In conversation with... Simon Kendrick and Jonathan MacDonald

The need to be agile is more important than ever in business, and advertising and media agencies need to be able to forward-read changes in technology, consumer behaviour, and social trends in order to maintain their own understanding of the world, and to pass that understanding onto clients at a premium price.

However, are the ways in which agencies relate to clients, and the way in which they price their services, right in today's commercial climate? We asked two leading thinkers and the authors of two recent articles on Imperica, Simon Kendrick and Jonathan MacDonald, to give us their views.

What is wrong with the current commercial model?

SK: In terms of issues with pricing and revenue, my main concerns are fundamentally linked with inputs rather than outcomes. Whichever type of agency we have, it increasingly moves towards fee-based structures which are commoditising the process - whether it's production of a 30-second spot, focus groups or whatever. That seems wrong to me. You are commoditising craft, skills, and ideas, and you end up buying an item, irrespective of what's gone into it. It also seems to be quite salacious, as what companies are buying is the means to an end. They are not buying a 30-second spot or a focus group; they are buying a process, and are trying to feed it into their overarching business objectives. They are then trying to look for successful outcomes: sales, mindshare, and so on.

I think that if an agency is going to be helping a business achieve its objectives, then it should be remunerated based on its relative success. It should be tied much more closely into how the business objectives are met. It's moving to a 2-layer approach. On the first level, you have a basic level of inputs where you are almost charging at cost, and then there is the second level above that, which is based on benefits and success: it might be sales - and if that's the case, the agency currently doesn't get anything. If there is success, then the agency should be part of it, and credit should be apportioned.

JM: Issues within the revenue model are a fallout, a component of the value-chain structure. Ad agencies are used more and more as production houses for delivery on stuff that has been ideated, either internally within a client, or partly dreamed up in combination between client and agency.

Nonetheless, around 20 years ago, creative agencies started to give away ideation, innovation, and consulting time as a value-add, and thence commoditised and marginalised themselves into a place where they can only charge for time. When I started in the industry, media and creative agencies were split. The next thing to happen was that both parties started to give consultancy and ideas away for free, in the same way that supermarkets are now in a price war where Asda will allow you to put in your receipt and they will give you a refund for lower prices elsewhere. You don't have to be a financial analyst to know that it's a race to the bottom and a negative vortex, where he best price for a product is zero, and the people making money out of the price, ironically, are those capitalising on the vortex. The same thing happens in the advertising industry, where they are giving away free ideas and running workshops free-of-charge with clients, where great ideas happen, but with the hope of being paid £80k for a website.

Advertising has self-created the problem that now exists; I concur with Simon's point that it seems to be a unidimensional pricing model where there is no moderation for success. It is a production pricing model, full of commoditised products. I also concur regarding the desire for a better world, where there is cost-plus: cost on production, and 'plus' on reward.

However, one of the fundamental structures inside advertising is that budgets are set by the client long before the advertising and media agencies are involved. Those budgets are signed off as much as four quarters before the actual budget is used. I have often thought that there must be a performance-based way of budgeting, but there is a huge resistance to changing the model from the client side, because if the CFO says "We are going to launch this campaign and there is £5m in the pot", having part of the pot on a performance basis means 2 things. Firstly, the client would not know how much money they're going to spend; it's suffering in style as the more successful the campaign the more they spend, but the more they spend the more success there is. There is a client resistance on that. Secondly, the resistance is from the advertising agency who would not, under any circumstances, want to have variable budgets because they have Soho offices costing £55 per square foot with 930 staff, with spiky hairdos, checking Facebook. You can't pay for that on a variable budget. They need to win a deal for £1.3m retention and that deal needs to be validated by the CFO as "Against this deal of £1.3m, we can now spend money on getting the 20 staff to produce what's needed".

Without me damning the potential of measurement-based pricing, which I like the idea of: measurement pricing would split 'the men from the boys' in the advertising industry. I also believe that advertising agencies should move as closely towards retail revenue as they can, and if I were to be asked in 10 years time what will the revenue model look like, I think that advertising agencies would be platform facilitators of retail sales.

So, I think that the measurement model would come in, but probably not as an evolutionary morphism. I think that what will happen is a fairly small, nimble but powerful agency, or group of agencies, will emerge, but not in WPP or Omnicom, and they will emerge with a measurement-only model which doesn't have a 'Production-plus' or 'Cost-plus'. It may happen in a developing territory, where there is no legacy model or Soho office. This performance-based pricing is shown as proof of efficacy, and then reverse-rolled out across what we call the developed world, although as each day goes by in my career, I realise that what we think of as being the developed world is underdeveloped in very basic thinking.

SK: Jonathan's right with his typology of advertising agencies with overheads. They can talk the big game in terms of performance measurement and variable pricing, but when you have bills to pay at the end of the month, the risk-taking is put to one side and you become much more pragmatic; easy, guaranteed money coming in this month is preferred to what may or may not happen down the line. It's going to be a challenge for agencies to take this approach on board.

In terms of who's doing it, the WPPs and such like... it would be great if one of these [majors] could take these processes and see how it works. We have entrepreneurs and small agencies experimenting in these agencies, but they have limited means. WPP has something like 6 agencies competing against each other in any given space, so why not have one experimenting with a new system? The type of budget going towards funding that would effectively be a rounding error in their end-of-year financials. It wouldn't cause a huge impact. It goes back to the idea of creative disruption; innovating around the edges. WPP would still continue to have its big agencies, so why not put a little disruptive agency out there, to see if it would attract a certain type of client to go down a measurement-based route?

One of Jonathan's earlier points touched on the fragmentation between media and creative agencies. The whole structure of fulfilling a client's strategy is so fragmented, how easy is it to assign credit when it comes to measuring relative success or failure? We might have creative agencies, media agencies, PR agencies, research agencies, consultants and so on... I'm sure that they would all be happy to take the credit when success arrives, but how is that money distributed? It's a difficult challenge. If we go back down the route of a measurement-based system, then perhaps we need agencies that can do everything. I was recently at Firestarters, where Mel Exon from BBH Labs was talking about a networked agency: a collection of specialised individuals, rather than a series of static groups within the same structure. Perhaps the agency of the future, when taking credit for its relative success or failure, needs to be holistic and perform everything for the client, instigating a long-term strategy which becomes measurable, based on the success or failure of delivering on core business objectives.

JM: This point of attribution is massive. Like the revenue models being born of the structure of the industry, the attribution issues that you point out are born of the centralised, protective, and slightly paranoid behaviour of individual companies. If you think about how bands share credits for royalties, you can have solo artists who get together to release a new song, such as Otis by Kanye West and Jay-Z, where they both rap for the same amount of time in it. But, the deal in the background is quite an intricate one, which took around a year to put together. Different things happen in the same way with bands like Coldplay, who share the royalties four ways. No-one is genuinely going to think that the bass player is necessarily contributing as much as Chris Martin, but nonetheless, the bass player gets 25% of everything. If there was a holistic, long-term strategic view which was collaborative and less protective in its structure, then there would be a way of delivering attribution which was more to do with getting the ball over the line in general, and then awarding all 11 players their £100k-per-week salary, rather than looking at whoever is the last person to kick the ball over the line.

What we're talking about here is the difference between solo artists and bands, and protectionism versus collaboration. This isn't helped by the fact that at the moment, clients are equally looking at the whole agency landscape and thinking "We can do quite a lot of this ourselves". Burberry's in-house team including Musa Tariq and Carl Martin who strategise, create and launch... these guys are on fire. They have incorporated the best people from agencies around the world into their brand. They are working like an agency inside their own company. Their relationship with agencies is to be slightly different than a company like GSK or Unilever. With Unilever, they are heavily reliant on a roster of agencies, but even then, they have internal L&D exercises to increase their own capability. The more you look at it, the more you end up with a situation where rather than having a door opening that's pushing against the agencies to commoditise them, the agencies are helping the door being opened by saying "If you can't pay £180k for an app, we'll do it for £25k; just give us the deal". I have seen this over the past couple of decades; you end up with agencies winning deals for £28k, but will cost them £42k to deliver. They look at the £28k revenue and say "We have another £28k in the book". It's only when the CFO, CMO or CEO raise the flag at the quarterly meeting, that they see that they lost £14k on the deal. There doesn't seem to be a link between P&L and business development. So, we even have internal attribution issues as well as external ones.

SK: It's a great point, regarding clients increasingly taking on functions themselves. An agency has to be able to differentiate on its expertise, its specialisation, to really know the difference between what it can produce, and what a client can produce internally. If we're moving towards commoditisation, then what is an agency competing on? The fact that it can do it cheaper, or the fact that it will save the client time? That's not a great competitive strategy in the long term.

JM: It's hugely risky. Peter Drucker must have said 80 times in 80 years, that there is no bigger risk than to compete on, than price.

SK: Agencies are also at a disadvantage. The fact that they are so fragmented, specialising in one niche, means that they only ever see part of the picture, so how can they provide value to the overall strategy when they only ever see one part of it? The client is the puppetmaster with all of the strings coming out to their roster. To use the analogy of the film industry, the CMO is the director, and the agencies are the set designer, cinematographer, cast director, and suchlike. They are being hired on a flat fee to perform a task to the director's - the client's - strategic vision. While they get flat fees, the client reaps the ultimate benefit of success - or failure. With Jurassic Park, Spielberg had a profit-share where he earned around $250m, while the cinematographer or set designer probably just got their fee. They were part of the biggest money-making film of all time (at the time) and got the same fee as if they were taking part in any other film, whereas Spielberg as the visionary behind the project, bringing people together to build a coherent vision, reaped the ultimate benefits. That seems to be the client's prerogative in contemporary advertising, and yet the agencies are getting the same reward, come what may.

With tensions between cost and creativity, and a lack of agility to move into new spaces... surely agencies should have figured these issues out years ago?

JM: It's hard to comment without sounding cynical; I can only concur. Common sense ain't that common [!]

SK: I agree. there is a race to the bottom, and to the top. Many agencies seem to be racing to the bottom, but with the race to the top, you have the tensions between agencies and the clients that are doing it internally. Will the agency of the future be doers, producers, or will they be the thinkers? If they are the thinkers, then how will they differentiate from what the client can do internally, where the client has that holistic vision of multiple disciplines which feed into their strategy? It's a tough one, and the only way that the only way that an agency of the future can succeed in that is by taking over that holistic vision and becoming multidisciplinary. It's bringing in that network of specialists, so that the agency as a whole can become generalists.

JM: I totally agree.

Agency networks are not necessarily what "networks" should be like, which should be more free-form, and agile. Are we going to see a redefinition of the meaning of an agency network?

JM: I don't think that the word 'network' has had any different meaning, other than a self-created meaning by the advertising industry. In other industries of today, the term 'network' means what we imagine it should mean. From symbiotic, social interrelationships in fan clubs, through to network infrastructure, networks are as they always have been. The term 'advertising network' is a self-created meaning for that particular instance, in the same way that 'social media' is, according to a lot of people, media to which we can advertise on a social platform. The reality is that social media is two-way, interactive, conversational content, but the advertising industry has taken social media and thought "Fantastic! Media - this is where we can blast people's eyeballs, and Social - loads of people are doing it." The network agency is currently thought of differently in people's heads inside agencies than you imagine it would be, had you had just landed on Earth and someone described to you what a symbiotic network is.

In terms of the future, you will end up with two types of agencies in the market, on a 99/1 rule. The 99% will be the cheap production houses that are procured on price and quality, but mainly price. You will then have 1% who are pro-active, retail and advocacy-transaction paid, rather than through time-based payment. They will be proactive in upwardly consulting and nurturing clients in being reactive and being price-competitive. It's a rosy future for those who can create enough agility in themselves, through probably not through someone who isn't agile already.

What goes up tends to stay up. What we're talking about here is a speedboat structure coming along, and disrupting the market in such a way that it doesn't break the existing model, but it just fast-forwards the existing model into a commoditised one. The final irony is that this is seemingly desired by those very same agencies that will mostly be out of a job when it actually happens.

SK: I agree; the status quo is slow to shift but we will see movements in these directions. On the one hand, agencies are moving towards becoming production houses, that provide work at-cost. You know what you are getting, and they are going to do a robust job that's not particularly creative; they do what they are paid for, and that's fine. On the other hand, you will have those that can provide creativity, the ideation, the expertise.

Regarding evolving networks, we talk about networks within a WPP or Omnicom-like model. That means that everyone in that network is under WPP or Omnicom's employ. Networks of the future, with small and agile agencies, will become networks of individuals, mimicking the way that network theory has evolved over the social web, in that you increasingly see specialists coming together for different tasks, functions, projects, and strategies, depending on the nature of the project. They become more nimble and agile across different types of project, rather than being part of a one-size-fits-all agency working on one-size-fits-all projects. You will see much more fluidity in the future.

Simon Kendrick works at Essential Research, a media and technology research company. He also blogs at Curiously Persistent and is @curiouslyp on Twitter.

Jonathan MacDonald is the co-founder of business and marketing consultancy this fluid world, and co-founder of Every Single One Of Us. His website is jonathanmacdonald.com, and he is @jmacdonald on Twitter.