that focus on the objectives of the client rather than their own self-interests. One agency manager interviewed said:

"PBR removes hidden agendas from the relationship. Often clients think the agency is out to just win awards. But with PBR, things are, and have to be, more transparent."

PBR promotes greater mutual understanding.

Our interviews revealed that PBR has brought clients and agencies closer together and helped them to understand one another better. One key benefit of this new relationship has been an increase in understanding of each other’s business, business model and organizational culture. This comment was made about agency knowledge of the client’s business:

"Usually agencies know a bit about their client’s business but they know very little about the sector. Up until now, they’ve had no desire or even need to understand. PBR changes all that. Now they have to understand how their client’s business works, how they make money, how they record a profit, how they define their profit and so forth. They need to know all of this so they can determine how to grow their client’s profit. At the end of the day, that’s all that matters."

A related benefit, we were told, was that agencies now view their role in relation to the client’s business in a very different light:

"At the end of the day, you want agencies to bring passion to the business and there has to be more to it than just getting the agency lined up with you. You should be able to do that anyway; they should be obsessing about your business regardless. What PBR should encourage is a deeper transformation. In our experience, we’ve sometimes found that the agency has thought more about the future of the business than we have. What we’ve managed to achieve with PBR is a strategic alignment of vision, plus a joint accountability that ensures we are faithful to that vision."

"PBR has shifted focus to ’How is the business doing?’ instead of ’Did we get the copy done?’ The agency is less narrowly focused now they can see the bigger picture. In fact, PBR has internalized the focus on the business. No one has to be told what the focus should be. It is well understood and actions are taken with it in mind."

"PBR encourages our agencies to think outside the box. Alternative proposals are a good example. Under PBR, we’ve seen our agencies come back to us with more than one proposal. Since their financial success is tied up with ours, they want to make sure they have a winning campaign. Rather than just follow orders, they are now really thinking about our business and how they can improve our marketing effectiveness."

PBR helps attract and focus the best agency talent.

Clients and agencies felt that PBR was the surest way to attract and retain the best people, most especially creative talent. They elaborated on this point by explaining how incentives encouraged individuals to perform at an optimal level. They also added that incentives – if designed correctly – tended to provide better rewards to the people who were doing the best work. Rewarding the best people was viewed as a key business strategy:

"We want the best people working on our business. And we demand the best people on our business. We see PBR as a way to achieve this."

PBR increases agency engagement and input.

Both clients and agencies agreed that PBR involves the agency in the decision-making process in a more positive and fundamental way:

"(PBR helped focus our agencies on) the visioning process and strategic planning. Since they understand the brand intimately, they bring a lot to the table in terms of understanding the brand’s positioning relative to the competitive set – not just in terms of the numbers and charts you get from the marketing team, but in terms of a gut instinct about what’s going on out there."

"(PBR encourages our agency) to have a voice in situations where they think our vision is totally out in left field and that there’s no way we can achieve it..."

"(The people at our agency) are extremely valuable in the decision-making process now because they speak more as a business partner (whose outside perspective often) gets the conversation heading in a transformational direction."

"Often our agencies, particularly our agencies at a global level, are in a better position to make certain market judgments. They are, after all, privy to information at the highest level."

PBR improves communication between client and agency.

Clients strongly believed that PBR had improved the quality of communication with their agencies in a number of ways. One key improvement had to do with performance measures bringing important issues into focus:

"By putting certain disciplines in place, PBR ensures that the agency and client are talking to each other about the important issues."

"We’ll share with the agencies all the steps we are taking to get there...we share all the plans and allow the agency to work with it."

The range of benefits expressed was most enlightening. Whether this was the PBR arrangement itself or the process of goal alignment and open discussion doesn’t really matter. Rather, like the development of business or marketing plans, it is often the process of planning itself that is more important than the actual plan. In both cases, the thinking, sharing and establishment of rewards to complete the system are all required.

Agency Perspectives

From our interviews with agency management for this study, we learned that many agencies are on the same wavelength as clients when it comes to PBR. They see many of the same benefits:

"It’s about trying to achieve marketing and, to a certain extent, sales goals. It is based on consumer measures – research scores, etc.and agency evaluation. We are rewarded when we are in the top quintile."

"It’s about qualitative and human performance, and that can be very subjective. It’s money-based. We take less at the start provided there are opportunities to earn more than we normally would at the end of the contract."

"It creates a tighter bond (by making sure) we have the same vested interest. It makes the client think of the business we are in. We ask more questions, make more informed decisions – that’s the way risk-reward works. We have full disclosure and this kind of open relationship results in a more long-term outlook. And since we are sharing the risk, we have to be honest when we say, ’We really believe this is going to succeed.’"

"It makes us say, ’Is this going to sell?’ It drives the quality of the work up and gets us thinking out of the box. It also kills more mediocre ideas – we get less creative drift."

"It allows us to be more unconventional. It works really well with (a particular client) that is entrepreneurial, appreciates creative and knows value. Our account staff practically live at their place."

Just as clients felt that an entrepreneurial attitude towards risk had to be adopted in order for PBR to work, many agencies believed that a positive outlook toward risk was an essential precondition to PBR:

"If the client’s culture doesn’t have any entrepreneurial instincts, PBR will never work. The client has to adopt an entrepreneurial outlook."

"We will do it if they cover the base costs and there’s a high upside. We will gamble. In the new economy companies, it’s the only way."

Agencies also stressed the importance of transparency and openness in sharing information, objectives and goals:

"It works when the kimono is open. It’s not an incentive if there is no transparency."

Not surprisingly, agencies firmly believed that in order for an agency to risk its profit – or an agreed portion of its profit – the objectives and performance measures used in a PBR scheme had to be reasonable and fair:

"I applaud the client articulating something I should be working for. The measures have to be ones that motivate an agency and their staff to change their behaviour."

"We try to understand the client culture – how they measure success and outcomes. We ask them: 'Do you spend time on measuring the right steps or the right results?' When we talk about measures, we want to see the big picture. We want to look at the total organization’s success."

Naturally, agencies also felt that remuneration had to be fair in order to keep the agency motivated and focused. One manager told us about an account where the incentive didn’t even pay for all the work needed to fill out the paperwork.

Another manager added:

"When clients implement PBR just to squeeze costs, that harms the relationship faster than anything else. We have seen instances where, in hindsight, PBR was set up just to cut the fee. The relationship ended within months."

One agency executive concluded by indicating that the risk/reward ratio had to be a key consideration. If this was understood then the likelihood would be that despite concerns already discussed, there was ground for the integration that is the basis for higher marketing communications effectiveness:

"If you don’t give a lot of thought to what you’re paying agencies for, it will do more harm than good. We’re willing to risk our profit on the performance we give you. We’re not willing to risk our costs. To risk our profit, we have to see a bigger upside beyond normal agency profit."

Finding the right PBR Performance Measures

The strengths of having specific goals and target measures lie in the learning that comes from their achievement and/or non-achievement. Specific target measures allow feedback loops on strategies and actions and so, in the words of the 1990s business literature, enable an organization to become a "learning organization."

The weaknesses of having specific goals and measures lie in their choice (italic copy indicates verbatim comments from key contacts used for this report):

"There’s a big risk that the agency will work on what you ask them to work on. When new issues come up, they don’t respond because it’s not tied to their remuneration."

And, the wrong target measure well-executed is often more harmful than the right measure badly executed. It is this concern that often lies at the heart of agency resistance to PBR. In many cases, they are right.

When we asked how agency performance should be measured, we heard that measures needed to be "very straightforward" and that the "greatest challenge with PBR was finding a way to make it fair." It was stressed that it was important to ground measures in tangible outcomes and not just procedural steps.

Our research indicated that PBR measures were evolving into a loose formula that had three types of measures:

  1. Client business results such as sales, share and profit;
  2. Marketing communications performance measures such as brand awareness and reputation, trial and repeat purchase rates, advertising effectiveness and so on; and
  3. Agency evaluation measures such as timeliness of work delivery, cost management, insights and so on.

The difficulties arise from the fact that this set of measures includes a combination of controllable and uncontrollable ones for the agency. Finding the best balance of these is one of the most difficult tasks in establishing and managing PBR.

Agency concerns about 'uncontrollable’ measures

One concern expressed was with the setting of measures that were not in some way "controllable" or that could be influenced by the agency and its work. If measures such as sales, share or profit goals dominated the PBR "formula," then the feeling was by some agency executives that these would be unfair. The view was that product quality, price, the extent of distribution and customer service are the main "drivers" of business success. As such, if all or a substantial part of the PBR formula were based on these, then the agency remuneration would be based on measures they could not control or influence.

This is, of course, not a unique situation. In the same way that staff team-based reward systems may not fully recognize the contribution of a particular individual, the critical element is that when the team does well, the individual also benefits. As team-based rewards encourage an acceptance of broader responsibility by each individual, so the less "controllable" measures such as sales, share or profit encourage marketing communications agencies to think about how they can contribute to these overall goals.

Many respondents indicated that their experience with PBR had utilized staff performance remuneration systems as a basis for their thinking:

"We relate PBR to how employees are paid in risk-based remuneration systems. We have an internal staff performance system where high performers are paid more than low performers. First we agree what the risk remuneration will be based on. Then we measure by output, not just sweat."

"We had a long-established employee incentive program that influenced us. However, our mistake was that we made the translation (to PBR) too literal. Now the philosophy is still intact but the standards have been, and continue to be, evaluated on a regular basis."

Most recognized that while important and valuable as one set of measures, they should not constitute the total formula for PBR. There had to be inclusion of some more directly "controllable" measures. However, one component of the overall PBR formula had to be these business measures precisely because they would encourage the agency to think about the client’s fundamental goals and encourage them to think about how their work could more actively contribute to the achievement of these goals. As one executive explained:

"We started out with evaluating people’s skills. We then spread it out to things like measures of market share or brand health. Although we haven’t been able to make the brand health measures fair enough, we have found that measures such as real volume growth, economic profit, market shares for the brand and process measures like management excellence scores have been quite effective."

Concerns about specific ’controllable’ measures

Another concern expressed by both client and agency executives related to the exact choice of the "controllable" output measures: Would those chosen be legitimate measures of success or performance?

For example, if a chosen measure was copy test results, then the advertising agency may simply learn how to do advertising that does well in the particular form of copy testing chosen.

The problem lies in the fact that the relationship between copy tests, advertising effectiveness and stimulus to sales and profit are at minimum non-linear and at maximum simply unknown. Good agencies know this and are rightly suspicious of performance measures based solely, or largely, around copy test results.

Here the key is that first, more output-based measures should be used – measures such as in-market tracking-based brand awareness, brand image, brand trial and repeat purchase rates, advertising awareness, advertising communications results and so on. Second, that if interim measures such as performance in pre-tests are used, there should be a well-established and understood relation to in-market experience. And finally, that a combination of in-market and pre-market measures be utilized in conjunction with the business measures discussed earlier and agency process measures.

The role of agency ’process’ measures

Process measures such as those often captured in agency evaluations have some major strengths and weaknesses.

These measures such as timeliness of delivery of creative and media plans and executions, cost management, quality of account management, planning, creative and media service, and business-building ideas and initiatives received have the advantage of being directly experienced by the client and therefore able to be evaluated relatively easily.

However, all best practice advice and comments received indicate that output, not process measures, have the greatest impact in focusing effort. The solution seems to be that while some of these more easily obtainable process measures should be included in the final PBR formula, they should not constitute the largest group of measures.

PBR measures: a guideline

The difficulty in addressing concerns raised about PBR measures is further compounded by the fact that there is no one right formula that we can give your organization. The measures and weightings chosen must be based on your organization’s objectives and activities in the business environment of the appropriate time period.

They should be guided by the role of marketing communications in the marketing mix. They should be guided by how knowledgeable your organization is about how marketing communications contributes to business results in your industry and for your brands.

Again, the work involved in selecting the measures has immense value in and of itself.

For example, a rigorous examination of what marketing communications is contributing to your sales will be the start of a better understanding of how it works. Although we cannot, therefore, suggest specific measures, as these will be organization, industry and time specific, we can – based on best practices – suggest some guidelines.

The most satisfactory formula seems to comprise a combination of the following types of measures:

  • overall business performance;
  • marketing communications effectiveness;
  • agency process evaluation

Elements of all three should be included in the final "formula."

Output, not process measures, should constitute the primary measures. Sales, share and profit targets are often used for business performance. Brand and advertising awareness; image/reputation, likeability and impact measures; purchase intent, trial and repurchase rates; and brand loyalty/health measures are often used for marketing communications effectiveness measures.

Process measures like agency evaluation issues such as service quality, media planning and buying achievements, timeliness of work, cost management, initiatives and business-building ideas all have their role to ensure the overall formula has some "effort" basis to ensure equity.

There is no one right measure. Exact measures used depend on the organization and its circumstances:

"You have to make absolutely sure the measures are consistent with where you want to go in your business."

"When a brand is at low ebb, there can be a huge lift from advertising. When a brand is mature, it’s a hell of a lot tougher to see if advertising is having an impact. Therefore look at the life cycle of the brand you’re working with."

The measures used depend on a growing understanding by the client and the agency of the contribution of marketing communications to achieving its goals:

"The standards and measurements we use now will be re-evaluated. We believe flexibility is key. If the wrong standards are used, there will be no shifts in performance behaviour. We have to keep experimenting to find the right standards. At the moment, we use measures such as market performance, productivity and brand health."

Goals can be both short term and long term.

In establishing the mix of measures of performance, fewer rather than many measures are recommended. Fewer are easier to handle and will force decisions about what is really important.

The measures chosen must align with the goals and measures used throughout the organization – not only the overall organizational objectives but also departmental and personnel objectives at all levels:

"We want to find objectives that are common to every business unit and have the same measuring standards across the board. We also want to have the same standards for all regions. The problem is that the dynamics are different in each region. All the same, we still have to measure the gains throughout (with some equity)."

The measures must be agreed to by both parties.

The measures must be revisited regularly – at least yearly – to ensure that they represent what the client really wants to happen and to ensure that both parties achieve win-win results.

The PBR rewards should be applied after a financial arrangement that covers the agency’s cost and an agreed minimum profit has been established as a foundation.

"One challenge for us has been learning how the agency’s cost structure works and figuring out where to draw the line for measurement. It took us time to decide how much to assess."

The rewards need to be significant to really encourage excellence:

"The biggest design challenge for us is making sure the system keeps the agency motivated all the time. Right up to the last fiscal day of the year, we want to see that performance objectives are not just met but also exceeded."

These rewards must be expected and budgeted by the client. There must be an expectation of full payment, not a formal or informal belief that this amount is a "reserve" of some kind.

The rewards should be available along a simple sliding scale that does not contain too many levels.

Even cost-effectiveness was regarded as a difficult measure, even though it may be a key result:

"After doing it for a year, we decided to change our approach. We wanted to find objectives that were common to every business unit. We wanted to have the same measuring standards across the board. Our aim was to reduce costs but more in terms of cost efficiencies. The idea was not to spend less but to spend better. However, cost efficiencies can be tricky to calculate. There’s a lot of subjective judgment involved in looking at numbers in the workplace."

Remuneration structures

Given the preceding guidelines, we can see how the PBR part of the remuneration formula is unfolding. This is the bonus part of the arrangement. The base part that ensures a minimum level of profit also needs to be negotiated through this process. Going into negotiations, the combination of the two components, the base agreement and the bonus (PBR), need to be considered in tandem. Some participants commented on this point:

"We started by negotiating a flat fee for the work. Determining what can be achieved within the fee requires some real negotiation. On top of that fee we add a bonus."

"We calculate our bonus on the following: Did our sales revenue grow? If the answer is yes, they get a percentage. Agencies understand that there are many other variables they don’t influence but in the real world, the line manager can’t influence everything that affects their performance. Fifty per cent of the bonus is determined through an agency performance review. Our review is data-based and very disciplined. We believe it is very fair."

"When our present agency first approached us (in order to get the business), they agreed on a fee to cover costs and then risked their profit on a bonus. Their bonus was based on how our staff was bonused - gross margin."

The key is that whatever the base financial arrangement, it must recognize the need for the agency to make money so that the PBR arrangement can act as a genuine bonus and incentive. Then the process of working on the bonus component can proceed.

To summarize: From our research and interviews, we found that companies are still feeling their way through the central challenge of remuneration structure, even in the most advanced situations. There are no hard, fast rules for which measures to select: market dynamics, corporate culture and measurement capabilities make every situation unique.

The outlines of "best practice" are starting to take shape. Based on what we heard, we agree with the companies that have decided PBR remuneration measures should have three components:

  • client business results;
  • marketing communications effectiveness;
  • evaluation of agency performance

The uniqueness of every situation means that each client and agency will have to engage in the painstaking work of determining what to measure and how much weight to put on each measure.

However, the benefits as discussed are such that the journey is more than worthwhile.

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