What is the most effective form of payment for advertising services

Why is contextual advertising with performance-based payment a gamble that brings losses to both the client and the advertising agency? What form of payment for services is effective?
What Is The Most Effective Form Of Payment For Advertising Agency Services

Annotation. Why is contextual pay-per-click advertising at the beginning of a project a gamble that in most cases brings losses for both the client and the advertising agency? How to choose the optimal payment model for the advertising agency? When and under what conditions is it possible to use the variant of work with payment for the result? Let us discuss in this article the advantages and disadvantages of the common models of cooperation between the client and the advertising agency.

Keywords: contextual advertising, advertising agency, payment models, advertising services for clients, payment for results, percentage of the budget, premium, risks, traffic.

In the advertising services market, the prevailing opinion is that contextual advertising with payment for results is the best model for the advertising agency. This approach is actively promoted by the clients of advertising services.

In an ideal world, people live forever, good triumphs over evil, you can earn easily and do nothing, eat candy and not get fat. Attracting referrers to a company by paying for results (leads) can be classified as one of these ideal worlds.

Overall, four compensation models for an advertising agency can be distinguished:

  • Payment by the hour;
  • Combination of the basic rate and a percentage of the advertising budget;
  • Bonuses for results according to achieved KPI;
  • Payment for the result – treatment (CPA – cost per action) or order (CPO – cost per order).

Let us analyze each model separately and consider its positive and negative sides.

Payment for agency services under the hourly model

The client purchases services in the form of actual specialist hours spent on the project. In this way, the agency can cover the main part of its expenses for the salaries of its employees. A good specialist is expensive. His work can be paid at a fixed rate or on an hourly basis. The hourly rate allows you to effectively sell your services by charging all the cost components of a specialist hour – the profit margin, production costs, including wages, administrative costs, rent, taxes and other agency costs.

The main disadvantage of this system for the customer is that they pay for the process, not the result. Customer representatives are rarely in a position to judge whether the agency’s labor costs are commensurate with the volume of work. Unscrupulous contractors can quote arbitrary values, and the customer will still buy the service. This problem is particularly acute in small businesses and start-ups where the owner performs all major functions.

This situation can be illustrated by a household example – a visit to the dentist. Suppose you hear from the doctor at the appointment, “How did you get into this condition? All your teeth need to be treated and crowned, but this one needs an implant. Immediately you think about whether the doctor is trying to cheat you out of money.

If you use the services of an advertising agency at an hourly rate, you pay for the time, but you are not sure of a favorable result for the company. In this case, it is hard to tell if more hours spent on your project will lead to better results.

But there is another side to this situation: the ad agency. Let us say their staff realizes that more effort is needed to get results in order to work on the website conversion, but the client does not want to pay for the extra time. As a result, the client is dissatisfied with the results, and everyone loses.

In this case, at the beginning, it is almost impossible to estimate exactly what work and how much work will be required to achieve the result. Often there are situations where hours are already included in the project, but in the course of the project it turns out that the professionals need more time, that there are difficulties that, for whatever reason, were not considered at the beginning.

To sum up, the hourly rate is possible only in case of trustful cooperation, when the agency explains the price of the service in good faith and provides details about the work. This helps the agency justify the cost and ensure that the client understands what they are paying for and what they are getting. Specifying the hours of work required to complete the project in the contract gives the advertising agency and the client a specific framework, so the parties should trust each other and be honest partners to achieve a profitable outcome. The more detailed the description of the process and the result is, the better for both parties.

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The motivation of the advertising agency should be based on achieving results for the client’s business, i.e. increasing the number of calls from new customers and sales. In this case, the agency must compensate the labor costs of its professionals, because no one works for free. In this regard, I recommend discussing the following points when signing the contract: the number of working hours required for the implementation of the project, the fixed cost of the specialist’s hour required for the completion of the project, the premium for achieving the goals of lead generation (gaining applications and calls).

Thus, the hourly rate is applicable if all conditions are met:

  • interaction is based on a trusting partnership between the parties;
  • work is described in detail by the agency, the system is transparent for the client;
  • motivation of the agency takes into account not only the volume of hours, but also the bonus for the result.

A combination of the base percentage and a percentage of the advertising budget

A common form of payment for advertising services is for the client to pay a fixed percentage for the maintenance of the advertising campaigns plus a percentage of the advertising budget on a monthly basis.

The problem with working with a percentage is that agencies are interested in increasing the budget regardless of the goals of the project. The drawbacks of this approach are clear: the risk to the client and the agency’s disinterest in the work. This leads to the fact that any problem with advertising can be justified by a lack of budget.

To reduce the risks of cooperation under such a scheme, the client must set clear goals, agree on the services provided each month, and set KPIs for customer engagement and sales over a specified period. They must also determine the budget.

But even this is no guarantee of achieving results. The market is a dynamic system, where demand, algorithms of advertising systems, competitors’ activities, and other factors can change. Not everything depends only on the quality of the advertising agency’s services and its interest in the project. The role played by the economy, the general demand, the reputation of the client, the quality of the product, and other factors means that there are more disadvantages than advantages for both sides in this system.

In an ideal world, the agency should be interested in developing the client’s business for the long term and investing resources in the project, focusing on the long term so that the client can then increase the advertising budget. However, not everyone can endure a long haul, as the motivation to increase the budget percentage may not be strong enough to justify the agency’s long-term investment, given the need to pay staff salaries here and now.

For agencies, the drawbacks of the percentage arrangement include the fact that the agency’s salary and administrative costs are fixed, while the client’s money comes in as a variable percentage of the budget. The fixed fee is usually minimal, which means that the agency runs the risk of falling short on project deliverables and budgets, not having funds to pay staff, and ultimately losing the team.

In this case, the agency depends, among other things, on how motivated the client is to build its own business. Practice shows that many entrepreneurs reach a certain cash flow or revenue level and then retire.

This payment model is often used in the market, but the significant drawbacks of this payment model impede the long-term development of business partnerships for both parties.

You may be interested in: How to avoid marketing agency scams

Bonuses for results according to KPIs

This model is similar to the previous one, except that the agency’s premium is calculated based on a formula that takes into account correction factors for seasonality, competition level, budget volume, quality of incoming calls, etc. Statistical forecasting models must be created individually for each company and adjusted in a timely manner.

The problem is that after signing the contract and agreeing on the cooperation scheme, it is difficult to change it if it turns out to be disadvantageous for one of the parties. In this case, everyone tries to pull the blanket over themselves. The results-based payment model looks very attractive technically, and besides, each manager believes that their company runs efficiently. It seems like an ideal interaction scheme, but it is good only for a perfect world. In practice, the following problems occur:

  • There is no infrastructure for data collection.
  • The work of the sales department is affected by the human factor.
  • There is not enough statistics to analyze and build a model.
  • KPIs are not always measurable and relevant to the business development strategy.

Most of the projects we were involved with did not have call tracking, a well-established CRM system, or advertising channel integration. Many had not even heard of web analytics counters. In the ideal digital world, this would be a disaster, but in reality, it is the case for both large and small companies.

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In the end, both parties will spend much more time creating, refining, and maintaining the KPI payment model than on the project itself. Agency staff will be busy calculating KPIs and bonus rates instead of driving customer revenue. Such a model can be used only if advertising specialists are deeply immersed in the client’s business, have worked with them for several years, know their business inside out, and have a thorough understanding of the basic processes, market, and metrics. For a start-up company, this approach to paying for services is not appropriate.

I often talk to the heads of leading advertising agencies from all over the world, and most of them say that only 3-5% of all the agency’s clients switch to such a system after a long period of cooperation.

In summary, we can conclude that payment for the result achieved by KPI is a viable model that can unlock the potential for profit growth for both the agency and the client, but it is applicable only in a limited number of cases where the company has clearly built business processes, all metrics are taken into account, and the agency has a good understanding of this business.

Payment per result (CPA / CPO)

In this model, advertising professionals are paid for consumer actions (an application, a call, an order, or a purchase). The agency invests its own money in advertising and essentially does traffic arbitrage.

This is ideal for the client and unfavorable for the agency. In this model, the client completely loses motivation to move forward, invest resources in the website and improve the product, as all risks are borne by the agency: If there are no results, there is no payment. In this approach, the risks of losing customers and poor quality of handling requests by the client’s sales department are obvious.

There is a serious problem in the advertising market: services are valued less than material goods. Human labor is a secondary phenomenon in our country. This attitude has emerged due to the prolonged stagnation of the economy. Everyone is talking about the results-based work system: everyone wants to use it, but few understand how it works and when it can be applied. If the agency risks its time and money, it should become a full partner in the company.

We often get calls from clients who want to order contextual advertising and pay for results only: SEO with pay for leads, marketing consulting with a guarantee of increased sales, targeting advertising with a guarantee of business, landing with a guarantee of conversion, etc. Otherwise, they assume that they have to pay for air.

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Paying for results is a one-sided game against the agency. The client does not have to care about the quality of the analytics, the optimization and improvement of their website, the qualifications of the managers, the price, and the quality of the goods/work/services. The agency, which often works only with traffic (sometimes with landing pages), assumes the risks of the entire business chain. In this case, a potential client may call the company and receive the following response from a sales representative: “I am on my lunch break in five minutes, call back later”.

The cooperation must be in good faith and mutually beneficial. When choosing such a system, all processes must be perfectly coordinated, the project must be perfect from a technological point of view, and there should be robots with advanced artificial intelligence in the sales department.

You are promised a pay-per-performance (CPA / CPO) at the beginning of the project? Do not accept the offer hastily. In 95% of cases, you will be flooded with fake requests from people imitating customers. There are even specialized “farms” that sell fake applications. They bring you supposedly real customers, but none of them will become a client. Do you need such a service? I doubt it.

Freelancers also do freelance work. People are not always aware that they are involved in a fraudulent scam. They are asked in a freelancer exchange to visit the pages of a certain resource, leave requests or comments, or add items to the shopping cart. For each action, the freelancer receives a few bucks. The payment difference is collected by an agent who works on a CPA model with the company that owns the resource.

Another possible scenario: a freshly graduated Internet marketer who has taken a two-week course on how to earn 100,00 bucks a month offers his services to the company because he needs something to launch his career. Such specialists grab at everything, but the result matches their qualifications. There may be some unique individuals who quickly become highly qualified specialists, but I personally have not met such nuggets.

Even with the necessary budget and without changes in advertising campaigns, it is impossible to create a sterile environment for constant customer retention. Since the agency works on the pay-per-results model, it takes certain risks associated with the increase in traffic costs, new competitors in advertising, market demand, and changes in the algorithms of advertising systems. In addition to market factors, the result is also influenced by the nuances of the client’s work – the company’s reputation in the market, product quality, competitive pricing and other conditions.

When placing advertisements on the Internet, the advertiser has no direct impact on the algorithms of advertising systems, which consider the number of participants in advertising auctions, market demand, and product relevance. It is difficult to guarantee and take responsibility for the exact number of clicks within the allocated budget.

The CPA/CPO compensation model is suitable when a company has been on the market for a long time, has established demand for products and services, tracks sales in the CRM system, and already works with customer acquisition channels. In this case, the agency can leverage its own advertising techniques to improve performance.

Performance-based advertising aims to achieve specific financial goals in the shortest possible time. Some of our clients work with us under this model, but this collaboration is often preceded by other forms of interaction. To succeed in a pay-for-results model, several conditions must be met.

There must be a sufficient level of traffic conversion at various stages, and the conversion rate of current traffic to inquiries and sales must be estimated before starting a project. The company must also have a high profit margin to cover the cost of the team’s work and advertising. There should be constant demand for the product, and the presence of competition is a sign of market viability. Finally, a professional sales department is essential for a successful pay-for-results model. A poorly performing sales department can undermine the success of the collaboration.

When an agency takes on a results-based project, they are investing their own money. If you are not confident in your product, your team, or have no experience in successful sales, no agency will take such a risk. In lead generation, the agency is responsible for driving traffic and presenting the client’s existing product, not their business as a whole. Often, clients try to shift all risks to the agency due to factors such as inflated prices, poor quality, and poor process management.

The product that will not sell without advertising will not sell profitably with advertising.

Albert Lasker

Moreover, it is easy to deceive the client in such a scheme. The Internet is full of loud promises: a guarantee of the number of inquiries, a guarantee of website conversion, etc. If you are looking for a magician, you will probably find a storyteller. Agencies that cannot find clients get involved in high-risk terms. If you are looking for someone who agrees to work under such a scheme, you take the risk of getting something:

  • Fake recommendations and visitors imitating an order or adding goods to the shopping cart;
  • A cleverly designed promotional offer that attracts not customers but onlookers who have no intention of buying the product;
  • Inflating indicators of visits to the site and viewing ads to blame you for the failure of the advertising campaign.

Do you know what will happen in your life tomorrow? I think you can guess, but you are not 100% sure. An advertising agency is not a fortune teller. There are a huge number of dynamic variables, and it is impossible to take them all into account, especially at the beginning of a project. No one can be 100% sure what will happen tomorrow or in a few weeks, months, or years.

The client who wants a pay-per-performance service is not really looking for an advertising agency but a wizard. They may find a contractor who will convincingly tell them what they want to hear, but they will not be satisfied with the results. The world does not stand still, the market is a living system, competitors and new product alternatives constantly appear, selection criteria and preferences change, and the company that insists on paying for the result requires the agency to look into the future and give a guarantee.

The desire for such an arrangement usually hides banal fears and an attempt to reduce risks, shift responsibility to others, and, in the event of failure, blame the advertising agency rather than themselves.

Each project is a unique challenge for the agency. The entire team works on the development of the client’s business and tries to maintain a mutually beneficial experience of cooperation and development for years. However, the agency cannot know everything and confidently take on results-based funding. There are too many risks and pitfalls that cannot be considered at the beginning, and even after a month of hard work on the project.

To summarize, I would like to quote Philip Kotler from the book “Marketing from A to Z”:

“Marketing is not limited to the department that creates ads, selects distribution channels, organizes mailings, and answers customer inquiries. It is a more comprehensive process that involves a systematic study of what products to produce, how to draw attention to them and make them available, how to get the customer to buy only from you… Marketing is not the art of finding clever ways to get rid of what you have produced. It’s the art of giving the consumer something that has real value to them, of helping them improve their lives.” [1]

A reputable agency will agree to a pay-for-performance system if the company has a strong base and a professional sales department, produces a quality product, and offers a profitable proposition to the market. Advertising promotion depends on the competitiveness of the product and the company as a whole.

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Otherwise, the agency and the client run the risk of being left behind and wasting time and money. However, even if all the conditions are met, this model requires several months of preparation for the project, working on the “fine-tuning” of the company and its advertising strategy, analytics systems and automation of processes in the CRM system. Only then can the project be converted into a pay-per-performance model (CPA / CPO).

Conclusion

We have examined the primary models for compensating advertising agencies. Each model possesses its own unique characteristics, benefits, and drawbacks. If you collaborate with an agency and pay for their hours worked and are content with the project’s progress and cost-effectiveness, then you have found a partner with whom you can grow together. The same can be said for the other payment models discussed in this article.

A sustained positive impact can only be achieved if all parties comprehend each other, are familiar with their partner’s business operations, and are committed to fair collaboration.


Journal: “Advertising. Theory and Practice.” March. №1 2022.
Article: “What format of payment for advertising agency services is the most effective.”
Author: Konstantin Tyesov, Managing Director, Uwindi Agency

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