Your next agency pitch will cost you. Here’s the math…

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The practice of going to tender at the end of the agency contract period has become a habit for many major brands. Procurement will argue it is the only way to truly test an agency against the market. But as we have highlighted previously, this is a flawed approach.

Nevertheless, the practice continues, and for more than a decade going to pitch has resulted in advertisers negotiating lower agency fees as part of the process. But that is all about to change if you believe the headlines about the impact of the Great Resignation. Either that or someone is not being completely honest in this conversation.

The Great Resignation

You cannot have missed the news across the business media about the impact on employee resignations as we come out of pandemic induced lockdowns. Apparently, millions of employees around the world have reassessed their current occupation and decided it is not for them and they are resigning in droves for a better career and better lifestyle.

This has impacted almost all categories and markets to various extents. But the trend is consistent and significant enough to get coverage by the mainstream media globally. The marketing and advertising trade media are also reporting on the impact of what is now known as The Great Resignation. Agencies have been reporting significant increases in salaries required to keep staff and attract talent to their agencies. This can only create upward pressure on agency fees.

Impact on agency fees

As we have explained over many years, the agency fee model is based on cost recovery. This takes the direct salary cost, either actual or industry standard, and then multiplies this by an agreed overhead and profit multiple and divides by the agreed number of billable hours per year to obtain an hourly rate that is charged to the advertiser.

You can see straight away that any impact on the direct salary cost will impact what is charged to the advertiser. A 20% increase in salary will translate into a corresponding increase in the hourly fee charged to the client, all other variables remaining constant. Even if you are not using actual salaries, but using an agreed industry pool, this will be impacted over time as the number of salary increases affects the pool.

This will be quite shocking for many in marketing and marketing procurement, including many of their advisors and consultants, as agency salaries have in many markets remained relatively stagnant for more than a decade. This sudden spike in salaries will lead many to believe it is an anomaly and encourage many to ignore the issue. But it will be at the marketer’s peril.

Attracting and keeping talent

The Great Resignation is driving up the cost of labour in the market and this must impact your agency and the retainer you pay. Let’s look at an example of this.

Take an agency retainer of 50 people, for convenience. Of those 50 FTEs, typically marketers only see 20% on a regular basis (such as account management) – so you may be able to assess their capability directly. Perhaps another 20% are seen on a less frequent basis (strategic and creative) but you can nevertheless assess their capability through the outputs of their work. So, that is 40% or 20 FTEs from the 50 you are paying to retain.

The interesting part is these people also often represent the more expensive resources in the agency retainer mix, as they are more likely to be significantly committed to your account (in the case of account management) or significantly expensive (in the case of strategy and creative).

Let’s say that half these valued agency staff members are poached by competitors with a salary increase of 20%. To keep them or replace them with equivalent talent will cost the agency at a minimum of an additional 20% in salary cost. What is the impact on your agency fee?

Current FTEs 50
Current agency fee $7,500,000 per year
Average cost per FTE $150,000
Valued staff 40% or 20 FTEs
Current agency fee (for this valued group) $3,600,000 per year
Average cost of valued staff per FTE $180,000
Agency Staff Poached (from this group) 50% or 10 FTEs
Cost to retain or replace $2,160,000
New Agency Fee $7,860,000 per year
New Average cost per FTE $157,200

If the agency passes on the cost of retaining just ten of the agency team that the advertiser knows and values, it will cost an additional $360,000 per annum. If this cost is not passed on the agency has two options:

  1. Promote a lower cost resource, with therefore possibly lower capability and experience, from within the agency.
  2. Recruit a lower cost replacement, with therefore possibly lower capability and experience, from outside the agency.

Either way, the advertiser will be getting what they pay for and when this is across 20% of the agency team, that can have significant impacts on the perceived value and performance of the agency.

Worse when you go to tender

So, the agency has been replacing key staff with lower-cost options, until the advertiser decides enough is enough and goes to market. Except that a decade of flat fees and a need from procurement to prove their value by reducing cost means there is also an expectation of delivering a saving of 10% on the existing fee. To achieve your agency fee expectation means the successful agency will be competing for talent in the market at 16% below the new market rate.

Current FTEs 50
Current agency fee $7,500,000 per year
Average cost per FTE $150,000
Procurement pitch expectation Reduced by 10%
Expected agency fee $6,750,000 per year
Average cost per FTE $135,000
Market Average cost per FTE $157,200
Market Agency Fee expectation $7,860,000 per year
Difference 16.4%

With an account of this size, it is very unlikely any agency would have the resources to staff more than 20 – 30% of the team and so they will be in market looking to recruit 15 to 20 staff or more in a highly competitive talent market – and already at least 16% below market expectation.

What should marketers do?

  1. I know this is strange coming from a pitch consultant, but do not go to market unless you absolutely must. Just calling a tender on the incumbent could trigger many key staff to leave and go to other roles before the worse can or does happen.
  2. If the incumbent comes and requests an increase in fees, request complete transparency into who and what the additional fees are for and make a business decision on the value of funding the retention of that role or not. But remember, you cannot buy commitment.
  3. Avoid discussions on general increases as high as 20% or more due to The Great Resignation. While individuals may be commanding these increases on a one-off basis, as you can see, based on a total agency retainer, this may only be a single-digit increase, depending on the number of agency staff impacted.

And if you need any advice on any part of this, talk to us. We can advise and inform you on the best decision to deliver and maintain value from your agency.

Shared by Darren Woolley, Founder of TrinityP3, our partners in Asia. With his background as analytical scientist and creative problem solver, Darren brings unique insights and learnings to the marketing process. He is considered a global thought leader on agency remuneration, search and selection and relationship optimization.

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