For a Brighter Financial Future, Align the Incentives

In today's unpredictable economic environment, professional service firms of all types have an opportunity to reimagine the nature of their client relationships. The current needs and financial resources of client organizations create the imperative to focus only on initiatives that produce business results.

Even before the present crisis, a major shift in business priorities was underway. A recent survey by the Association of National Advertisers (ANA) in the U.S. showed that two-thirds of the chief marketing officers want to change the way they compensate their advertising agencies and other marketing partners. The leading reason? Not to cut costs, as many would surmise. Their main motivation is to “improve business results.”

Today’s smart marketers realize that paying their agencies for activities and efforts (hours) does not directly align with business results. In fact, the hourly billing system puts clients and their marketing partners in complete misalignment. What the agency wants more of (hours billed to the client) is exactly what most clients want less of. 

Repairing trust in client relationships

Negotiations centered on either increasing or reducing billable time is a zero-sum game. If one side wins, the other side loses. But there is a better way: structure remuneration agreements around outputs and outcomes instead of inputs. Especially in the case of outcome-based approaches, clients and their service providers are focused on accomplishing exactly the same thing, the very definition of win-win.

Tony Rogers of Sam’s Club argues that the key to an effective, trusting agency-client relationship is alignment of objectives. “If the agency is truly incentivized on growing the brand and the business, and not just selling more advertising work,” says Rogers, “that sets the foundation for a trust-based relationship.”

The right kinds of behaviors — on both sides

The key finding from a global survey of marketing professionals by the World Federation of Advertisers is that 70% of marketers believe that a different approach to the way they pay their agency partners will improve the client-agency relationship. The momentum behind a performance-oriented business relationship has never been stronger, and the motivating reasons clearly go beyond financial incentives. Besides improving levels of trust, most marketers are convinced that outcome-based relationships provide all the right incentives for professional firms to work more diligently, staff assignments with their best talent, and complete projects more quickly. Studies by London-based Source Global Research show that 96% of client organizations also believe that outcome-based approaches have a significantly positive effect on the quality of the work delivered by the service provider.

Win-win approaches create different behaviors on both sides. Professional firms work harder and clients treat them better. As Carl Johnson, co-founder of the agency Anomaly once observed, a performance-based approach “creates an emotional contract, not just a financial one.”

The self-confidence to stand behind your work

Many professional service firms continue to resist the idea of engagements based on aligned incentives because they are reluctant to tie their fortunes to sales metrics they can’t fully control. They fail to consider there are hundreds of success metrics they directly influence, all of which are potential candidates for an outcome-based approach. There are more than 1,800 metrics that can be measured from a single Facebook campaign. So the challenge isn’t a lack of metrics; its a lack of foresight and willingness to do the hard work of identifying the metrics that matter and the self-confidence to put some skin in the game.

Beyond the marketing business, professional buyers in other industries know the value of skin in the game. In defense and aerospace contracting it’s sometimes referred to as “Performance-Based Logistics.” According to a paper published by Wharton, underlying this approach is “the notion that risks and incentives should be more equitably aligned between suppliers and customers than has been possible under traditional cost-plus contracts.” Performance-Based Logistics is now the standard methodology used by many jet engine manufacturers. Rolls-Royce doesn’t attach a fixed price to their engines; rather they sell the promise of “uninterrupted flying time,” taking responsibility for the quality and performance of their product.

Now more than ever, incentives matter

Outcome-based approaches can range from simple (a single metric) to complex (a set of weighted metrics), but an excellent starting point is to ask “The Five Golden Questions of Value” proposed by Khalsa and Illig in their insightful book, Let’s Get Real or Let’s Not Play:

1.   What are the key metrics of success for this assignment?

2.   How can they be measured?

3.   What are they now?

4.   What would you like them to be?

5.   What is the value of the difference (now, and over time).

The central truth of economics is this: incentives matter. In an era of abundant information, professional firms have the opportunity to engender a spirit of trust with their clients and get paid fairly for the value they create by committing to remuneration approaches that align the economic incentives of both parties.

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

Twitter: @TimWilliamsICG