Tim Williams urges the advertising industry to catch up to the modern pricing practices of the 21st century.
Client organisations have long had pricing -- not just accounting -- as a core function of their organisations. Major marketers employ pricing professionals in pricing departments -- trained professionals who attend pricing conferences, read pricing books, belong to pricing associations, participate in pricing webinars, and may have even earned a university degree in pricing.
In the agency business, however, only 23 percent of firms of agencies consider pricing to be a core competency, according to the IPA’s 2016 survey on Pricing, Selling and Negotiation. Agencies may be experts in "costing," but that's a very different skill set. Costing is a science; pricing is an art. Costing is a calculation; pricing is a judgement. Costing is tactical, while pricing is strategic.
Because pricing is a high-level strategic function, it should be centralised among a small group of professionals in the firm. And while the IPA survey indicates that 61% of agencies believe pricing is centralised in their agencies, it's likely to be centralised in the wrong place: the accounting or finance group. Pricing is not accounting, and very often the CFO is the exact wrong person to be involved in pricing. Oscar Wilde's observation about people who "know the price of everything but the value of nothing" unfortunately describes the approach many firms bring to their remuneration agreements. The overwhelming majority of today's agency-client agreements are based predominantly on the costs of the seller rather than the value to the buyer. More than two thirds of the revenues earned by IPA member agencies is from cost-plus contracts.
Negotiating the right thing
When professional firms base their pricing approach on the costs they incur rather than the value they create, it produces a cascading series of incorrect and ineffective practices. When challenged by clients on their prices, the IPA study shows that most firms respond by explaining and justifying their costs, which is precisely the wrong reaction. Agencies are sub-optimal negotiators not just because we're generally amateur sellers pitted against professional buyers, but because we're negotiating the wrong thing. Every buyer on the planet wants to reduce cost, but every few want to reduce value.
In fact, professional buyers actively work to keep the discussion focused on costs, in part because it puts the agency on the defense and in part because that's just what professional buyers do; it's their job. But you as the seller have a job as well: to discuss, package, and sell the value of your services. The buyer may want to discuss inputs (hours, staffing plans) but effective sellers keep the focus on outputs (deliverables) and outcomes (results).
Capturing the value slipping through our fingers
It's because most agencies negotiate the wrong thing -- cost instead of value -- that we are also so ineffective in matching reductions in fees with reductions in scope. As the IPA study shows, very few firms "always reduce scope" when confronted with cost-cutting requests from clients. In this area, marketing services industry can learn a lot from construction companies, the industry that invented the "change order." The smallest change (adding a door to a bedroom) equals a change in scope with a corresponding change in the price.
Given the constant changes in scope by clients around the globe, agencies should be supplementing their base fees with significant incremental income. But in pricing audits our firm has done among multinational agency networks, we have consistently found that less than 10 per cent of their total annual revenues are derived from the equivalent of change orders, and a consistent majority of agencies rate themselves as "poor" in their ability to capture additional value for additional work. It doesn't take an economist to ascertain where these leads in terms of year-end profit margins.
Agency professionals are masters of estimating costs. Now, with average agency profit margins hovering just above 10 per cent globally, there is a strategic imperative for the industry to finally abandon the industrial-era cost-plus approach and catch up to the modern pricing practices of the 21st century.
Tim Williams will be speaking at the forthcoming IPA Commercial Conference. The IPA will be unveiling survey results on commercial and pricing strategies at the conference and this article is based on a preview shared with the author.
Last updated 21/06/2016