I received a letter from a friend in the agency business in California.
“The client asked to see copies of all vendor invoices coming into the agency with regard to their job projects,” she wrote. “The agency does not want to disclose vendor invoices, as markups vary.”
What’s an agency to do?
First of all, understand that in almost all cases clients rule the roost. We serve at their pleasure. It’s their money. If they demand to see the bills, agencies must ultimately comply.
I don't think this is a good idea, however; markups vary in today’s market. To make money in the advertising business, agencies must make more than the historically acceptable 17.65 percent markup on outside purchases. Our target is for agencies to make an overall 30 percent Adjusted Gross Income (AGI).
At one time, a traditional ad agency made about half of their billings in media and the rest in collateral work and other services; half of the agency’s billings were already only making 15 percent Agency Gross Income. That means agencies needed to achieve substantially more than 30 percent margin on the rest of their billings for their overall margin to reach 30 percent. Considering the fact that creative billings (art, design, copy, etc.) make 100 percent margin (payroll should be an overhead, or below gross margin expense, not a direct expense), markup/margin on outside purchases needs to be much higher than most clients will accept. If you told clients the agency was making a 40 percent markup on printing jobs, they would surely hit the roof. To further compound this markup/margin problem, on some smaller outside purchases, such as buying fonts for a specific client campaign, etc., agencies may be able to achieve markups of up to 100 percent or more.
This is one problem with having a detailed contract with a client. The amount agencies need to make on outside purchases is always more than the client will buy on a contract that states all agency charges and commissions line by line.
The only way I’ve ever seen to finesse this vendor invoice situation is to train your client from the beginning to accept estimates from the agency that consist of ONE BOTTOM-LINE NUMBER. Clients buy a finished product from the agency and can only question THAT price and not the individual outside costs. Agencies are not selling clients artwork, or copy, or printing or separations individually; they are selling clients services as they relate to a complete, delivered job. That combination of services and outside purchases makes up a unique, individual creation that the agency has the ability to assemble. See how our members handle invoicing.
The unique chemistry, proper mixing of in-house creative abilities, and outside vendor relationships that combine to make the client’s finished product is proprietary to the agency. For the client to see one segment of this uniqueness outside of the whole is not only unfair to the agency, but reveals part of their proprietary formula. Would the client ask the supplier of his manufacturing machine to detail the price of the steel? Would the client ever demand to see the markup on the paint used by the painter who paints his factory? Hell no! And, since most companies today sell products that consist, to a great extent, of outside-purchased component parts and services, would the client reveal their markups on those particular outside purchases to their customers? Everybody has the right to sell at a bottom-line price. So do ad agencies.
How did we let this situation get out of hand?
All of this peeking at vendor invoices only signals that clients think of agencies as vendors. No, strike that. Clients think of agencies as LESS than vendors! What they ask agencies to do, they would never think of asking vendors to do. Agencies must do their best to convince clients they are marketing partners, not vendors. If this can be done successfully, clients generally will not try to second-guess agencies’ every move. Agencies become trusted members of the client’s team. Their efforts count in the process of selling the client’s goods or services. Clients will be less likely to want to bargain item by item.
Today, some agencies are foregoing markups altogether. They bill their clients net for outside purchases and charge clients for the amount of hours it takes to supervise the job on press, etc. These hourly charges are in addition to the time billed for design, computer art, art direction, etc. This recoups some of the potential markup for outside purchases, but does not give the agency an up-side opportunity. Agencies simply work for wages.
Clients seem to like this, however. For some reason they do not feel badly about paying additional hourly rates, but do feel badly about agency commissions and markups. It’s all a matter of perception.
I will venture one more suggestion, with reservations: Agencies could have outside suppliers put the agency markup into the bill remitted to your agency (like a gross media bill). This way clients see the same number the agency is billing them. Simply discount the invoice when paying the supplier. What I don’t like about this is that the agency reveals the amount of their commission to the vendor. That information can be used against the agency in the right circumstances.
All in all, this is a sticky situation. Agencies cannot deny clients. Your best hope is to deal with the situation beforehand, at the front-end of the relationship. State your billing practice and hold fast. And try to move away from hourly pricing to a value-based pricing model.