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SEM: Pricing Revolution

Compensation models for SEM firms are changing and must continue to change. Over the next two or three years many of the dinosaur agencies will fall because they cannot adapt. Changes must come in the pricing models and in the overall compensation amounts, and these changes will revolutionize the industry...for the better! PRICING MODELS: We've long argued that pricing models impact agency behavior. Let's take a look at the two most common models, and discuss a more rational approach to compensation. Revenue Sharing Contrary to popular belief, revenue sharing arrangements do not serve the advertiser's interests for a number of reasons.
  1. Too much money for too little work: In paid search, particularly for advertisers who spend a great deal of money in offline advertising, often the lion's share of the revenue tracked to paid search comes through navigational brand/trademark search. The first five minutes of work for that advertiser -- building the brand campaigns -- might get the agency 60 - 70% of their pay check. This creates great incentive to grab little more than the lowest hanging fruit and move on to the next client. We often see the evidence of this in data from rev-share rewarded agencies.
  2. Too many battles over tracking: Who's numbers prevail in cases of dispute, and how much time you want to spend arguing over the counts are salient issues, here. As multichannel attribution mechanisms evolve this will become a bigger and bigger problem.
  3. Agencies focus on the highest rev-share percentages: Like commissioned sales, and many partnership referral deals, whoever offers the biggest reward gets the attention. For agencies with clients who are competitors of each other, this can lead to favoritism or pressure to pay larger commissions that the advertiser neither can nor should afford.
  4. Lost control over marketing objectives: Advertisers go through periods of pushing for top line growth, vs bottom-line profits. Sometimes this is done to qualify for specific manufacturer incentives, sometimes to meet specific goals, whatever the reason: rev-share leaves the decisions regarding aggressiveness to the agency. Changing their compensation levels doesn't necessarily lead them to be more aggressive, they may decide just to enjoy the extra proceeds.
Markup on Advertising Spend This is a much better model. The agency has to work to spend money cost effectively. Brand ads spend very little, so the big rewards require doing the hard work of building and managing the competitive search program. But there are problems here too.
  1. Incentive to spend: The agency has incentive to spend, perhaps far beyond the point of diminishing marginal returns.
  2. Work doesn't scale with spend, necessarily: As a rule, advertisers who spend more demand more of their agencies. That makes sense. But there is a disconnect. Whether a Keyword generates 100 clicks in a week, or 1000, the agency doesn't necessarily have to do more work to manage it; certainly not 10 times as much. Similarly, whether the average CPC is $0.50 or $5.00, the work seems pretty much the same.
The origins of the markup model lie in traditional agency relationships. The idea being that a block-buster advertising campaign will end up producing huge rewards for the agency that came up with the brilliant concept. Successful campaigns have legs, produce spin-off ads, more advertising and reward creative genius. Mediocre campaigns don't get very far, don't spend much money and don't produce big rewards for the advertiser or their agency. Here's the thing: there's not that much creative genius involved in paid search. There is engineering and smart statistics, analytic excellence and execution...but paid search programs are primarily large or small because of market forces, not because of the agency. The cost of managing a hugely successful program is not exponentially larger than the cost of managing a modest program, and both require similar levels of expertise and advanced tools. Unlike traditional media, the basic size of the program (large, medium, small) isn't a reflection of the quality or quantity of a competent agency's work. {A well-managed program will, of course be larger than a poorly managed one, the point is that Amazon's program will be huge regardless of how well it's managed} Ad markup models are often adjusted to rationalize for these effects: by creating a tiered percentage structure, or, like us, creating a maximum fee cap. Neither of these mechanisms is ideal. PRICE RATIONALIZATION IS COMING: Ultimately, the agencies compensation must gravitate towards the cost of providing the service. An advertiser's fee should cover the cost of the analyst time, a share of the cost of the ongoing software development, and some markup over those to cover operating expenses and return on owner investment. Good agencies require and deserve to make a reasonable profit, but the days of agencies making $100K per month or more on large accounts are coming to an end. Google sees its primary avenue for growth in contextual advertising: be that display advertising, video advertising, rich media or text ads. Growth rates in search advertising have slowed precipitously and at this point are mostly tied to growth in the user base. However, Google sees some opportunity to grow search revenues centered around two facts:
  1. They see agency fees coming out of their pocket: if advertisers pay 10% of their advertising $ to an agency, that's money that could go to the media fees instead. Top agencies will rightly point out that advertisers spend more than they would without our services because we manage the programs to peak efficiency. Google would likely agree with this point, but rightly contends:
  2. Most agencies manage search poorly: Not only do they shave off a percentage of the advertiser's money for themselves, they also do a lousy job of managing search programs, such that the advertisers could spend much more within their efficiency requirements under proper management
  3. Small programs are underserved: The cost of managing paid search well is fairly high, and prohibitively so for small programs. Better self-management tools will allow small niche online advertisers, and more importantly, local brick and mortar businesses to advertise cost effectively without need for a ton of management expense.
Google intends to serve this third group, and to dis-intermediate poor agencies by providing increasingly powerful do-it-yourself tools. We maintain that no black box algorithm will ever do the job as well as a smart analyst with terrific tools and a keen interest in the success of their own account. That said, Google's tools will very likely run many weak agencies out of business, and as Google's tools improve agencies charging outrageous fees may find it harder and harder to justify their existence. For agencies that have grown fat collecting huge fees for mediocre work the day of reckoning is near. We say: Bring it on!
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