Issue 10: 2Q 2009

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Value Pricing in a Challenging Economy

2nd Quarter 2009 Issue 10

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Issue 10: 2Q 2009

2u Section One page 2 Value Pricing in a Challenging Economy u Section Two page 12 No More Excuses? u Section Three

page 17 The Goal is to be Profitable, Not Busy

Creating Value is a quarterly exploration of the ways marketing communications firms are transforming themselves to become more valuable and competitive in the new multi-channel, media-neutral marketing environment.

In This Issue

Published by Ignition Consulting Group, Inc.Copyright 2009, all rights reserved. By subscription only atwww.ignitiongroup.com/publications/creatingvalue

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Differentiating the Agency Brand

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Issue 10: 2Q 2009

What marketer wouldn’t prefer to pay for value received instead of hours worked – especially in a challenging economy? And what agency wouldn’t prefer to get paid for their ability to apply creativity and innovation to solving marketing problems no matter how much time was involved? Do you pay your financial advisor to “put in the hours” on your behalf, or do you pay him to select and recommend the smartest investments?

In a recent article “Firms Try Alternative to Hourly Fees,” The Wall Street Journal reported on what is finally appearing to become a trend. Says the Journal:

“For decades, marketing firms, accountants and other professional-service companies have all billed nearly the same way – by the hour…But the recession is chipping away at that tradition, with companies forced to adopt performance-based pay and fixed prices in an effort to retain and attract clients. The billing changes affect a broad swath of businesses, including marketing, advertising, accounting and recruiting.”

The article goes on to give the example of Florida-based Button Communications who has traded traditional retainers for a pay-for-performance model where the firm earns money only if it secures publicity for a client.i Instead of asking their clients to pay them for trying (something most clients can’t afford, especially in a recession), Button asks to be paid for performing.

Speaking of Buttons, blogger Jared Spool tells the story of “The $300 Million Button,” a compelling example of how marketing firms can create tremendous value without spending a tremendous number of hours:

Many marketing firms are wondering, “In this tough economic climate, isn’t this the worst possible time to try to move to value pricing?” Of course our answer is that it’s quite possibly the best time to adopt a value-based approach.

Marketers want to lower price, but not value

It’s true that clients want and need to cut costs right now. But they’re trying desperately not to reduce the value they’re getting from the business partners upon whom they’re dependent for their success. By paying their agency for outcomes instead of activities, marketers feel they are getting more value. Agencies also benefit because they are paid a fair price for an assignment, regardless of whether it took 30 minutes or 30 hours.

What’s wrong with this equation?

Time = Value

Value Pricing in a Challenging Economy

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Issue 10: 2Q 2009

The $300 Million ButtonIt’s hard to imagine a form that could be simpler: two fields, two buttons, and one link. Yet, it turns out this form was preventing customers from purchasing products from a major e-commerce site, to the tune of $300,000,000 a year. What was even worse: the designers of the site had no clue there was even a problem.

The form was simple. The fields were Email Address and Password. The buttons were Login and Register. The link was Forgot Password. It was the login form for the site. It’s a form users encounter all the time. How could they have problems with it?

The problem wasn’t as much about the form’s layout as it was where the form lived. Users would encounter it after they filled their shopping cart with products they wanted to purchase and pressed the Checkout button. It came before they could actually enter the information to pay for the product.

The team saw the form as enabling repeat customers to purchase faster. First-time purchasers wouldn’t mind the extra effort of registering because, after all, they will come back for more and they’ll appreciate the expediency in subsequent purchases. Everybody wins, right?

We conducted usability tests with people who needed to buy products from the site. We asked them to bring their shopping lists and we gave them the money to make the purchases. All they needed to do was complete the purchase.

We were wrong about the first-time shoppers. They did mind registering. They resented having to register when they encountered the page. As one shopper told us, “I’m not here to enter into a relationship. I just want to buy something.”

Value Pricing in a Challenging Economy

Some first-time shoppers couldn’t remember if it was their first time, becoming frustrated as each common email and password combination failed. We were surprised how much they resisted registering.

Without even knowing what was involved in registration, all the users that clicked on the button did so with a sense of despair. Many vocalized how the retailer only wanted their information to pester them with marketing messages they didn’t want. Some imagined other nefarious purposes of the obvious attempt to invade privacy. (In reality, the site asked nothing during registration that it didn’t need to complete the purchase: name, shipping address, billing address, and payment information.)

Repeat customers weren’t any happier. Except for a very few who remembered their login information, most stumbled on the form. They couldn’t remember the email address or password they used. Remembering which email address they registered with was problematic - many had multiple email addresses or had changed them over the years.

When a shopper couldn’t remember the email address and password, they’d attempt at guessing what it could be multiple times. These guesses rarely succeeded. Some would eventually ask the site to send the password to their email address, which is a problem if you can’t remember which email address you initially registered with.

The form, intended to make shopping easier, turned out to only help a small percentage of the customers who encountered it. (Even many of those customers weren’t helped, since it took just as much effort to update any incorrect information, such as changed addresses or new credit cards.) Instead, the form just prevented sales - a lot of sales.

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Issue 10: 2Q 2009

“Last week I was in a meeting with a pharmaceutical company. We learned that the biggest problem faced by medicine overall was not a scientific one but a human one – non-compliance. People not completing their course of antibiotics. Easy, we said. Just make 20 of the pills white and four of them blue. Tell people to take the white ones first, followed by the blue ones.”

What’s the value of that idea? Certainly not the 15 minutes it took an experienced practitioner to come up with it. A more conventional approach would have been to recommend a multi-year, multi-million dollar advertising campaign to “educate” consumers about why it’s important to take all their medicine. Instead, both the client and the agency should benefit from a much better idea.

Knowledge work requires a different set of assumptions about productivityThe clock is an outdated metaphor for value in an age of knowledge work. It’s really a relic of the industrial age when it really mattered if you were “on the clock” because it meant you were present on the assembly line “creating value.” But knowledge workers can create value at their desk, sitting in a Starbucks or taking a shower, because the value they create is in the form of intellectual capital.

The designers fixed the problem simply. They took away the Register button. In its place, they put a Continue button with a simple message: “You do not need to create an account to make purchases on our site. Simply click Continue to proceed to checkout. To make your future purchases even faster, you can create an account during checkout.”

The results: The number of customers purchasing went up by 45%. The extra purchases resulted in an extra $15 million the first month. For the first year, the site saw an additional $300,000,000.ii

Apples and oranges When Hulu ran one 60-second spot in the 4th quarter of the 2009 Superbowl, it produced a 49% increase in visits to www.hulu.com.iii Those kinds of results simply don’t correlate with the hours worked to produce the spot. Its apples and oranges.

Rory Sutherland, the new president of the U.K.’s leading advertising association, the IPA, recently delivered a speech in which he called for agencies to use their considerable creative abilities to solve

problems for clients in ways that transcend advertising. He shares the following example:

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Issue 10: 2Q 2009

Industry legend Mike Hughes, the decades-long creative force behind The Martin Agency, has come to the conclusion that “Advertising’s value should be determined by its performance.” Says Hughes, “Our industry ought to stop and take a deep breath and say, ‘This is where we are going.’”iV

Better or Worse?If you were a marketer paying your agency for outcomes instead of hours, would you expect that the agency would be:

Better at gaining an understanding of your business or worse?

Better at clarifying expectations or worse?

Better at planning or worse?

Better at managing workflow or worse?

Better at communicating with you or worse?

Better at providing you with proactive thinking or worse?

The answer in every case, is of course, better. So why exactly would an intelligent procurement professional be opposed to this approach? They wouldn’t.

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Agency principal Andy Fletcher says “We don’t want to be paid for what we do, but for the results we produce.” His firm, Fletcher Martin, approaches every new client relationship with the question, “What results does this client need to produce, and what creative way could we use to tie our compensation to those results?”

Domino’s Pizza pays its agency Crispin Porter + Bogusky a fee that varies based on 1] Same store sales; 2] Orders, and; 3] Ticket size. This is based on the client’s strong belief that the agency should have the same incentives as the marketer.

PR firm Creative Communications Services charges its clients for outcomes, not hours. Here’s how they describe it:

Other public relations agencies have probably viewed us, over the years, as naïve. We’ve never cared. We’ve just smiled and gone about our business—because, in the 35 years that CCS/PR has been serving our Fortune 500 clients, we’ve proven our value many times over, earning our clients’ loyalty and repeat business, as well as a steady stream of word-of-mouth referrals. Our secret is what we called “package pricing. For example, we arrange for the placement of articles before we start writing them, so clients only pay for print-publication pieces that actually reach their intended audience. Yes, this model means we assume some risk. But because we assume the risk, we work smart, and there’s a built-in integrity to our services delivery. We focus our efforts on results—because we’re paid for results, not for “effort.” We find ways to work efficiently—because when we work efficiently, the operational savings go straight to our bottom line, allowing us to bid more competitively for work while still remaining profitable. We are inherently comfortable with metrics. It’s easy for us to document the results of our services on our clients’ behalf,

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Issue 10: 2Q 2009

A formula for value?Even though it was published on April 1, many readers of Ron Baker’s post on the VeraSage website didn’t stop to think this might be “April Fools.” Here for your reading pleasure is a “Value Pricing Formula.”

After fifteen years of extensive research, VeraSage has determined firms should use the following formula to derive a Value Price.

Start with estimated hours x hourly rate (this will establish a cost accounting minimum floor beneath your pricing).

If you offer a fixed price, add a premium of 12.613% (this is similar to the premium charged for a fixed rate mortgage versus a variable rate mortgage).

If you utilize change orders, add 3.14% (again, because you are offering fixed prices for all scope creep).

If you offer a service guarantee, add 22.245% (a service that is guaranteed is worth more than a service that isn’t).

If you offer a price guarantee, add 16.301% (this insures the customer they don’t have to pay for work they didn’t authorize).

If you offer payment terms structured around the customer’s cyclical cash flow, add 14.729% (customers have budgets, they will value this highly).

Since all value is subjective, add a “black box” component of 25.298% to reflect this fact.

If you follow the above the formula, you will accurately Value Price all of your work, and invert the now artificial ceiling of hourly billing to a floor.

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because our work is focused on achieving results.

And we don’t overpromise to our clients or overhype what they can accomplish—because we know we won’t get paid for promises we can’t keep.V

The business model of New York based Sarkissian Mason is based on creating intellectual capital, not advertising. Founder Patrick Sarkissian established what he calls the “75/25” rule: 75% of the firm’s time is spent on client business, the other 25% is devoted to creating their own IP, such as their online property The Contrarian. In working with clients, when they present an idea that their client finds risky or doesn’t want to fund, the agency will often fund it themselves and then license it back to their client, as they did with Shopnik and their client Mazda.

Bartle Bogle Hegarty is innovating in a similar way. It’s brand-invention company, Zag, creates its own brands and brings them to market with joint venture partners. Founder Nigel Bogle says “Our experience of developing and launching our own brands will enable us to have more empathy and commercial awareness of what our clients go through. There is no guarantee that we will succeed every time, but the trying creates value in itself.”Vi

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Issue 10: 2Q 2009

The world’s most famous brandCoca-Cola’s new approach to value-based compensation is an impressive effort to align the economic incentives of their agencies with those of the Coca-Cola Company. In professional pricing circles there is a concern that the agencies (the sellers) should be setting the price instead of the client (the buyer), but Coke took this step forward because their agencies didn’t.

Coke’s Sarah Armstrong and her team turned the principles of value pricing into practices by developing a process for establishing the value, not just the cost, of an assignment.

Coke sees the historical evolution of agency compensation in three parts:

Commission system rewards agencies for spending

Hourly fee system rewards agencies for activity

Value-based system rewards agencies for resultsTheir new value-based approach is based on the realization that Coca-Cola is buying talent and outcomes, not structure and activities. Rather than pricing an assignment based on costs, Coke uses a five-dimensional system to evaluate value:

When the world’s most well-known brand (Coca-Cola) and the world’s largest marketer (Procter & Gamble) adopt a value-based approach to compensating their agencies, it certainly takes away one of the primary excuses of many marketers and their agencies:

“I’ll do it when I see one of the major brands do it.”

In fact, having P&G and Coke as practitioners of VBC deflates a whole list of excuses:

“I can see how VBC would work for smaller organizations, but we’re a big company.”

“VBC could probably work if you have a single agency relationship, but not if you have to manage multiple agencies.”

“VBC would never work for our brand; we’re a global company and it would be much too complex to administer.”

No More Excuses?

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Budget reality. (This is always a logical place to start, and historical budgets are often a good indicator of value.)

Scope of work management. (Is this project a “straight path” or will it require complex project management?)

Strategic priority. (The more strategically important this is to Coke, the more value.)

Talent. (Specific quality agency talent is always more valuable.)

Industry dynamics. (Is this agency uniquely qualified to do this work, or are there a lot of agencies who could do it. Unique qualifications are more valuable).

Success is ultimately judged by a set of metrics established at the beginning of an assignment. Metrics can be in all or just some of the following four areas:

Agency Evaluation Rating Specialist Metrics Marketing Communications Metrics Business Performance Metrics

In the end, the real impact of Coke’s new approach is that it helps shift the agency compensation paradigm because it:

Acknowledges that there is no correlation between labor and value.

Begins with a discussion of “What does success look like” rather than “How many hours will it take?”

Fundamentally changes the basis of agency compensation from hours and activities to value and outcomes.

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Seeks to apply a set of factors other than time to determine how an assignment should be priced.

Puts in place a set of tools and processes that allow Coca-Cola marketing people to better clarify what they’re trying to accomplish – scope of value, not just scope of work.

Gets the client out of the business of controlling and dictating the agency’s profit.

Makes the concept of hourly rates and rate cards irrelevant.

Changes the dialogue and language away from billable time, FTE’s, and cost-plus to instead talk about results and performance.

Coke acknowledges there is still some work to be done on this new approach. But, says Armstrong, “We can’t wait for perfection to start the journey, otherwise we would still be stuck in the old model.” Vii

In other words, we shouldn’t let the perfect become the enemy of the good. Overall it moves the industry a huge step in the right direction.

The world’s most famous marketerProcter & Gamble has been practicing a form of value-based compensation for years by paying its lead agencies based on sales increases of their major brands. This year, P&G took VBC a

step further by tying agency compensation to three metrics:

1] How did sales improve? 50% weighting

2] How did business share improve? 25% weighting

No More Excuses?

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Issue 10: 2Q 2009

At a time when prospective clients are scarce, it’s easy to be lured into the belief that some new business is better than no new business. The self-talk among agency executives is that the account “will help keep the lights on.”

But something is not better than nothing, because some things are worse than nothing because instead of making money they cost money.

As the joke goes, the bank believes they can afford to sell loans below cost because they will make it up on volume.

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Agency compensation can vary by 10% -- up or down – based on these factors. Says Procter’s Rich Delcore, the principal architect of this new program, “We’re interested in outcomes, not deliverables.” Viii

P&G has piloted this program with 12 brands so far, and will implement it with half their brands by next year.

P&G further aligns incentives through the concept of what they call the BAL – Brand Agency Leader – the agency charged with marketing leadership for the brand. The BAL has the ability not only to hire but to pay other discipline-specific firms necessary to fulfill the brand’s marketing objectives. Procter writes one check to one agency – the BAL – who then decides what to pay the other agencies based on their role and contributions.

Every brand talks about the importance of collaboration among their various agencies, but P&G has actually put the right incentives in place to make sure it happens.

Brilliant.

No More Excuses?

The Goal is to be Profitable, Not Busy

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Issue 10: 2Q 2009

Being worth your priceBesides being squarely focused on value instead of cost, there are a number of things you can do to add to the perceived value of your price:

A fixed price vs. variable price. A fixed-rate mortgage always costs more than a variable-rate one. That’s because there’s value in knowing exactly what you’re going to pay for a service or outcome.

A professional service guarantee. Offering a 100% guarantee that your client will be pleased with your services is worth a premium price. It’s also a powerful reflection of your confidence and self-respect.

Pre-authorized pricing. Tell your clients that they never have to pay an invoice they didn’t authorize in advance. This does two things: 1) It forces you to price all of your work in advance (vs. letting the costs just run through the system), and; 2) It provides your client a guarantee of no surprises. Doesn’t that make working with your firm worth a little more than the agency down the street?

Customized payment terms. For some clients, cash flow is sometimes more important than the price itself. Be firm on your price, but flexible and creative on the payment terms. This overlooked strategy can make working with your firm more attractive.

Nobody’s business but yoursAnd remember that your profit margin is really none of the client’s business. Do you know what Apple earned on your iPhone? Probably not, and it’s really none of your concern. You bought it because you wanted the value it delivered. An unfortunate

When winning is losingPricing expert Alan Weiss preaches that failure isn’t from insufficient business; it’s from the wrong kind of business – the kind that creates drag, friction, and fatigue.iX His point is pricing a new business win too low is worse than losing the pitch.

In their excellent book, “Pricing with Confidence,” Reed Holden and Mark Burton would put it this way:

The price isn’t wrong, the customer is.

It does your firm no good to add volume without adding profit. Volume may or may not be profitable. It’s the client’s job to try to lower price. It’s your job to protect it, and most importantly to protect your profit.

Negotiating the right thingWhen a prospective client keeps pushing unreasonably on price, one of three things is happening.

The client doesn’t believe in the value you’re offering.

The client doesn’t believe that what you do will provide that value.

The client believes they can get the same value elsewhere for less.

So to get to the real issue, try asking your prospective client these questions. As discussed earlier, clients will always try to reduce price but they don’t necessarily want to reduce value. So negotiate value instead of cost.

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Differentiating the Agency Brand

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Issue 10: 2Q 2009

number of major clients – 48%, according to the Association of National Advertisers – insist on cost and profit information from their agencies.X But as both Coke’s Sarah Armstrong and P&G’s Rich Delcore would say, the profit the agency makes is really none of the client’s business. It’s up to agencies to run their business in a way that earns a profit.

Value Pricing Pioneer: Kelliher Samets VolkKSV, with offices in Burlington, Vermont, Boston, and New York, has made the leap from cost to value by trashing timesheets, forming a Value Council, and proposing a value-based approach to all prospective clients.

Early this year, when the firm made the decision that timesheets serve an outdated paradigm, CEO Yoram Samets shared these observations with his staff:

What we’re giving up

Tracking utilization

Analysis on a micro level

What we’re gaining

Reduced stress between brand management and creative

No more shell game with time

No surprises to the client

Fewer billing challenges

More talk about profitability and less talk about time

Fewer reports

100% focus on the work

Higher profitability because value has more worth than time

New internal language and culture

Pricing expertise

When it comes to new business, instead of publishing a traditional schedule of hourly rates, KSV uses language like this:

“Unlike other agencies, we don’t sell time; we sell intellectual capital and business results. In fact, we believe that the traditional ways agencies charge works against the best interest of both the agency and the client. Hours and timesheets are focused on efficiency, and we don’t believe you’re buying efficiency. You’re buying value, effectiveness and results.

Because we don’t bill by the hour, we don’t have hourly rates. In fact, we don’t even have timesheets, because timesheets only serve to point us in the wrong direction. We trade the time that would have been spent tracking internal costs and invest it in tracking the external results we create for your brand.”

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Creating Value is edited for senior professionals in the marketing communications business. All content is copyrighted by Ignition Consulting Group, Inc. and may not be reproduced or retransmitted without express permission.

Creating Value is available by paid subscription only, and is distributed as a downloadable PDF. To subscribe, visit www.ignitiongroup.com/publications/creatingvalue.

Creating Value is published by Ignition Consulting Group, Inc., a consultancy devoted to helping marketing organizations create and capture more value. For more information about Ignition, visit www.ignitiongroup.com, e-mail info@ignitiongroup.com, or call 801.582.7297.

Endnotes i “Firms Try Alternative to Hourly Fees,” by Simona Covel, Wall Street Journal, April 2, 2009 ii “The $300 Million Button” by Jared Spool, as published at www.uie.com iii As reported by Hulu CEO Jason Kilar in an interview during the AAAA Leadership Conference, San Francisco, California, April 2009. iV As stated during a speech at the AAAA Leadership Conference, San Francisco, California, April 2009. V As reported by Kirsten Mortensen of Creative Communications Services in blog posting on www.verasage.com. Vi “While Everyone Else in Adland Zigs, BBH Zags,” Advertising Age, November 17, 2008. Vii

From presentation by Sarah Armstrong, Coca-Cola Company, Association of National Advertisers Financial Management Conference, April 2009 Viii As presented during the ANA Financial Management Conference, Scottsdale, Arizona, April 2009. iX From “How to Acquire Clients,” by Alan Weiss. X “Client Views of Agency Profit,” The Advertiser, October 2008.

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As different as... (orange and apple) - theBlackBrian - Flickr Clock - CarbonNYC - Flickr Just a Minute...My Secretary Has the Day Off - foundphotolj - Flickr