It wasn't until Joseph Lister aggresively promoted germ theory that medical practices finally started to change.

The fact is that billing by the hour is built on the wrong theory, and faulty theories are always exposed, refuted, and ultimately overturned. The labor theory of value, postulated by thinkers such as Karl Marx, states that value is created by and correlates directly with labor; the more work that goes into something the greater the value.  While this might have been true for the assembly line workers of the industrial age, it certainly is not true for today’s knowledge workers who live in a society where more than 70% of all wealth is created not by labor, but by intellectual capital.

Most agency executives still haven’t come to terms with the fact that their compensation agreements with clients are built on the wrong theory of value.  But the more they observe the fact that time expended bears no relationship to value created, the more they will begin to change their compensation practices.

As I’ve written about many times before, the advertising business stands at the edge of an opportunity to realign the interests of agencies with the interests of marketers by fundamentally redefining the agency-client financial relationship.  By moving from a time-based approach to a value-based approach, agencies will be in a vastly better position to provide “excellence” in everything from strategic planning to execution.

Planners are in a pivotal position to make this happen, because increasingly successful agency-client relationships will be defined by the agency’s ability to identify, test, and measure brand success drivers.  In other words, in order for marketers to pay agencies for value created instead of hours worked, planners will have to work with C-level clients to define the brand’s leading indicators of success.

Ask marketers point blank what metrics they care about, and they will almost always give the same answer: sales.  But sales is a lagging indicator – an after-the-fact measurement that looks in the rear view mirror.  The more important question is what are the factors that predict the success of the brand; the leading indicators of success?  In agencies, the planner is best suited to answer this question. Most leading indicators never appear on a financial statement, but they have predictive causation with profitability––that is, they will drive the numbers that ultimately appear on the financial statements.  The correct leading indicators will predict the lagging indicators.

Once identified, a brand’s leading indicators of success can form the basis of an outcome-based compensation agreement between the agency and the client.  By paying their agency for outcomes achieved rather than hours worked, clients are assured the agency’s best efforts and best thinking because the agency has all the right incentives.  If the client wins, the agency wins, which incents the agency to devote their best talent, apply truly creative strategies, provide unasked-for ideas, and solve problems in unique ways.  It redirects the dialogue away from efficiency (concerned with hours and costs) to effectiveness (concerned with achieving results).

Planners are central to making this all happen because they are in the best position to objectively identify the drivers of brand success – the foundation of effective outcome-based agreements.

In an attempt to stay true to the overreaching concept of “full service,” agencies are in the habit of assigning and assembling complete “account teams” for each major assignment and client. Meanwhile, time and cost pressures are driving in the opposite direction.   To better adapt to current client needs, agencies can take a page from software companies who have adopted the concept of “agile” development and production.

This way of working is based on “The Agile Manifesto,” which includes the following key concepts:

1. Build projects around motivated individuals. Give them the environment and support they need, and trust them to get the job done.
2. Simplicity — the art of maximizing the amount of work not done — is essential.
3. At regular intervals, the team reflects on how to become more effective then adjusts its behavior accordingly.
4. The team welcomes changing requirements, even late in development.
5. The team delivers working software frequently, from a couple of weeks to a couple of months, with a preference to the shorter timescale.

The jazz ensemble is a good metaphor for how agencies should be organized; small groups who improvise. This is the opposite of the traditional agency model, which is much more like a classical orchestra. *Photo by OhWeh

In an agency environment, this means fewer, better people operating in smaller teams.  It means less of a top-down, command-and-control structure and dismantling the cumbersome levels of review and approval that make work slow and expensive.  In the agile model, meetings don’t require the writer, art director, associate creative director, and executive creative director – they just require one senior creative who is empowered to make day-to-day decisions about the assignment.  Same goes for the levels of client service, media, etc.

In many ways, software companies are better models for what agencies could and should look like.  The philosophies of iterative development, continual optimization, and test-and-learn are essential to success in a marketing environment in which “good and fast” is better than “perfect and slow.”

You can read the following comments from real people in real agencies and draw your own conclusions about the tyranny of billable time.

“Agency management gives mixed messages about what the agency values. We promise projects to clients with the lowest possible amount of hours, then are told to manage written-off time. The idea is that we can squeeze efficiencies out of the creative process, which can’t be done. So we have to decide where to go the extra step to make the project great, then listen to complaints about write-offs, or we have to decide to come in at the budget level, and not put extra effort into producing great work for the client.”

“The competition for client budgets within our own agency hurts our collaboration. There is no incentive for me to bring in other team members to work on a project, because they take budgeted hours away from my department, making us less ‘profitable.’ So while there is a greater agency profitability from collaborating and doing better quality work, it is undermined by departmental ‘profitability.’”

“I am basically penalized every time I contribute to an agency-related project such as our blog, recruiting new people, looking for new business prospects, or developing myself professionally. Because if I do any of those things, my “billable hours” drop, as defined by the agency.  This is a mark against my productivity.”

“People in salaried positions (which is most of us) often feel like we are treated as hourly workers with the ‘billable hour’ mentality.”

“Project estimates based on hours essentially plot one department against another for billable work.”

“Because everyone is so concerned with being billable, new employees aren’t getting trained.”

“The focus on write-offs is driving creative talent away from the agency. If I could write a piece faster, I would, because I have other work to move on to.  Sometimes I work really fast and get it right on the first draft. Sometimes I work really slow because I can’t find the right opening paragraph. Sometimes I’m going back to make something that’s a little weak stronger. You can make more money off the best work I produce than you can the quick work I produce. Because no client we have can duplicate my best work. They can all duplicate my quick work.”

“The hyper attitudes of management about “writing off time” means there’s no appetite for us to collaborate, experiment, or explore new ideas.  Our incentive isn’t to innovate, it’s to manage our time to the estimate.”

While I’ve paraphrased and edited a few of these comments (to protect the identities of the creators), they represent what Ignition hears consistently in the many internal surveys we do with marketing communication firms across North America and Europe.  Besides being an ineffective way for agencies to capture the tremendous value they create for their clients, the billable time system actually inhibits agencies from internal collaboration, professional development, and innovation.  It creates a system where efficiency reigns at the expense of effectiveness.  And if marketing isn’t effective, nothing else matters.

The foundation of a value-based approach is to accept the premise that advertising agencies don’t sell hours, they sell the “utility” that the hours produce. Economists going back to Adam Smith have taught that nobody buys a product or service; they buy the utility the product or service creates. This is as true for agencies as for anyone else.

Adam Smith had it right

There are innumerable ways for agencies to be compensated in ways that have nothing to do with hours or time. A fee doesn’t have to be tied to a complex set of metrics to be “value-based” — it just has to be based on something other than time sheets. Some digital firms, instead of charging for the time they invest in developing branded widgets, simply charge per download. We’ve seen direct marketing firms get paid per qualified lead. One Major League Baseball team pays its agency 50 cents for every non-season ticket sold. We know of an agency who was a finalist in a luxury car brand review whose compensation proposal took hours completely out of the equation and instead proposed to earn $50 for every car sold.

Of course, next comes the complaint from agencies that they don’t have complete control over any of these things and would therefore never agree to tie their compensation to them. But they’re looking through the wrong end of the telescope. If agencies want more control, this is precisely how to get it. As Dave Beals of the agency search consultancy Jones Lundin Beals points out in the above-referenced Advertising Age article, it fundamentally changes the dynamics of the agency-client relationship when the agency has some skin in the game. Because the economic incentives of the client and agency are aligned, there is a much higher degree of trust and mutual respect than in the standard pay-by-the-hour-regardless-of-results mentality.

Value-based compensation can also mean that the client pays the agency to use its IP. This isn’t a far-fetched idea; it’s being done by some progressive agencies every day. Firms like Sarkissian Mason have IP ownership at the center of their approach to compensation.

Finally, value-based compensation can also mean just quoting a simple, fixed price that is based on the value to the client rather than the costs of the agency. This is how pricing works in virtually every other industry, and it will become the standard in professional services as well. There’s a pricing revolution underway, and it’s up to the agencies (the sellers), not the clients (the buyers) to make it happen.

If you were a marketer, would you prefer to pay your agency for efficiency or effectiveness?  Yes, it’s a simplistic question with an obvious answer, but the sad fact is that most agencies are still selling – and clients are still buying – efficiency.

Efficiency is based on the old advertising model of exposure, which is measured by such time-honored metrics as reach, frequency, gross impressions, and cost-per-thousand.  But what if no one is paying attention?  And in today’s consumer-controlled marketplace, fewer people are.

No more frequency

As a matter of fact, the Advertising Research Council (ARF) has been lobbying for a few years now to discontinue the metric of frequency altogether.  Just because a media schedule achieves an average monthly frequency of 4 doesn’t mean anyone was actually paying attention.  So when agencies sell media programs based on the concept of exposure, they’re selling something of increasingly questionable value.

Effectiveness is what we should be selling.  Effectiveness is about engagement, measured by such metrics as attentiveness, receptivity, and page views.  Nielsen now evaluates not just which programs are most “watched” (exposure), but those that are most “liked” (engagement).  A lot of digital media are sold based on actual engagement.

Solving marketing problems through a different lens

The implications of this for agencies go way beyond the media plan.  When agencies approach a marketing problem through the lens of “exposure,” they instantly jump to the question “Is the budget big enough to sustain a media schedule?”  But if you look at the problem through the lens of “engagement,” the budget question is a lot less relevant.

Imagine that a small travel destination comes to you wanting big results.  Looking at this potential client with the “exposure” mindset, many agencies would just walk away because the client can’t afford much of a paid media program.  But if you approach this assignment from the “engagement” perspective, you might create something like the award-winning campaign for Queensland Australia tourism that was executed for a fraction of the cost of a conventional campaign and produced an incredible amount of impact.

Marketing spending will cease to correlate directly with market share

Remember that in a world where many of the major communications channels (YouTube, Twitter, etc.) have a media cost of zero, the real currency of marketing is no longer money, but ideas. Truly.  In the near future, market share will no longer correlate with how much money you spend, but rather how good your ideas are.

Because most agencies are selling the wrong thing, they’re also charging for the wrong thing.  We can get paid for the value we create (effectiveness) rather than the hours we work (efficiency). The question isn’t how – some of the most successful agencies and marketers are already working this way.  The question is when.  When do you plan to start working this way?  No one is going to force you – not the 4As, the ANA, not even your clients.  It’s up to each individual agency to decide they want to be in the effectiveness business and structure their approach for where our business is headed instead of where it’s been.

Marketing communications firms are scrambling to reorganize and restructure to meet the needs of a marketplace that’s changing at warp speed.  Agencies need to meet this disruptive change in the market with disruptive change within their organizations.  But to get the right answers you have to start with the right questions.  Here are Ignition’s top 20:

1. Beyond advertising, have we defined what business we’re really in?

2. Can we articulate the ultimate value we bring to client relationships?

3. How can we focus on being best in class instead of trying to be best in everything?

4. What do we need to do to extend idea generation beyond the creative department?

5. What additional skills or capabilities do we need to make the transition from mass marketing to one-to-one marketing?

6. How can we create more value for our clients in the area of brand experience, not just brand perception?

7. How do we effectively deal with the increasingly blurred lines between advertising and PR (paid and non-paid)?

8. In today’s world of multichannel communication, who is the gatekeeper of ideas?

9. How can we devote just as much creativity to message placement as we do message creation?

10. What else do we need to do to make digital a competency instead of a department?

11. How can we retool the production function to be more versatile and creative – production in the Hollywood sense?

12. How can we change our process to from linear to organic to better reflect the ongoing nature of digital assignments, including real-time analytics and optimization?

13. How can we demonstrate more accountability in our client relationships?

14. How can we further flatten our organization to provide better client access to our best people?

15. How can we remove any of the disincentives – real or perceived – for working collaboratively?

16. How can we redesign our jobs and role descriptions to better reflect what we really do (not what we used to do)?

17. What unconventional ways can we use to market our own brand?

18. What do we need to do to make pricing (not estimating) a core competence of our firm?

19. What’s holding us back from experimenting with new forms of compensation that are not based on the misaligned “billable hour” system?

20. How could we develop, own, and profit from more of our own intellectual property?

Devote the rest of this year to answering these questions and you’ll be well on your way to reinventing your business model to be more relevant and valuable to your clients.

At the heart of every notable brand is a compelling brand story.  This is the tale of how your firm got started, what its creators were trying to accomplish, and the difference you are trying to make in the world.

As with all good stories, brand stories have central characters and a central plot.  They also have conflict — a recounting of obstacles, challenges, and tough decisions.

When describing your firm to a prospect, consider how much more interesting it would be to engage in some storytelling instead of just a dry recitation of facts like agency size and capabilities.  Storytelling is the most basic form of human communication, and for a good reason; everyone — even prospective clients — loves a good story.

An effective agency brand story isn’t just a factual history of the agency.  Rather it should include the elements that make for good short stories in general, including:

Setting

What are the circumstances under which the story took place?

Plot

What are the forces at play in the story?  Good plots usually include the elements of rising action, climax, falling action, and denouement (the final outcome).

Conflict

Without conflict there is no plot.  Conflict is any form of opposition or challenge that faces the main character. For example, what are some of the decisions your firm made about what it isn’t?  What are some of the times the principles upon which you founded the firm were put to the test?

Protagonists and Antagonists

What were the central characters trying to accomplish, and what or who was standing in their way?

Theme

What ultimately is the  controlling idea or central insight?

The story behind Toronto-based Teehan+Lax begins this way:

“Five years ago we set out to build a company that focused solely on delivering great user experiences in the digital channel. We couldn’t rely on the legacy of past employers as the basis for our new company. Instead, we challenged the conventional formula and created a new approach and process.”

In everything from RFP responses to new business proposals, this firm describes their brand using the elements of a good story, built on the central theme that the agency they were trying to create didn’t really exist anywhere else.

When you add it all up, your agency’s brand story is an articulation of your value proposition.  It’s a way of packaging up and describing your positioning in the marketplace.

Everything is always more interesting when told as a story.  So the next time a prospect says “Tell me a little bit about your agency,” consider it an invitation to tell a compelling brand story.

The end.

Some of the biggest stars take the biggest risks when it comes to compensation by taking a percent of the box office.  A good film makes more than a bad film, and the leading actors get paid accordingly.

In the world of professional photography, a good photograph earns more than a bad photograph.  Because the photographer owns the rights, the more the photo gets used, the more the photographer earns.  The iconic Maxell photo showing a man in a chair “blown away” by the sound of Maxell tape is still earning royalties more than 25 years later.

Despite the fact that most of the professionals that advertising agencies draw upon to complete their work — photographers, actors, musicians, etc. — earn more for good work than bad work, most advertising agencies themselves are stuck in a compensation paradigm that doesn’t correlate to value.

It’s time for marketing communications firms to realize that they’re in the intellectual property business instead of the hourly rate business.  Here’s how agency principal Mike Reineck describes how his firm, Atlanta-based Kilgannon, captures the value they create:

“For the first 70 years of the twentieth century, agencies were paid based on how much media they bought for clients. This imploded after the growth of television drove the cost of media (and consequently the amount they paid agencies) through the roof. So for the next 30 years, agencies got paid based on how many hours of service they gave their clients. This imploded after client-side consultants and procurement folks practically drove agencies out of business by process-engineering the costs down to nothing.

Problem with all this is that it has nothing to do with the core offering of an agency. What is that – Media? Not anymore. Services? Not really. Most clients hire agencies because they want help persuading prospective customers to buy more of their stuff. That generally requires a bright idea that gets effectively communicated to those prospective customers. So, do clients pay agencies based on how bright the idea is? Or how effectively it reaches the customer? Or if it helps sell more stuff? Nope.

A media transaction is a market-determined price, so it’s easy to value. An hour of time is easily measured by a clock. But, how is the brightness of an idea measured, or the effectiveness of communication? These are really fuzzy, non-touchable things to measure. In the land of lawyers they’re called “intellectual property,” and payments for them are generally determined through royalties and licenses.

Underlying the license and royalty are the basic concepts of “Use” and “Value.” If intellectual property has value, it probably is going to be used a bunch. For example, Microsoft Office creates a lot of value to a personal computer. I am using it now to write and post this blog. Our enterprise decided to use it a bunch by loading a version on every computer in the agency.  Even though the disc it came on only cost a few cents, we paid a couple hundred bucks for each license on each computer. The program had value; we used it a bunch. We paid Microsoft accordingly. Our procurement people don’t pay Microsoft based on how many hours their programmers spent developing it, or on how many bytes of media the program occupied on the disc. A similar use and value license is employed in the music, publishing, or art world. Back here in advertising, though, we are a little slow on the uptake.

Despite the difficulty of measurement, agencies and clients need to move to a compensation model tied to “value and use.” It more closely links to what we do and what clients want from us. Most every idea gets embodied into some kind of material (an ad, a banner, content, SWAG, etc.). Most of these materials get used (TV, radio, internet, events). Generally speaking, the better the idea the more it gets used.

The payment system should deliver money to the agency based on the idea’s use and the value it creates, even if the client is still using the material and the Agency is not providing services. Why? Because the idea is still producing value to that client and they are using it. In a Darwinian Adam Smith-type system, this would ultimately lead to good ideas and the agencies that produce them flourishing, while bad ideas and their agencies go the way of the Edsel. Isn’t that the most efficient market mechanism?

At our agency, we have spent a long decade trying to transform our compensation systems to ones based on use and value. In the long run, it’s the only win-win for us and our clients. It involves us identifying ideas, tracking their use, and putting skin in the game based on whether they produce value or not for our clients. Last year 25 percent of our revenue came from intellectual property payments.”

(From the blog Kilgannnon Says.)

So next time you hear that an IP-based approach can’t be done, consider the fact that it already has been done.  It works because it aligns the economic incentives of the agency and the client, the hallmark of effective agency-client relationships.

Are you ready to get some experience with value-based compensation?  The first step, of course, is to be clear about what you’re really selling: the value you create, not the hours you work.  A value-based approach to pricing can take an almost endless variety of forms, but to get started here are three basic forms to consider.

1. Straight Fee

The simplest form of a value price is simply a straight fixed price based on the mutually-agreed value of an assignment.  This is different from a traditional estimate of hours multiplied by the hourly rate, because the value associated with the price isn’t correlated directly with time.

One of the best examples of a professional firm using a straight fixed price associated with value is the public affairs firm that brings tremendous value to an assignment by virtue of its contacts and relationships in government.  Sometimes a single phone call can create the desired value for the client.  It’s really irrelevant that the firm only invested a few hours in the assignment.  What’s relevant – and valuable – is that the client’s objective was accomplished.

2. Usage Fee

More and more, the best solution to a marketing problem is not a conventional advertising campaign, but rather some other form of branded content.  Yet structurally agencies still operate as producers and distributors of “ads,” even going so far as to stipulate that their work is “work for hire” that is wholly-owned by the client.

Compare this to the creative service partners agencies work with: actors, voice talent, models, musicians, and photographers.  A photograph is owned by the photographer and licensed to the firm or client.  The more a photograph gets used, the higher the price to the marketer.  The less it gets used, the lower the price.  This correlates directly to the value of the image to the client.

For example, a photographer typically charges a flat fee to take a photograph, but this never comes close to the income the photographer needs to make the assignment profitable.  The photographer’s “session fee” is subsidized by the licensing fees for the use of the image.  A similar approach could be used by agencies where the development of branded content is priced significantly lower than in the traditional “work for hire” model; the firm then makes its real money on the usage.

With the usage fee, the more effective the branded content, the more it gets used, the more the agency earns.  This approach actually solves the problem many marketers have with hourly-rate system where a bad idea costs the same as a bad idea. Not so when you charge like photographers do.  (See American Society of Media Photographers for a look at how the usage concept works.)

3. Results Fee

Unlike the “straight fee” which is a fixed price, a “results fee” is a variable price.  In the results fee approach, the firm ties its compensation directly to specific indicators.  Progressive consulting firms pursue this approach.  Over 30% of Accenture’s contracts include some type of performance measures.

When identifying KPI’s — Key Predictive Indicators — keep in mind that the health of a company is not measured exclusively by one metric any more than the health of the human body is measured exclusively by heart rate.  Choosing the right metrics is critical, of course (the subject of a much longer discussion), but keep in mind they can all be weighted based on the agency’s ability to influence them.

For example, agencies are famous for arguing that they don’t have enough control over sales to tie their compensation to it.  Fair enough.  Make sales just one metric of several, and assign it a low weighting.  Assign a higher weighting to things where you have more direct control and influence, which might include such measurements as brand awareness, brand likability, website page views, etc.

Beyond these three basic approaches, marketing firms can exercise remarkable creativity in developing compensation approaches based on value created vs. hours worked.  All it takes is your willingness to start experimenting with a better way to get paid.