Up Close and Personal

Requests for personal salary data from Deutsch grabbed the headlines after the agency’s recent split with Pfizer, but the subtext of the story offers a more telling glimpse into the changing dynamic in compensation negotiations between agencies and their clients.

More and more marketers are adopting a vendor mentality when hammering out compensation contracts with their ad agencies. Increasingly, client procurement executives are becoming a driving force behind the scenes in fee negotiations, as was the case with Deutsch and Pfizer, which spent a year trying to agree on a deal and still could not come to terms. Last week the growing clout of purchasing executives was underscored when Ford Motor Co. overturned the decision of its president, Nick Scheele, to single-source its advertising and marketing services with WPP Group. In media leaks about the developments, Scheele’s authority in making marketing decisions was said to be undermined by the automaker’s procurement prerogatives.

From the point of view of the agencies, it’s a troubling reversal: They were considered vendors before they earned credibility as marketing partners. Now, with procurement executives viewing them once again as vendors, agencies are at risk of becoming commodities chosen largely on the basis of cost, like paper clips or office desks.

“I don’t think that’s true,” counters Dorothy Wetzel, vp of consumer marketing, US Pharmaceuticals, at Pfizer. “This is an idea-driven industry, and in our business more lives are saved by a great idea than by a mediocre one. But you can get a good idea in the shower after five minutes or after two or three months of difficult research and analysis. We’re just seeking verification of what we’re paying for.”

As the disagreement between Pfizer and Deutsch showed, the problem lies in the difficulty of quantifying the resources that go into the creative process—specifically, the components that comprise agency overhead. In its recent evaluation of compensation practices, Pfizer is said to have asked Deutsch for details such as individual salaries and rent. Wetzel denies this. Deutsch executives declined comment on specifics of the negotiations, but the agency released this statement through a representative: “We take great pride in our relationship with Pfizer and in the integrated marketing programs we created for Zoloft and Zyrtec. We were disappointed that we could not reach a resolution to a number of the contractual terms.”

Such disagreements are inherent in fee-based compensation. The ad industry’s long-held commission system, under which agency pay was tied to a fixed 15 percent of media spending, made things easy for agencies—particularly since they got an automatic raise as inflation ratcheted up spending.

Adding more pressure to fee negotiations today, of course, is the slowdown in the economy after the merger and acquisition boom of the ’90s. Cost-cutting clients are looking to rein in their marketing expenditures—which fall straight to the bottom line—as agencies are under greater pressure to meet the margins dictated by their holding-company parents.

Fee negotiation has opened the door to a host of industry outsiders who are sniffing out business opportunities: Leading the charge are big-business consultants, who enjoy greater access to the levels of top corporate management than agencies, which have seen their influence wane. (The Association of National Advertisers’ Advertising Financial Management Conference in May will include sessions like, “McKinsey’s Perspective on Restructuring Marketing for ROI Growth.”)

“The strategic initiatives of these consultants usually start with the [marketer’s] CFO, and the CEO,” says Richard Roth of Roth & Associates, New York. “The consultants say, ‘We can save you all this money.’ Clients looking at overall costs get swept into this. But the problem is these consultants start treating the advertising business as if they were ordering paper clips. These people know nothing about advertising or media or how you negotiate the fees involved.”

At the other end of the spectrum are the smaller, industry-specific consultants like Roth. Among the more controversial are those that have carved out a niche determining whether agencies are overbilling their clients, seeking highly specific agency information in the process. Firms like Morgan Anderson Consulting and Beekman Associates ask for details such as salaries of individual staffers, but say they keep the information confidential. (Just how confidential is a matter of debate, since these consultants feed the information into databases, which they use to market their services to other clients.)

Other consultants say an educated guess can be made about costs for things like creative, account service and planning payroll through estimates of individual salaries developed from group figures in a department and salary levels provided by the American Association of Advertising Agencies. “You need labor cost compensation by department,” says Linda Fidelman, a principal at ADvice & ADvisors, New York. “An aggregate number is fine in developing a good estimate.”

A position paper on advertiser/agency compensation agreements published in December by the 4A’s and the ANA offers these guidelines: “At times, access to individual salary amounts is requested. Advertiser’s access and review of individual salary amounts is always inappropriate. Any verification necessary should be conducted on a confidential basis by a mutually agreed, independent auditor.”

Labor costs may be the biggest component of agency overhead, but they are just one element. Others include rent, benefits, electricity, phones, office equipment, executive salaries and bonuses.

In the view of Pfizer’s Wetzel, at issue with Deutsch was verification, not specific requests for overhead details. (Beekman, whose principals include former Ogilvy & Mather executive Julian Clopet, is said to have worked for Pfizer in seeking verification.) The pharmaceuticals giant said its contract negotiations with Deutsch were part of an evaluation of compensation practices across Pfizer agencies. The aim was to ensure that differences in compensation were tied to performance results rather than differing accounting methods, Wetzel says.

“As our investment in advertising grew, we had to make sure we had the right processes and methodology commensurate with that investment,” she says. “We just needed to verify what we were paying for. If we get great ideas that move our business, we expect to pay for that agency performance.”

Pfizer’s other agencies, including Deutsch’s Interpublic Group sibling McCann-Erickson, Omnicom’s Merkley Newman Harty & Partners and WPP’s J. Walter Thompson, have all agreed to the new contracts.

Even before its merger with Pharmacia, New York-based Pfizer was among the largest advertisers in the U.S. It represents a large percentage of its agencies’ billings. If an agency does not make its margin on Pfizer, it may not make its overall numbers.

One thing both sides agree on is the quality of Deutsch’s work for Pfizer. Its success had garnered top payout for Deutsch among the marketer’s agencies.

“[Deutsch’s] kind of resistance happens to varying degrees,” says one industry consultant. “The hot-shot creative agencies feel their product stands for itself and they can charge more. On the one hand, that’s true. On the other hand, these relationships are exclusive, so it’s time consuming and expensive to change agencies, which may make some clients reluctant to hire them.”

Other marketers are pushing for pay-for-performance compensation, too. ADvice & ADvisors’ Fidelman recalls consulting on the launch of a new product for a Heinz division. The client was offering a labor-based fee plus a 10 percent profit margin. (The agency had been asking for 20 percent.) The consultants built matrix measure performance criteria, offering an upside potential of 30 percent. At worst, the agency would break even. In fact, the shop earned a 39 percent margin in the first year and 32 percent in the second.

The current economic client notwithstanding, the ad industry is still perceived by many clients as a fat and happy business. Not helping matters were recent disclosures about double-booking of revenue at McCann-Erickson (even though that was an internal problem that hurt the agency more than its clients) and the role of former Grey Advertising staffers in the Color Wheel scandal, in which the agency overbilled clients and provided kickbacks to the print production company.

The deteriorating status of agencies as influencers in the executive corridors of marketers is also undermining the industry’s position in negotiations.

“What’s contributed to this is the lack of principal-to-principal relationships you used to have in this business,” says consultant Arthur Einstein of Arthur Einstein Advertising in Stamford, Conn. “Agencies have been pushed into vendor status. If you’re a client who believes agencies are vendors, you’ll push for the lowest price. If you believe an agency brings added value, then you’ll pay for it, even if you still try to get the best price.”

There are precedents to show that professionals outside a client’s marketing department can develop an understanding of the nuances of a business where the assets go down the elevator every night, versus an industry in which employees earn hourly wages. “Agencies have learned how to work effectively with client legal executives, and client legal executives have learned to understand advertising issues,” notes Joanne Davis of Joanne Davis Consulting, New York. “Agencies need to learn how to work with procurement, and procurement needs to learn how to work with agencies.”

Adds Arthur Anderson of New York consultants Morgan Anderson: “Any smart buyer —whether it’s a company buying advertising or a consumer buying an auto—knows it’s a question of price versus value. Costs, in this case, are just one component of value.”

In more and more compensation negotiations, however, the corporate executives who can recognize value aren’t necessarily the decision makers.

“The Pfizer review smacked of a procurement mentality,” says a source at a Pfizer agency. “The marketing people didn’t really play a role in the process; it seemed like more of a corporate initiative. The process took on a life of its own, and in the end you could see that the marketing people wished the company could back off.”