Guest Author, Tim Williams
You’ve just found $100 on the sidewalk. Should you put it under your mattress or buy a lottery ticket? What role does your tolerance for risk play in your decision?
In business circles, risk is almost always treated as something to be minimized. But can risk also be an economic positive?
The iconic Peter Drucker made a profound observation when he said “All profit is derived from risk.” Ponder that truism as you consider the nature of the compensation agreements you developed over the last 12 months. It’s likely you injected little to no risk in your proposals, which is in directly violation to the principle that if you want to make more money, you must take more risk.
Harvard’s Benson Shapiro offers this perspective: “Performance-based pricing is insurance. It insures that the seller does not undercharge the buyer.” In other words, introducing an element of risk in your compensation agreements not only holds the potential of making more more, but also making you a better pricer.
Who Bears the Most Risk in Agency-Client Relationships?
Now let’s look at risk from another perspective. Jack Skeels of AgencyAgile believes “The primary mediating characteristic of buyer-seller relationships is how risk is handled.” Says Skeels:
“When we ask agencies, ‘Who carries more risk in the relationship, you or your client?’ the answer is almost always ‘We do.’ Nothing could be further from the truth. Your client carries more risk than you do … by a million miles … Clients are completely vulnerable to your efforts (which they don’t see, understand or control), and when you fail, they can die.”
The method of agency compensation is an important factor here. Clients who buy hours are really only buying buckets of inputs that may or may not correspond directly with the needed outputs. But more importantly, these inputs may or may not produce the desired outcomes. Herein lies the risk being taken on by the client. The agency will work its hours and collect its fees regardless of whether or not the work is effective. While every good agency desires to do good work, there is no real economic incentive for them to do effective work.
True, the agency can get fired at the end of the contract period, but that misses the point. After nearly 30 years using the hourly rate system, smart clients have realized that this approach has a fatal flaw. Brand growth has been stagnant for more than a decade, and most major marketers have been slogging along in a low-growth mode, unable to generate the needed ROI on their marketing investment. These clients have now concluded that the hourly rate system does absolutely nothing to help this situation; they’re simply “renting people” in advertising agencies.
Accompanying this current low-growth cycle for brands is an understandable low-cost mentality. Hence the rise and power of procurement. The prime directive at corporations everywhere seems centered on efficiency and cost cutting.
But what are these client organizations truly buying? No company ever saved its way to success. My friend Tom Lewis, formerly of the IPA, observes that professional buyers of marketing services are now squarely in the habit of attacking the seller’s cost base, insisting on as low a profit margin as possible while purposely leaving workload ill-defined. This, Lewis says, results in a low seller’s profit and a low cost of purchase for the buyer. In return for a lower price, the buyer unknowingly accepts compromised quality and effectiveness.
So instead of complying with buyer requests to lower costs— which will not provide the client with what the results they’re attempting to procure — could agencies instead lower their client’s risk?
Three Things Clients Buy
One of the world’s foremost business strategists, Michael Porter, asserts there are three main reasons businesses buy the services of companies like agencies:
To increase their revenues
To lower their costs
To decrease their risk
While most agencies don’t know it, even the most hard-core procurement professional thinks in these terms. Former WPP head of procurement Tom Kinnaird emphasizes that cost is just one of four areas in which procurement professionals seek a “win.” They also seek to obtain value, maximize cash, and minimize risk. This risk can take the form of:
The risk of suboptimal performance by the seller
The risk of not receiving the promised features and benefits
The risk of the service provider not producing the agreed-upon results
Writing in the WPP publication Atticus, Scott Brenman proposes the idea of a “threat audit” to help identify risks your clients face. He then recommends including on briefs a section about risks and threats to keep both agency and client focused on ways to minimize them.
KBS+ co-founder Jon Bond believes that agencies aren’t really in the ideas business — or even the results business — but rather the insurance business. The best agencies, he says, embrace the idea that their essential purpose is to reduce risk for their clients. Bond proposes that agencies should proactively sell their services this way, which he believes leads not only to more new business wins (risk reduction is a powerful proposition) but also better pricing (the best insurance companies command the highest premiums).
In the end, Bond says, “Economics are more powerful than negotiation.”
Propulsion is written by Tim Williams of Ignition Consulting Group, a U.S.-based consultancy devoted to helping agencies and other professional firms create and capture more value.