Why Percentage Of Spend Is The Best Pricing Model For Agencies transcript

[Music] hello and welcome to the Andrew Ferris podcast thanks so much for joining me for another episode of the show today I'm going to talk about agency pricing this is an issue about which people have very strong opinions including yours truly actually I would say my opinion is not that strong here but it's pretty strong I have a clear preference for how agencies price their Serv Services as somebody who has been on the brand side the agency side as a strategist and then the aggregator brand side and now again now on the agency side as an owner of an agency or something like an agency a very very small agency and so I've seen it from every angle I've seen a lot of structures happen and I have a clear preference and I want to tell you why I think percentage of AD spend is the best model for most e-commerce businesses to use to price their agency I will explain and defend in just a minute let's jump in first I should say if you're watching this on YouTube or on Spotify which now I'm uploading video podcasts tooo as well at least big shout out and huge thanks to my friends at pretty booy at yopr boy.com who were so kind as to send me this hat because they said they were listening to Ben and Kevin from pretty boy said that they had were watching my podcast saw that I was wearing a hat most times and so they sent me along a hat as a way of saying thanks for this this is not me being thirsty for more hats I have plenty of hats but it was a very kind gesture and I appreciate it so go check out pretty boy if you need some skin care for active men upand cominging skincare brand really cool they're doing some really cool stuff actually so go check out y pretty boy.com thanks Ben and Kevin appreciate it all right let me get into it for real so agency pricing this is as I said in the intro a big conversation point for a lot of people I see Twitter threads often blow up and e-commerce fuel Forum threads often blow up with this question how do you price an agency best and I have come to a conclusion about this and as I said in the intro my favorite model of agency pricing is to price an agency to be priced on percentage of AD spend that is the more the agency spends the more you pay them all right and I'm going to defend that uh in a couple of different ways and some of you are already watching listening and screaming and going that's a perverse incentive that's a perverse incentive you're just telling people to spend they're going to spend all my money Etc and so I will get to that critique because I I know it so just know that's coming that I'm going to address that critique it's the most obvious problem with it but but let me say at the front end I actually think flat fee pricing makes a lot of sense as well particularly for larger Brands and as I will explain uh in a bit my own agency pricing actually becomes a flat fee at some point and is capped so percentage of spend I I think is ideal for a large stage of businesses though at some point your business gets big enough to where a flat retainer makes the most sense you may create some bonus structures and this way your agency pricing at at a later stage I'm thinking like sort of 30 million plus in Revenue some where in there right give or take your agency pricing at that point can function more like an employee where you've got a salary plus a bonus potential basically in fact in general agency pricing I think in some ways ought to reflect similar thinking to employees at least in some elements but that flat fee notion I think works at some point really well just a straight up retainer it's nice on the agency side too and by the way if you are on the brand side you actually do want a structure that your agency likes one of the worst things brands do in dealing with agencies is they try to stack the deck too much in their own favor and squeeze pennies out and those sorts of things and what that's going to do is going to be to make it so that your agency doesn't like you very much and they don't care as much about your business unless you're just Mass paying them tons of money like but you want to treat your agency well because they're really important partner in your e-commerce business if you're working with an agency and it's not a great idea to just try to make the deal as good as possible for you you want them to succeed you want them to make money from you you want them to have margin on you you really do so that way you will be a valuable client to them and they will give you their best Services it's not always easy for an agency to deliver on but that's certainly something they will try to do I've seen this over and over when they like you and when you work when you work hard to make it so that it works for both businesses and that when your business grows their business grows Etc that's what a real partnership looks like and just keep that in mind now of course you should advocate for your business where you need to as well but I wanted to say state that out front so I'm thinking really here of agency pricing from brands that are sort of 2 to three million in Revenue up to about 30 million in Revenue before 2 to 3 million in Revenue you should not hire an agency let me just say that upfront as well you should instead learn meta ads yourself and I would say inde d to see if you are planning to grow with ads at all if that's going to be a core part of your growth strategy before you hire an agency before you pay an agency you should learn the basics of meta ads yourself because if that's going to be a core part of your growth strategy you are going to need to manage either an employee or an agency at some point who does this for you and you will be really helped if if you can do a good job learning your way around around the best practices for meta ads Plus at uh sort of under two or three million bucks unless you have external capitalization you just are not going to be able to afford agency pricing it's just unrealistic for you to be able to do that in a way that makes sense for the agency and if you can't pay an agency you know at least a few thousand doll a month depending on what kind of agency or a freelancer they are and really probably $55,000 a month that's the bottom of my fees then you shouldn't be thinking about working with an agency at all because it's just not you're not going to be valuable enough to them they're not going to have enough margin Etc you get the idea you should at that stage of business this is something I counsel people to do regularly do that so I'm really thinking that sort of3 to $30 million we just kind of make that the range that that zone of growth that you should be thinking about so how should you price there as I said I think the answer is percentage of AD spend and the core reason why that I think that is that percentage of AD spend both scales with your revenue and costs in your stage of business that you're in like if you're at 3 million you cannot afford to pay an agency what you can afford to pay them at 10 million and what you can afford them to pay afford to pay them at 30 million so you can attract good quality Talent a good quality agency or good quality freelancer or whatever by incentivizing them that hey look if you can grow my business for me in a way that is profitable or that meets my business's goals you will get increasing value from my business and that kind of partner who can actually help you go from 3 million to 30 million or or whatever along that Journey right that kind of partner is in valuable to you you should want to keep them they are so they're so valuable to your business it's just crazy and so you should want them to be incentivized to get you there because if they can grow your business that much then the value your Enterprise Value as the shareholder in the business is just significantly significantly higher it really matters that you can have somebody who gets you there and there are lots of bad agencies who struggle with with that there are lots of good agencies who could do a great job and so finding that partner who can do that for you is worth paying for and worth incentivizing to get there okay so in the early age especially you don't have probably the money to really pay them what they are worth a lot of times but they may be able to then see the value of your business and want to grow with you as your Revenue grows along the performance that they create so put more simply than all of that spend is a great proxy for performance that's what I really think and this is the thing that people are very confused about the total ad spend in any channel is a very good proxy for performance if you are spending a bunch of money okay if you are spending a bunch of money on ads and you are not producing value in your bank account then your ads are not actually performing and you should spend less dollars okay but if you are producing money in your bank account like you don't even really need not only like a third partyy attribution tool you don't even need meta Dash meta's ads manager to and by the way I'm thinking of meta first and foremost for foremost here as usual but you don't even need meta's dashboard to tell you whether or not the ads are working if your account is growing as you spend more if your bank account is growing as you spend more or if your IA is growing as as you spend more sometimes that's not always the same as your bank account number going up then your ads are working you know again within reason obviously you know if you have Tik go viral every day and you're spending you know maybe there's some tricky thing there but you see what I'm saying basically if that's a core part of your growth strategy then as you spend more then you will generate more revenue and therefore spend and and if you're not generating more Revenue you will spend less and therefore spend is a great proxy for your ad performance and for that reason I think it works very well as a simple incentive to pay somebody on if they can grow your spend it's because the performance is coming with it and if they cannot grow your spend it's because the performance is not coming with it and it's that simple all right it also by the way tags nicely to two other things it tags it's a good proxy for inventory issues so this happens if you are on the agency side and you're listening to this or freelance side and you decided to price yourself on percentage of spend and let's say you smash for Brands doing 3 million and you're going to get to 15 or 20 or whatever pretty fast if that's growing really fast hey fantastic but you know what they are not going to be forecasted with enough inventory to grow that fast in most cases and therefore your spend will not be able to go up as fast as would like it to that's okay that's normal that's part of what you signed up for to work with a growing business and you should know it's what you signed up for if you're on the agency side and on the brand side the speed at which you grow along those lines now is going to be the speed at which you pay your agency more and more and more and you will not pay them faster than you can have the inventory to support the spend if that makes sense and so it tags it it tags along nicely to that and further seasonality right it really I'll come back to this in a minute but but you know if you're have a highly highly seasonal brand and your spend is going to be way higher in November and December for example then in you know August or something then you as a business are also going to have more money to pay after those moments and so if rather than paying a flat monthly fee where it's going to be really expensive for you in August and really cheap for you in November instead it's going to be easier to plan your cash movement in your business if your spend uh if your agency fees are tagged to your spend along with your seasonality and so that's sort of a convenience for both businesses all right and everybody can plan accordingly for for those moments so that's ultimately the point so you might ask at that point if spend is a good proxy for performance well in that case if performance is the goal and incentivizing incord performance and I'm going to come come back to some other reasons I like percentage to spend in a minute but if you if that's the point why not just use revenue or Rass as what somebody gets gets compensated on and the answer is I actually think that neither nether of those is as good of axy for performance as spend is and that sounds a little crazy but here's the issue revenue is burdensome so I've seen some people suggest hey I'll pay you 3% of my revenue for forever you know if you keep growing with me and forget the Forever part but like all you've done now is introduce a variable costs that a brand cannot get out from under and they are going to be bitter about that 3% for forever they're going to hate that 3% at some point they need economies to scale in their business and yes the agency fees are part of it and there needs to be a way for there to be clear moments where they can reduce percentage variable costs against their business and so they if you have some percentage of Revenue forever it will frustrate you so much and also Revenue immediately creates all kinds of other challenges right because what happens if the business adds a major retail partner or what about Amazon or something like that does the agency get credit for sales on those channels well you say okay no just online store only good point Andrew you don't want to do that just online store only but wait a minute I know for a fact that my ad spend is affecting your Amazon channel so why shouldn't I get credit for that right it's simpler to just do percentage spend because you will spend according to the performance and that leads to another thing this is the reason why roas doesn't work because two things first of all your goals change all the time so revenue and roas goals actually constantly change okay and so you might say yes as long as you keep me above a two row s that works for us right well okay but what happens when you change products and you get a bunch more margin and everybody decides you know what we'll take a 1.7 we'll take a 1.5 and we're going to win on the LTV we'll take a 1.5 and we're going to count some Amazon halo effect Etc now you have to go rebuild the contract based on all those things no spend you just Chang your OS Target and then spend more and look boom now your spend covers any changes in the incentive along the way all right so row changes plus Ras is an attribution problem and of course there's that challenge as well R according to what according to meta according to Triple wh according to like I mean who knows so instead again spend will go up if the if the brand is performing and it will go down if the brand is not performing and it's that simple it really is that simple and spend therefore works really nicely I can't think of a scenario well I can think of one but I can't think of very many scenarios besides one where spend doesn't actually work very well as a proxy for performance and that's really the key Point here that if in the early stage of a business you're going to bring out an agency and you want that agency to grow with you and you want their business to do to do well as they go with you and you you want them to be incentivized in the right way then ultimately spend is the best incentive structure in an agency fee and that allows the agency to look and say I'm willing to invest serious time and effort and maybe even dollars into a client that I think can grow a lot I am dealing with this right now with multiple clients where I can see a pathway to Growing the spend of multiple clients of mine and it makes me sincerely motivated to win for them the incentive works I'm going out of my way to build processes and creative building and maybe hiring on additional Talent that's going to hurt my margin in the short term but I think will help it in the long long term to all these things to add resources so that I can grow a business faster and therefore I can make more money off of the client and the client will be happy about that because they will make more money if I can just grow their spend and so and I'm even helping them think financially about their total business so that as their business grows you know or as their business spends they're ready to grow effectively and produce actual contribution dollars and all those things all right so spend works with proxy performance and that gets into that question of the incentive which I said is sincerely motivating okay so that's the most obvious reason to do percentage of spend is that people like the in the idea of an incentive for performance and that's great so the incentive is is reason number one that both parties send to like it but there's another reason why which is that costs really do scale spend too for an agency so part of the reason you should pay an agency more when you spend more is that it actually cost cost them more to manage that because of two things first a larger spend is harder to manage it requires more attention and more detail in the ad account the more skews you have and the more stuff you're spending on and the more products you're putting into the ad account the more attention I have to pay to to like how is my bidc cap sitting relative to my aov at the level of every single ad set that I have running right I have to think more about planning out my spend across larger amounts and I have to think more about all of the different creative that's moving around and be ready to analyze all kinds of creative as it launches and pay attention to what's performing and what's not and why it's performing and why it's not so all of those things really do create more work and what's more creative costs go way up as you spend more and this is the really obvious one whether you as a brand or sharing in the creative cost or whether the the agency is paying for all of them or the agenc is paying for none of them in that case probably the creative issue is less important if the agency is not paying for any the creative depending on your your structure but if you're spending more like if I'm spending $30,000 a month versus $100,000 a month versus $300,000 a month you just have to be able to Output a whole bunch more creative to support $300,000 in spend than you do for $30,000 and spend you do it's a lot harder of a job and therefore as the costs go up with that the agency should be incentivized along those ways along those lines if your business is somewhere near like 5 million in Revenue maybe even a little less 3 million you know the headache that inventory management demand forecasting warehousing shipping all of these things are starting to become it is a big job at that point if you've been running the business yourself or with a small team you know how overwhelming it can be especially on the demand planning side gosh I've watched so many businesses go so wrong at that stage of Business by getting that wrong and I am excited to tell you that my sponsor for this episode more staffing has launched a new service called more fractional supply chain it is fractional supply chain help with incredibly deep e-commerce experience I'm talking super Pros in the Philippines who have worked on a lot of e-commerce businesses they know their way around supply chain Logistics warehousing shipping all that stuff and can bring that expertise to your business at a fraction of the cost of hiring that person in the US but at a great price for them which means you're going to attract great talent it is a winwin and you also get a special offer on working with more fractional supply chain if you use the code AJF 20 to get 20% off your first 3 months of that service I have told you a lot about what I love about more Staffing and why I think running a lean Opex is a crucial part of running a great DC business I mean it I believe it I am Staffing up my agency side of my business with my friends at more Staffing they have been an awesome partner to me I really love these people and so I highly recommend their services to you if you're Staffing the side the supply chain Logistics side of your business you absolutely should consider at least take a call with more fractional supply chain before or you go and add Talent internally in any other way so go do that by going to more now.co to go recruit get recruited trained all of those things coached e-commerce Talent around the supply chain side of the business in the Philippines really really great service from really great people go check it out use the code AJF 20 as I said to get 20% off and get supply chain help for your business at a better cost and it is also the case that let's say I have a brand that's spending $100,000 a month then I not only don't need as much creative but I'm not going to need let's say $50,000 a month if I'm spending 50 and I know that my performance is good so that I can probably keep scaling up it's very unlikely that I have the inventory on hand to support that very quickly and therefore I'm probably going to go from 51 month to 70 one month to 90 to 120 to 150 whatever something like that and my costs can scale slowly but surely along those along those lines and it really is less work for me at $50,000 to Output the amount of creative I need at that level of spend and therefore I should be paid less because I don't need to give you as much creative for that I don't need to work as hard in terms of the management and an ongoing sense so costs really do scale to where now like if you go back and listen to my episode from a couple weeks ago about where I went through eight buckets of creative if I'm thinking about eight different buckets of creative and building operational processes around producing all of those between me and the brand man that is a lot of work and and it's going to require a bunch of costs on my side so uh yes the work is harder it's harder to manage there's more creative involved and so those to me are the key reasons that percentage of spend works really really well the incentive is motivating the costs really do scale with the spend and therefore you should pay somebody more money as they spend more to manage your spend you pay an agency more money as they increase their spend okay all right so let's come back to the Bugaboo the big issue that's hiding out of the background that everybody's concerned about with percentage of spend which is what about overend spending Andrew isn't it the case that if I pay on percentage of spend a media buyer from the agency is just going to go ramp my spend up even if it's not performing because they get a percentage of spend and my answer to that question is no no they are not they're not going to do that and there are two reasons for that okay the first and the most obvious reason is so simple which is that they don't actually have an incentive to do that because you will fire them even if you have a long-term deal that you're locked into you know what you will do you will stop paying your bill and you will and nobody wants to like very few people are willing to get into legal battles over unpaid bills for longer term contracts because your party basically didn't act in the because an agency party didn't act in the best interest of the client like if somebody goes and does that they will get fired and probably they'll get fired by the agency before they get fired by you the before the agcy gets fired by you the brand although you may fire them also like so this is the point that the the concern is a perverse incentive and what I'm saying here is that incentive actually isn't there it actually isn't there the incentive that's there is for the agency to perform as well as possible for the brand if that happens the agency will retain clients and let me tell you selling and generating new business is much more expensive than retaining business for the agency and so if the agency doesn't have that clearly figured out yeah it's true maybe they'll just sell sell cell and try to keep the bis Dev train rolling and not really care if they turn clients well then you found about a and that sucks but that's how life goes because there are bad employees and there are bad agencies and there are bad vendors and there are bad partners and that's part of the reality of business right but ultimately most agencies it is actually in their best interest the true incentive here and this is what I'm saying the true incentive here is for the agency to serve the client as well as possible and therefore for the client to win and for in turn the agency to win and if they spend a whole bunch of money you will simply go I no I'm I mean what you'll do is you'll lock them out of the account and you'll make it so that they they are gone and they can't be there anymore so they don't actually have that incentive secondly what you are also suggesting this is this is reason number two why I think this incentive is not actually there that would suggest the person is simply a low Integrity person and the fact is no matter what part of your business you work in you have to find people of high integrity to be partners with so so what I'm saying is whether it's because of percentage of spend or something else finding people of Integrity to work with is important no matter what and if you find a person who just ramps up spend to try to run up their bill that person is acting with low Integrity even if it's subtler than that they're still acting with low integrity and they shouldn't be somebody you partner with and that's the reality of the world some people are just low Integrity people it's not really the incentive that's causing them to do that it's actually just the general problem of their lower level of Integrity in fact Jess Bachman made a great point about this in a recent Twitter conversation he said actually there's an incentive no matter what structure you build all right so if you do percentage of Revenue there's going to be an an incentive for example for a brand to same thing to spend a whole bunch of money to run up the revenue number and go from there if you do Rass targeting then the incentive is going to be for an agency to figure out the most generous attribution setting possible and push you towards that and go from there you know whatever right and if you do flat fee fixed cost then you have another now you created another incentive for the agency which is to lower their costs as much as possible against that fixed fee so they can run up their margin and so you can decide if that's what you want somebody who is purposefully going to keep their costs as low as possible against that margin or if you want to create an incentive for them to do that now again I actually do think fixed like a flat fee is the best thing at a certain stage of business and that's okay they this yes the brand is that or the agency is at that point incentivized to keep their cost as low as possible against that that might be better than than the percentage of spend model at that point but now you just have to decide which incentive you want you you actually may want to keep going with percentage spend at that point but yeah the incentive is there no matter what structure you do there is some incentive and so you just got to pay attention to which one you care about for me I like the percentage of spend incentive for a long part of the business because it keeps people hungry okay there are two other things I would do to protect yourself in case of the monster of the overspending agency all right and the first of those is to keep a a short deal commitment this is a tricky thing some agencies won't do this my own clients are all to month that's because I'm incredibly confident in my services frankly I'm not really worried that they're going to fire me and if they do then I will have another client at some point and in fact if they fire me it's probably because it was best for their business at the time or at least they thought they did and at that point my goal becomes to say good luck to you and that'll be okay all right now I'm in a position where I have plenty of business so I don't have to worry about it as much I also don't have a huge agency with a bunch of employees I don't have to meet much payroll like it's this is a drisk thing for me so I can do the month-to-month thing and not worry about it so much other agencies can't but I would never be committed to an agency for much more than three months at a time six months to a year can work if I really trust them if I really trust them but I would I would keep that as low as possible because then if they misbehave you can just fire them and you could fire them easily and get out of the contract and go from there secondly and this is another crucial one that people U miss out on I would absolutely create an opt out clause no matter what deal length you sign an opt out clause in your contract where you are able to get out of the contract if the agency changes who the account lead is on your account because highly talented people working in agencies get promoted to become managers and they stop managing accounts themselves they often they get deals with Brands where they go get paid a whole bunch of money to run growth or they go be Freelancers or start their own agencies or whatever talented people make more money over time and it's really hard to keep them in one spot and you really are you're getting the agency's institutional knowledge when you hire an agency but you are also getting a person I'm not saying you should definitely fire your agency if they change the account lead it is what I'm saying is you should have an opt out clause so that you can exit the contract whenever that happens if it comes to that if it comes to that okay so that's my case for percentage of spend there aren it's not Flawless but there is no structure that is Flawless there's and there's nothing that will forever fully protect you from you know people who are really bad at their jobs or who are just acting apart from Integrity all right but let me tell you my structure and how I've done this for my agency so that you just understand how my own pricing works okay this is what I believe is best for me it's what I believe is best for agf growth I'm including my couple of you know one fulltime and a couple of parttime and contractor type employees as well as for the brand I think this works really well for everybody my structure is a flat fee Baseline of $5,000 a month no no commitment it's like I said it's month to month flat fee Baseline of $5,000 a month so I could take on a lower level a lower Revenue client and I have done this many times who can't afford to pay me that much because my favorite stage of business to work in is businesses that are like around 2 to 5 million bucks and want to get to 20 or 30 or something that's my favorite stage of business so I built this contract to reflect that I want that kind of employee that kind of excuse me that kind of client and go from there all right so Baseline flat fee of $5,000 a month this protects from me getting to a point where I get paid like $1,000 a month after doing a bunch of work and and my work is just undervalued okay from there I take 10% of the first $150,000 in ad spend that is a revolutionary stage of business for a brand I think you should be incentivized I should be incentivized to make good money fast in that scenario often part of my my own service in this case is like Financial coaching for that stage of business and all kinds of general coachings I'm working really closely with an entrepreneur to navigate the landmines that's really going to take you up to the you know from two to three million or whatever you know towards 10 million you know 8 to 10 something like that depending on bunch of factors if you can get above that up to that $150,000 a month in spend and a little above that from there I take 5% of spend on the next 3 $100,000 in spend so that takes you to $450 per month and at that point I would be making 30 grand a month if you got to the end of that why a lower percentage of spend there because at some point while it is more work for me to manage an ad account as it gets there uh it is not linearly more work it is perfectly fair for me to make a lower percentage of that spend as I add on addition some additional creative output as I manage some things and actually a lot of times can scale pretty fast and so I think I should make a little less at that point the branches start making more and more and be able to to really see the profits at that stage of business at that point too I'm just making plenty of money frankly I don't need to make more at that stage of things if I'm managing $250,000 a month in spend and I'm getting 20 grand a month in a billable like that's great it can work really well and we can go from there and then it's cap at that 30k amount if I'm spending $450,000 a month that means this brand is Big it's getting plus that 20 million you know type stage of business 30 million at that point we really do want to move to that fixed fee model and see if we can keep that spend there and go from there so that's the way I've structured things because I think it works nicely along the journey for Brands it works nicely along the journey for clients I don't mind being public about that because it ultimately yeah I just think it's perfectly fine for agencies to share their pricing and that includes all of my services now the other thing I will tell you is that if you're wondering if I am doing this as a sales pitch for you I'm not I'm actually not taking on more clients right now if you're interested in working with me I'm sort of building a weit list but yeah I have no plans to add clients at this stage of things and so I'm not sharing it because I'm trying to attract your business I'm really I just think it might be helpful to you to hear what somebody's pricing it as transparently as possible and to go from there okay that's it I think that's everything I have to say about this topic let me know if you have thoughts because I'm curious if you think I've gotten anything wrong here and if you think I've just blown it but that's my Approach percentage of spend as the main bulk of agency [Music] pricing as I said I would love to hear from you about this if you have any agreements disagreements tell me your horror stories whatever it takes you can of course reach out to me at AJF gr. comom or you can email me at podcast a jf.com or even better tag me on Twitter and let's have this conversation in public that's andrewj Ferris as always please do go follow up with my incredible sponsor at more Staffing specifically more fractional supply chain as I mentioned on this show I think uh incredible offering to go pursue Supply Chain Services from incredible talented professionals if you have a growing business you really should pursue it go to more now.co tell them I sent you use the code AJF 20 to get 20% off your first 3 months and next week on the show I have an interview that's coming I have another I have also another opening the books episode coming very soon that you're going to like make sure that you subscribe wherever you're are watching or listening to this and I will see you next [Music] time I know with my eyes CL and I say that's all Ry little sisters in the weding