Declining Profits? Your Clients Are Not the Problem

Almost every professional service firm can recite examples of how their work created immense value for their clients, but returned only a small fraction of that value back to the firm. While various pricing approaches can be debated, one thing is abundantly clear: there is no correlation between the time spent solving a problem and the value of the solution.

It’s time for informed professionals to come to terms with the fact that the time-based billing isn’t worth debating; it’s just dead wrong. Using labor costs as the sole pricing mechanism makes absolutely no sense in knowledge work. And now that AI is demonstrating its ability to accomplish not just some, but most of the tasks and activities required to deploy a marketing campaign, migrating to a new revenue model is both a strategic and financial imperative.

In the advertising business, smart industry observers like Michael Farmer have shown conclusively that the math of time-based billing no longer adds up (and never did). Statistical analysis revealing the sharp declines in agency revenues and profit per head is startling. Farmer reports that since 2008, the number of advertising outputs per agency creative has increased more than 10-fold.

”Our clients will never go for it”

Week after week and month after month, teachers of modern pricing make the case for why the hours-based model is simply unsustainable. Yet most of the industry responds not by changing the model, but by shaving staff, cutting expenses, consolidating operations, and even acquiring and bundling together struggling organizations as if the problem will be solved through economies of scale.

When asked why their organizations persist in the old model, top industry executives have an easy answer: “Our clients will never go for it.” Period. End of sentence. End of discussion.

It’s true that many brand organizations have a knee-jerk reaction in compensation discussions in which they ask for hourly rates and detailed person-by-person time projections. But let’s remember why this happens: because agencies asked them to work this way. When agencies made the misguided decision (in the early 1980s) to abandon the commission system and instead bill by the hour, they prompted client organizations to re-engineer their procurement systems around time, hours, and staffing plans.

”Tell us more”

Professional buyers in today’s client organizations are happy to be shown a better way to structure business relationships. The reason most agencies don’t know that is because they have never proposed a different approach. And when they do, most are surprised at the reaction, which is not “Absolutely not,” but rather “Tell us more.”

Those of us who teach modern pricing to professional service firms have learned that the real resistance to revenue model transformation isn’t external; it comes from the inside. The resistance to change lives inside the firm itself, inside the minds, paradigms and mental maps that professionals have carried around in their heads ever since they filled out their first timesheet. The resistance is cultural, rooted in an outdated view of what the agency business is supposed to be like.

Even though all the real “Mad Men” retired years ago, today’s agencies operate as though we’re still in the golden era of advertising — a time when agencies were a much simpler business working in a less complex ecosystem with a much more straightforward compensation structure.

Back in the day, agencies could afford to run more laid-back, less structured businesses because they produced just a few hundred ads or commercials, running in a much more manageable number of media outlets. Today, even small agencies produce tens of thousands of creative assets each year, running in media outlets that literally can’t be counted (because thousands of new ones are created each day).

But against this backdrop, agencies still don’t manage the actual workload; they just track the hours. They have no means of tracking and valuing outputs, only inputs. They lack the ability to report how many outputs they produced, which kinds of resources were required, and what price they charged. This would be the equivalent of Apple being able to tell you how many hours their employees worked but not the number of devices they produced. Madness.

Internal leadership is the deciding factor

Agencies imagine that the solution to the revenue model conundrum is hopelessly complex. But the essence of the solution is markedly simple: stop charging for inputs and start charging for outputs. Instead of pricing the hour or the person, price the deliverable itself. This, of course, is how the rest of the business world approaches pricing. Your mobile phone carrier doesn’t charge for the effort that goes into providing reliable cellular service; they price the plan, offered up in small, medium and large versions. By reimagining their offerings as delivered solutions instead of activities logged on timesheets, agencies can do the same.

For almost 15 years, our firm has worked deep in the trenches of the agency business helping leadership teams remake their revenue model, guiding them step-by-step to trade the hourly rate system for a a modern, solutions-based approach to pricing. At the beginning of these engagements, we are often asked the question, “What can we do to ensure the success of this program?” Our leading answer is always the same: if the leaders of the firm adopt and model the desired behaviors, we’ll achieve our goals. The top executives must commit to the idea of changing the compensation conversation with both current and prospective clients.

Agency executives make the mistake of assuming their problem is sub-optimal negotiating skills; that they need to learn how to better defend their hourly rates. But that’s just getting better and better at doing the wrong thing. The point isn’t to improve how agencies work within the system — it’s to change the system, which means entering compensation discussions with a different, more effective approach.

Changing a flawed buying process

Agencies (and professional service firms of all types) must remember that it’s the job of the seller, not the buyer, to change pricing strategies. Rather than passively responding to ever-obnoxious requests for information regarding agency costs, agency leaders must introduce both new and current clients to modern compensation methodologies that represent the recent revolution in pricing.

This type of leadership requires a business development profile characterized as “The Challenger” rather than the conventional “Relationship Builder.” Described in the insightful book “The Challenger Sale,” this approach involves politely disrupting the client’s flawed buying process by showing a better way. Will this mean getting kicked out of a new business pitch? Based on years of experience working with agencies on this very question, we can say definitively say that the answer is almost always “no.” To the contrary, proposing a better compensation system is a strong competitive differentiator that improves (by 13 times) your chances of going on to win the business.

But you’ll never experience the benefits of a transformed revenue model until and unless you take the step of changing the conversation. You can’t expect your clients to take the initiative; they will simply continue to parrot back what they believe to be the current industry standard (hourly rates). When you do change the conversation, you can expect to be surprised by the response, which is not “You’re out,” but rather “A better compensation model is of interest to us.”

”We have met the enemy, and he is us”

As a leader, your biggest challenge will be convincing your agency colleagues to take this step, because they are all steeped in the conventions of the current system. For the vast majority of them, it’s the only system they have ever known. They assume it has always been this way, and that it will always persist into the future. They haven’t stopped to think that changing pricing strategies is their job, not the client’s, and that new pricing strategies are introduced routinely in businesses of all types.

The 1970s comic strip “Pogo” made famous the line that applies so aptly here: “We have met the enemy, and he is us.”

__________________________________

Tim Williams leads Ignition Consulting Group, an international consultancy that advises professional service firms in the areas of business strategy and revenue models. Tim is the author of several books, including "Positioning for Professionals: How Professional Knowledge Firms Can Differentiate Their Way to Success."

X: @TimWilliamsICG