Advertising Agency: Compensation

The revenues of advertising agencies are derived from commis­sions and fees. It has been customary for full-service agencies to charge a commission of 15 per cent on total billings for their services, plus reimbursement for advertising production costs. The 15 percent commission comes from the media in which a client firm’s advertising is placed rather than from the firm.

An advertiser is billed by its agency for the full cost of the advertising space used in the media. Then, the media bill the agency for the full cost of space lest a commission of 15 per cent (any early payment discount is passed back to the client). The agency’s revenue, then, is primarily the difference between what it bills clients and” what it pays to media.

In effect, the media are paying the agency a 15 per cent commission through a reduction in its billing to the agency. Moreover, this 15 per cent commission must cover most expenses of operating the agency, so that a client is actually paying for the full-service offering.

Boutiques, on the other hand, charge, a fee, rather than a com­mission, for services rendered. The movement toward a fee system will change the agency client relationship to the advantage of the client, for advertisers will be better able to buy only those services that they need from agencies.

There are two major methods of compen­sating advertising agencies-the commission and the fee method. Under the typical commission system, an agency receives an amount equal to 15 per cent of the cost of the media time or space. The commission is paid by the media, which bill the agencies for the stated rate, less 15 per cent- the advertiser pays the full rate to the agency.

Thus, if an agency prepares and places an advertisement in a magazine worth Rs. 40,000, the media will bill the agency for Rs. 34,000 (Rs. 40,000 less 15 per cent). The agency, in turn, bills the client for the full Rs. 40,000. It is with this income of Rs. 6,000 that the agency performs its services.

Most retailers deal directly with the local media and pay lower rates. No agency commission is paid on these rates. If a local advertiser uses an agency, he usually pays a fee.

For many years, there has been considerable dissatisfaction with the straight commission system. The profits of the agencies declined because they were forced by competition to perform more and more services without, additional compensation. Target advertisers, who bought much media time and space, felt that they were paying too much.

The agencies received the same compensation, whether they placed the same advertisement in ten different magazines or had the extra expense of creating ten different ads.

Today, there is a definite trend toward the use of the fee method, or a combination of the commission and fee methods, although the straight commission method is still probably the most widely used.

The size of advertising agency is measured in what may seem to be a curious way. While we indicate the size of most business organizations by their sales volume, the size of the ad agency is mea­sured by its “billings” figure. This billings’ figure is not the same as the revenue or income of the agency.

An agency with billings of Rs. 1, 000, 000, .actually enjoys an income of around Rs. 150,000. This latter figure assumes that the agency has been compensated on a 15 per cent commission basis, and that it has had no supplementary “fee” income. The billings’ figure is the price of the time or space charged by the media that in which ads are placed through the agency.

Thus an agency with billings of Rs. 1,000,000 buys for its client’s time and space priced by the media at Rs. 1,000,000. An illustration clarifies this relationship between billings and agency commissions in Fig.

Note that the agency in Fig. has purchased, on behalf of its client, space with a gross value of Rs. 50,000. For the sake of illustration, let us suppose that the space purchased is a full-page, four-coloured ad in a nationally distributed, general appeal magazine.

Note that the client pays to the agency Rs. 50,000, and that the agency

forwards Rs. 42,500 to the vehicle. If there were no other work placed by the agency, and if there were no “fee basis” income (such as research contracts) for the agency, its billing size would be Rs. 50,000.

The income of the agency would be Rs. 7,500, or 15 percent of Rs. 50,000. This illustration is perhaps oversimplified, but it indicates the basic relationship that exists between clients medium agency. A complicating factor is the giving of cash discounts by the- medium.