It’s important to understand the different ways advertising agencies get compensated for their work before choosing one to handle a marketing campaign. Full-service shops typically engage in some type of hourly billing, media commission and/or production commission. It’s usually standard practice for an ad agency to negotiate with each client to determine his or her own unique needs. That way, the two sides can work together to reach a fair and mutually beneficial agreement that can pave the way for a long-term relationship.

Advertising agencies don’t sell products, per se – they sell ideas, with the knowledge and planning to accomplish them. Those ideas do take the form of written communication plans, creative concepts, and the different media used to deliver a message, such as radio/ television commercials or website design. Since it’s not possible to assign a sku number to an idea, the concept gets translated into the amount of time it took to create it.

Most ad agencies deal in billable hours for accounting purposes. These hours have to take into account the amount of money the agency spends on salaries, internal resources, and all other overhead expenses. However, it’s important to remember that “time” doesn’t only reflect the minutes ticking by in a day. Time also includes the knowledge, experience and education of specialized idea makers and problem solvers.

Much like any other business, an advertising agency calculates billable hours by subtracting the cost of goods/services sold (adjusted gross income) from its revenues. The agency then calculates its hourly rate by dividing overhead by total billable hours.

Typically, a client will pay an ad agency a monthly retainer or a set fee for a particular project. Each of these has its own pros and cons. Here is a brief overview to determine which payment practice will best suit your needs.

Monthly Retainer

A monthly retainer is paid to an agency for the purchase of a pre-determined number of hours on one or more projects. The specific details of each project don’t have to be identified in advance. The amount of the retainer is determined by estimating the amount of man-hours and staffing needs for a particular project, based on past experience.

The invoice that a client receives from the agency is for the same amount each month, and reflects a block of hours at a rate that covers all departments (graphic design, copywriting, account management, etc.). Retainers are useful when you require long-term strategic planning.

Pros:

Uniform billing for the client and the agency
Useful for strategic planning of marketing campaigns
Enables client to plan and stay in line with an annual marketing budget
Agencies usually give clients on retainer top priority for their projects
A retainer hourly is usually lower than a per-project rate
Projects begin immediately upon request, with no additional paperwork necessary (as long as the project is within the scope of the retainer)

Cons:

Retainers often lead to excessive assignment requests which can use up hours
The amount of hours needed to complete a project in a given month is frequently underestimated. As a result, a client has to prioritize projects to work within the allotted time.
If a project needs more hours than allocated, an agency stands to lose major resources to accommodate a client’s needs. Both sides need to be able to work within the time allowed.
Sometimes, retainer hours are used up on unfocused rounds of revisions. After three rounds of revisions on an estimated project, a change order estimate will automatically be issued. This process encourages a more tightly focused resolution.

Per-Project Estimates

A per-project estimate is paid to an agency for the purchase of a preset number of hours to complete one specific project. Per-project estimates are useful when the client knows exactly what type of work he needs and wants. The trick is knowing what your target audience “needs” to get them to act. If you don’t know this, then you’ll need to come up with a strategic plan first. “Want” involves being aware of what the end product has to deliver in order to win approval from your organization. If you don’t know, you can’t expect the advertising agency to know.

Estimates are determined by previous experience with similar projects. Ad agencies usually come up with two or three design options for the client to review. A client will choose one to be revised further for the final project. Those options are included in the estimate. Any additional revisions that require the project to go over the allotted time will usually require a change order estimate before the new work can begin. Agencies typically notify clients when their hours are approaching 70% of completion.

Pros

· Provides a clearer perceived view of the project’s workload

· Requires a one-time payment from the client

· Useful when a client requires conservative solutions

· Review process more productive, since only a set number of revisions is allowed

Cons

Projects cannot be started immediately upon request. Work can only begin after an estimate is created and approved, a process that typically takes anywhere from 2-3 days.
Process doesn’t provide for ongoing creative solutions; estimates cover the precise work requested.
Agencies find it difficult to making staffing decisions, since it’s never clear when a project will be requested, or how complicated it will be.
Hourly rates are often higher than retainer accounts.

The key to creating a successful agency/client financial arrangement lies in both sides having a clear understanding of the project right from the start. Nearly all billing issues come about when there is poor planning or miscommunication.

A thorough understanding of both compensation models is essential in helping determine your needs. You also have to realize that estimating hours is not a perfect science. No project is exactly the same, so there’s no way to know exactly how long it will take to develop a project that fulfills the client’s expectations. Design is a subjective process. The agency could come up with a winner on the first try, or it may take multiple revisions, especially if there is more than one person involved in the approval process.

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