It’s no secret that the advertising market is extremely competitive, and we have written about this in previous blogs, so pricing services correctly is critical. This is a fine balancing act between making sure that your agency is making a decent margin vs keeping the price competitive. This is especially the case when it comes to winning pitches, in many cases against agencies who are prepared to take a loss to win the client.
So, let’s look at some best practices when it comes to calculating sales prices and pricing services in general.
Value vs Price
Ask any agency principal what their agency sells, and they will typically talk about delivering strategy and creativity to their clients. They will talk about the team’s years of experience and its expertise. They may go on to say the agency’s job is to connect a brand with consumers and it’s all about effective communications.
These are all value-based.
However, if you ask an agency about pricing services, it will inevitably sit down and estimate the effort and roles required to do the work. The number of man hours by labor category. These hours will have an assigned value and that is what is used to estimate the price of the job.
As you can see the value of the agency is in its expertise while the price it quotes is based on effort. The problem with this model is that client procurement departments are very familiar with it and will use it to negotiate the prices down.
Now, there is nothing wrong with an agency knowing the sales price per hour of its employees. In fact, we have a template that does this for you. You can download it here.
However, sales price per hour should only be used as one of many ways to price work. The focus should be on the value provided if possible. The sales price will be the target or minimum sales value.
Traditional Compensation models for pricing services
One way that an agency can differentiate itself and move clients to talk about value vs price is to change the compensation model. The models that most agencies use are based on a cost-plus basis which encourages the discussion to be all about price. For example:
These are great from a revenue and resource forecasting point of view as they are a predictable source of income. They are becoming rarer as clients opt for more and more work on a project-by-project basis. These are also notorious for clients to use to take advantage and assume that it means that the agency is at their beck and call.
Used a lot by traditional agencies to charge a commission on media.
There are various ‘flavours’ of project work. This can be Fixed Fee, Time & Material, milestone-based, etc. The focus and risks are different for each type of these, but they usually are estimated and priced based on estimated effort.
Alternative compensation models for pricing services
The following models for pricing services are rarely used in advertising agencies BUT they are based on a value approach.
Rather than a fee based on effort. This compensation model is based on the success of the campaign. The agency agrees on a set of success criteria and is paid a fee based on how many of the criteria are met. These criteria could be, the number of clicks, the increase in sales, increase in brand/campaign awareness, etc. BUT the important thing is that these are clearly defined and included in the agreement.
This is a more detailed version of the above. The agency gets a commission on all sales over a set baseline. The problem with this is that sales are not solely attributable to advertising so it should be combined with one of the other models.
This is the biggest risk for an agency and requires patience but may be very profitable in the long term. The client must also be agreeable to this type of remuneration.
Rather than receiving a fee for work done the client gives the agency equity in the business. This is real “skin in the game” because the agency directly benefits from the success of the campaign and the client on a long-term basis.
You can see why this is rare, but it should not be discounted.
The best way to price services
Perhaps unsurprisingly, the answer is to use a combination of the methods above. These combinations can be used in the same campaign. For example:
- Why not have an estimate for a campaign that has a fixed price base and a sales commission?
- Offer a success fee to a client procurement department that is driving costs down too much or a very competitive pitch.
The one thing that your agency must have is a good understanding of its costs and billing rates. The costs must be fully loaded costs. That means
- Salary + Staff costs + ALL Overheads
- These costs should be allocated to chargeable hours ONLY
- You must include your desired margin to get the billing rates.
Does that seem confusing, don’t worry we have a template that does this all for you. You just add your agency’s data and desired margin.
Finally, these need to be reviewed on monthly basis and tweaked if necessary. That makes sure that the information you have is accurate and that your estimates lead to profitable work.
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