• About the blog

    This is the personal blog of Simon Kendrick and covers my interests in media, technology and popular culture. All opinions expressed are my own and may not be representative of past or present employers
  • Subscribe

  • Meta

  • Advertisements

Overhauling the agency pricing model

Agencies are potentially losing out on beneficial and worthwhile commissions due to a fundamentally flawed approach to pricing their work.

(Note: My experience with pricing is almost exclusively tied to research agencies but I think this is broadly applicable to all industries).

Projects are commissioned when there is agreement between what an agency is willing to offer, and what a client is willing to pay.

My issue is that both of these components are based on cost.

Instead, they should be based on value.

£1 price tag

The agency side

The current model

Looking at the agency side first, it is clear that the focus upon cost makes the process far more transactional than it should be.

Using a dodgy equation (channelling John. V Willshire, who does this sort of thing far better).

P = d + αi + βt + p where P =< B

In English, Price =direct costs + a proportion of indirect costs/overheads + an estimate of the time spent + profit, where price is less than or equal to the client budget

(The alpha sign has arbitrarily been assigned to meaning a proportion, and beta an estimate)

d + αi + βt can be simplified to C for costs. Thus:

P = C + p where P =< B

Explaining the equation (this can be skipped if you trust me)

Of course, this is an oversimplification (though if agencies don’t use timesheets then the equation will lose the time segment and become even simpler) but it does explain the majority of the considerations.

Competitor pricing will be a factor. Market rates are to an extent set by those that have offered the service – an agency will seek to match, undercut or add to a premium to this depending on the relative positioning. This is reflected in the equation through time (premium agencies will generally spend longer on the delivery) and in desired profit.

An agency’s price will miraculously match the stated client budget (or in some instances, come in £500 under which I don’t understand since a) I thought psychological pricing had been phased out b) that spare £500 is not going to be able to cover any contingencies, expenses or VAT that aren’t included in the cost).

However, there are (at least) two things that aren’t yet factored in:

  • Opportunity cost – the cost in terms of alternatives foregone. This isn’t included since the only time you can really be sure that new requests for proposals appear is at the end of the financial year. Otherwise – for ad-hoc project work at least – there is no way to accurately predict the flow of work.
  • Competitive bidding – where profit is multiplied with expected success rate to give expected profit. While guesses can be informed by previous success rates, I don’t rate it as a) closed bidding processes mean competitor bidding strategies are unknown and b) perceived favourites are just that – perceptions (for instance, an incumbent may be secretly detested)

So what does this mean?

Ultimately, an agency will only submit a proposal if they think the profit they will make is worthwhile. The above equation can be reframed to reflect this:

p = P – C where P =< B

Or profit is price minus cost.

And this is where my main problem is with agency pricing. Profit is expressed purely financially.

Undoubtedly, finance is crucial. An agency requires cashflow to operate, it cannot survive solely on kudos. But it shouldn’t be the sole consideration

What I think should be included

Value should be added to the equation.

An agency should think not only about the financial margin, but about the business margin.

In addition to revenue, an agency can receive:

  • Knowledge – will the project increase knowledge of markets, industries, processes or methodologies that can be applied to other projects in future? This can be used to improve the relevance of business proposals, or be incorporated into frameworks of implementation
  • Skills – is the process repeatable, which can create future efficiencies? Does the project offer opportunities for junior staff to train on the job? If so, savings in training and innovation can be made
  • Reputation – will the results of the project be shared publicly – in testimonials, trade press, conference circuit or otherwise. If the agency is fully credited, there is PR value in terms of profile and attracting new business
  • Follow-up sales – will the project lead to additional work, either repeating the process for another aspect of the business or in up-selling follow-on work? Again, this can save on business development and can offer some future financial assurances (which will influence the amount of money borrowed and subsequent interest paid)
  • Social good – perhaps not as relevant for those in commercial sectors, but will the project create real and tangible benefits for a community – referencing Michael Porter’s concept of shared value

Thus, project gains are far more than financial. These intangible benefits should be applied as a discount to financial profit

Dodgy algebra (this can be skipped unless you want to pick holes in my logic)

Because while net gain would be:

N = p + β(k+s+r+f+g)

The net gains from a project are profit plus estimated gains in knowledge, skills, reputation, follow-up sales and social good (note that these factors can be negative or zero as well as positive). These can be simplified as intangibles:

N = p + I

These intangibles offer alternatives to financial profit. Increasing the amount can be gained effectively increases the budget:

P = C + p where P =< B + I

Assuming that an agency won’t offer psychological pricing, we can assume that P = B. This makes the equation

B + I = C + p

Substituting budget back in for price, and rearranging gives:

P = C + p – I

However, this assumes that the entire surplus is passed onto the client. Obviously, this shouldn’t be the case but equally the agency shouldn’t keep all of this surplus. Instead, I propose a proportion of the benefit is passed onto the client via a discount (in order to make the agency more competitive and improve chances of success).

Value is therefore a function of profit and discounted intangible gain:

V = fn(p – ɣI) where gamma is a discounted proportion

What this means – the conclusions bit

All of this long-winded (and probably incorrect) algebra effectively changes to equation

P = C + p

becomes

P = C + V

Financial profit is substituted for value.

I believe that the price an agency charges should be a reflection of their costs and the overall value that is received from the profit – both in tangible revenue and intangible benefits. Some of these benefits should be passed on to the client in the form of a price reduction, in order to make the bid more competitive and improve chances of success.

This also works in the converse. If there is a project that an agency isn’t enthusiastic about – it might be laborious or for an undesirable client – then the intangibles are negative and so profit needs to increase in order to make the project worth undertaking (in a purely financial equation, this means costs will need to fall within a fixed price/budget).

I should also make it explicit that I am not advocating a purely price-driven approach to bidding. Other factors – communicable skills and expertise, vision and so forth – are still vital. The reality is that markets are highly competitive, and price (or more accurately, the volume of work that can be delivered within a fixed budget) will be a large factor on scorecards used to rate bids.

The client side

This section doesn’t require algebra (fortunately).

My main issue with client budgeting is that it only concentrates on purchasing outputs. While these are tangible, these outputs (at least in research) are a means to an end. A client may want eight groups and transcripts, or a survey and a set of data tables, but the client doesn’t want these for the sake of it. They are purchased to provide evidence to validate or iterate a business process.

Therefore, I believe the client budget should be split into two.

  • The project budget – the amount that a client is willing to pay for the tangibles – the process required to complete the delivery of the project. These outputs are outcome-independent.
  • The implementation budget – which is outcome-dependent. The complexity or implications of a project are often unknown until completion. A project could close immediately, or it could impact critical business decisions in nuanced ways. If the latter, additional resource should be assigned to ensure the business can best face any challenges identified.

The majority of costs are incurred in the project, but the real value to the client comes in the implementation. This needs to be properly reflected; it currently isn’t.

Effectively, I propose a client should commission an “agency” to manage the project and a “consultancy” to manage the implementation. These could be the same organisation, they could not.

Wrapping up

There are undoubtedly things I have overlooked, and I’m pretty sure my algebra is faulty.

However, I believe my underlying hypothesis is valid. The current agency pricing model is flawed and needs overhauling because

  • Agencies ignore non-financial benefits
  • Clients ignore implementation requirements
Both of these are easily correctable, and these corrections can only improve the process.

sk

Image credit: http://www.flickr.com/photos/chrisinplymouth/3222190781

Advertisements

Google Firestarters #2 – Design Thinking

The second Firestarters event, hosted by Google and curated by Neil Perkin, was an excellent evening – probably even better than the first evening. There were lots of interesting people to speak to and debate with in the break-out session and afterwards, while the Google catering is unrivalled. I’m amazed the staff aren’t twice the size they are, given the volume of cupcakes around.

The primary reason for the quality of the event is the speakers. Both were very interesting.

Tom Hulme (IDEO)

Tom talked about design thinking as a set of beliefs. He advocated it as a form of divergent thinking. Strong companies that perform well tend to be good at optimising and being efficient in their areas of expertise. Creativity in opening up new avenues can bring in new aspects to a business, which they can subsequently optimise and renew the cycle. Traditionally these would be have been consecutive but with things moving so quickly they should now be concurrent.

Tom’s 8 steps for design thinking are

  1. Challenge the question
  2. Be user-centred (and do so in context. Focus groups are not the place to introduce ideas)
  3. Look to extremes
  4. Messages or experiences? The answer is both – they are coherent.
  5. Be holistic – the business model and marketing model are now indistinct from one another
  6. Value diversity
  7. Launch to learn – prototyping is now redundant as it is so cheap to launch and run A/B tests
  8. Stay in beta

Tom is a very charismatic speaker and came up with wonderful examples – from Sneakerpedia being an example of message and experience combining, to Steve Jobs’ calligraphy course as an example of diversity to his open document containing useful tips for start-ups.

He also ended with a great quote: “Looking at why people really hate stuff is wonderful inspiration to come up with new ideas”

John V Willshire (PHD)

John is well-known for his unique analogies, and he didn’t disappoint with a seamless weaving of Bad Religion and Adam Smith.

John was a counterpoint to Tom, in that he argued the case against process. Channelling Bruce Nussbaum, he said that companies are only comfortable with design theory when it is packaged as a process. And then they are principally purchasing the process, rather than the idea or outputs themselves. Real work, in other words.

Process might make bad things good, but it also makes great things good. It levels things out into mediocrity.

When Adam Smith discussed the division of labour, he noted that the benefits to industry would be in dexterity, time and technology. However, he noted that this process wasn’t applicable to agriculture due to its unpredictability and variety. As John noted with regard to marketing agencies, “The sell is industrial. The work is agricultural”.

sk

Image credit: http://www.flickr.com/photos/dunechaser/3339729380

Links – 1st February 2009

Part 2 of the Good Stuff, following on from links yesterday to top articles on insights, marketing and advertising, online video and music.

Social media

I haven’t yet read it but I’m sure it is brilliant: danah boyd’s PhD dissertation

The Vitrue top 100 social media brands of 2008 (with methodology included)

Charles Frith provides an excellent case study of how brands shouldn’t engage with social media. Whether the person was officially representing Miller or not, he got pwned.

A Wired journalist experiments with various geo-aware applications and finds out that they are not all that they are cracked up to be

Mozilla have proposed a free, crowd-sourced usability tool which sounds, from this at least,  fantastic

Technology and the internet

One one hand, Kevin Kelly argues that ownership may soon be a thing of the past, and that access is far more important. Bodes well for tools such as Spotify.

But on the other, Jason Scott argues against the Cloud, as it can’t be trusted to safeguard your “possessions”

John Willshire lists several free tools that can be very useful in tracking online consumer behaviour

Discover Magazine offers a counter-argument to Nicholas Carr’s Atlantic article. Through outsourcing the effort required for recall, Google can in fact make us smarter. Not sure I necessarily buy this, but interesting nonetheless

Business and ideas

A great interview with Nassim Nicholas Taleb, author of the Black Swan, in the (UK) Times

Henry Blodget’s plan to fix the New York Times includes cutting costs by 40%, raising the price of the print edition and – controversially – reconstructing a walled garden for premium content

John Willshire (again) live-blogged the recent PSFK ideas salon in London, and it is well worth a read

Copyblogger has six ways to get people to say yes

A lovely story of a designer recounting his experiences with notebooks. I’ve recently started using a notebook for more than transitional note-taking, but it remains to be seen whether anything useful will come of it

My Favourite Business Book – crowdsourced opinion

And, as always, I’ve been posting slightly more miscellaneous links to my Tumblr blog, which in theory now has comments enabled through Disqus.

sk

Reblog this post [with Zemanta]

Links – 31st January 2009

As Des’ree once bemoaned, “Life, oh life, oh life, oh life”. A hectic few weeks are *fingers crossed* finally over. Rather than just watching the evening news and eating toast in that time, I also managed to read and bookmark some interesting things posted on the internet. Here is part 1 of a two-part collection of said stuff.

Insights

I’ve enjoyed the back and forth discussion regarding the nature and usefulness of insights. Richard Huntingdon used Simon Law’s presentation as a basis to provocatively state that insights do not come from the research department but from a combination of within (presumably not from those within the research department though), real life, academia and “weird shit”. This inspired several other posts.

Rory Sutherland sought to distinguish between an idea – creative – and insight – deduction.

Kevin McLean, a Qual researcher, felt that a little humility could have been used in the argument.

Will Humphrey offered a balanced summary, arguing that research findings should promote creativity and lateral thinking, but that planners should be more “ballsy” when pushing for decent research.

In terms of being ballsy and challenging, Dave Trott offers an inspiring story of changing a slender brief to a truly impactful one after going away to research the product

My own thoughts? Bad research, and bad researchers, exist. As do bad planners, creatives, account managers, product directors and so on. A project is more likely to succeed if each stakeholder is capable of implementing the necessary vision. This requires dialogue on each side – utilising specific skills and expertise to challenge, mould, amend and hone a brief. It is a researcher’s duty to provide a bespoke solution that will provide real, accurate, tangible outputs. If they don’t then they have failed. But other people in the chain have just as big an opportunity to succeed or fail.

Marketing and advertising

Rory Sutherland wonder if we can outsource media planning to the public through recommendation mechanisms within social media.

John Willshire followed up on that post with the notion that this removes control on how the message is propagated. He gives a great example of how such a scheme can easily be commoditised.

Ad Week looks at the rising relevance of shopper marketing in times of media fragmentation.

Faris Yakob uses a brilliant (fan-made) Thundercats trailer to illustrate the power and benefits of recombinant marketing

Iain Tait has a minor rant about the trend of using the themes of connection and collaboration within TV advertising

Graeme Wood remarks on ways in which the internet and social media can be used to deepen involvement in a television show

A NY Times article on ways in which the internet is being used to promote new novels

“Trust Me” – a new shot set at an advertising agency has launched in the US (NY Times). Within the show, real life brands and campaigns are placed. Personally, I think this is a great way to involve brands into entertainment in an organic way. However, in the UK product placement is currently illegal and so I wonder whether the show could ever be shown over here. Precedents are mixed e.g. we may get James Bond films with the “kerching” moments uncut but the Coca Cola drinks within American Idol are pixellated.

Rohit Bhargava on how advertisers can use consumers to help promote them

Ad Rants takes a look at Bob Garfield’s overview of the widget economy. I’m now locked out of the original article, so if anyone has access I would appreciate it if a copy could be sent my way 🙂

Claire Beale on Walker’s campaign to crowdsource a new flavour of crisp

Online video

Jim Louderback makes an excellent point in that, online, the third dimension of depth – or engagement – is far more important than reach and frequency

Mark Cuban believes online video is overhyped because the technology isn’t stable enough for mass simultaneous viewing. I would argue that this is what TV is for; online video is not TV and its benefits are different, but complementary.

And to highlight that difference, because the web is much more about discovery and experimentation, we see a huge drop off in viewing between episode 1 and episode 2 of a web series. Newteevee has a great overview of a recent report

Music

A Freakytrigger post shows that the number of new entries in the UK charts has dropped off a cliff in recent years. A negative effect of the long tail?

A very interesting Music Think Tank post on a pull music paradigm shift. There is some dissension in the comments but I found it fascinating

Tomorrow’s update will feature articles on social media, technology and the internet, and business and ideas

sk

Reblog this post [with Zemanta]