Perspectives

If you pay peanuts, you get monkeys

A PR veteran looks at the valuation of this professional service

By By Doug Spong

The cynics in our business will tell you that PR firms are a commodity profession today: plenty of supply to fill the growing demand of clients. As a result, companies looking to retain PR firms often favor a search process that pits several agencies in a knock-down, last-team-standing competition for the right to serve as a client’s PR counsel.

Simply stated, there’s no commodity market for great ideas that materially defy gravity for client organizations. I learned long ago that if the work is great, clients never pay too much. On the other hand, if the work is mediocre, clients can never pay too little.

Collaborate with your PR firm on the most fair, equitable compensation

Let me pull back the shroud of mystery on agency compensation. PR firms earn their revenue from fees paid by clients. Not that long ago agencies used to combine fees with markup on production costs and media commissions for buying print, broadcast and digital advertising. No longer. Markups are a distant memory and media commissions died along with the three-martini lunch.

While fees are the only source of revenue for most PR firms, there are several different ways to invoice those fees. First, there’s the fixed retainer fee that is usually invoiced monthly in advance for a planned scope of work (SOW) and estimated fees. Paying a fixed retainer makes it easy to forecast expenses for clients, but tough for agencies that go above and beyond to delight their clients.

Second, there’s a project fee that has one or more identifiable projects with a defined start and completion time frame. Project fees are capped based on the mutually agreed upon SOW. If that scope changes, though, most agencies will present a revised SOW to reflect the change in fees.

Third, the most basic form of agency compensation is hourly billing. For publicly traded companies that accrue expenses in the period they are incurred, hourly billing is the most transparent form of compensation. However, it takes diligence and a strong stomach for the agency to forecast and the client to manage the peaks and valleys that come with the ebb and flow of hours from month to month.

Don’t let incentive comp become a disincentive for PR firms

For the past couple decades, it’s been fashionable for agencies and clients to discuss merit-based compensation. In other words, an incentive fee that aligns with the value of the results from the firm’s work. If the agency achieves certain agreed-upon metrics of success, then the agency earns additional fees that increases the profit margin. Or so the theory goes.

Despite everyone’s best intentions, incentive fees are few and far between. The best incentive compensation arrangements put a portion of agency profit at risk if the PR firm underperforms against agreed-upon metrics, and an incentive of additional fee if we the agency over-performs. The challenge is that most client budgets are tighter than a Botox-smile, hyper-scrutinized, and any “bonus” fee is not accrued in the budget. Besides, spending on outside PR services is a discretionary expense that is constantly at risk of being cut.

 

The underlying assumptions of agency fees

Regardless of the fee-for-service arrangement and talk of incentive compensation, what’s important is to understand the underlying assumptions that comprise agency compensation. Billing rates are established based on three basic parts: cost of people, overhead and profit margin.

Cost of people refers to salary and related expenses (benefits, payroll taxes) for professionals billing time to clients. Generally speaking, the more experience and expertise of the person doing the work, the greater their value to the firm and its clients. That’s why senior-level people with highly refined expertise are better compensated and demand a higher hourly rate. Overall, salary and related expenses make up 50% or more of the billable rate.

Overhead includes tangible expenses such as rent, utilities, insurance, marketing expenses, non-billable travel and administrative and support services including HR, IT, finance and new business. Typical overhead rates for agencies are 115%-120% of salaries.

“I learned long ago that if the work is great, clients never pay too much. But if the work is mediocre, clients can never pay too little.”—Doug Spong

Finally, PR firms don’t work for nothing. They bake in a profit margin on top of the payroll and overhead expenses. Most PR firms expect to earn anywhere from 15% to 25% gross margin before taxes and incentives.

Doug Spong, APR, Fellow PRSA, is the CEO of The Doug Spong Co. LLC, which represents a select portfolio of PR, advertising, design and digital agencies as well as blue-chip clients. Previously, he was the founder, president and managing partner of Carmichael Lynch and Spong in Minneapolis for 25 years. Doug is a recipient of Gold Anvil Award, the highest individual honor awarded by the Public Relations Society of America for lifetime achievement.