Why Paying A Percentage of Ad Spend Sets Everyone Up for Failure


Posted By on May 31, 2017 in Business, Industry Tuesday, Pricing

I have problems with paid acquisition agencies who charge a percentage of spend. It’s the PPC version of hourly pricing, where you’re paid for the number of hours that you work.

Here’s my problem with hourly pricing and thus billing a percentage of spend:

Incentives are misaligned and it rarely leads to a successful engagement on both sides.

Recently I was chatting with a friend in the industry who focuses on Facebook Ads and Google AdWords. This friend and I talk a lot about potential clients, struggles with pitching work, and especially pricing. They’re struggling to figure out their pricing levels and are testing out different fees for setups, management, bulk discounts (or lack thereof), and what percentage of spend might mean.

I have another friend who runs a small PPC agency who is constantly thinking about their pricing strategy. They have some clients on retainer, others on percentage of ad spend, and others on a combination of retainer plus lower percentage of spend. They’re still not sure which one to use.

Now, I don’t understand all the potential ways that different agencies and consultants price their work. I am constantly speaking with agencies who are trying new business models, sometimes performance based, sometimes retainer based. They play around with minimum project lengths, minimum retainers, levels of service they offer, and more.

It makes me think.

Paying an agency/consultant a percentage of spend, to me as a business owner, does not make sense 90% of the time. There is a time and a place and we’ll cover that at the end.

Let me explain.

Percentage of spend from the perspective of the business

If you’re a business owner looking to hire someone to run PPC for you, you may love the idea of paying someone based on the amount you spend and the number of hours that they work. Doesn’t that make sense?

Absolutely not. They might be bad at what they do. If anything above a retainer fee, you want to pay for the results that you get.

You might be thinking “but shouldn’t you get paid for the effort you put in?”

Absolutely not, is my answer.

Part of the business world culture is getting paid for showing up. People expect to continue getting paid and maybe even get a promotion (this reality of this one really escapes me) simply for showing up and doing some things. As long as numbers don’t go too far the wrong way, they’ll likely keep their jobs.

If you’re a business owner, why would you ever accept this from an agency much less an employee? Pay them simply for the number of hours they put in? What if they’re not actually any good and they just “do things” and get paid for it? Hopefully you’ll recognize this quickly, but if you’re not a PPC pro you may not until it’s too late.

I get it. It’s enticing to take the option where you think you’ll spend less to get the same results.

Your thinking goes like this:

“Well, we’re only spending $300. Great. That means I’ll only pay $XX to them plus the management fee”. If you can make $3000 from this $300 spend, then you’re thinking you got a great deal.

And you did.

But this is never where it stops.

Percentage of spend from the perspective of the agency

As noted at the top, agencies structure their pay structures all sorts of ways. But the most common that I see is a setup fee then a base retainer plus a percentage of spend.

From an agency perspective and without thinking about it too deep, percentage of spend is amazing! The thinking goes like this:

“If I’m spending $X,XXX of my client’s money and they’re making $XX,XXX, then why wouldn’t they increase their spend to $XX,XXX, make multiple $XX,XXX, and I’ll make more too!”

It’s attractive. It’s sexy. But it’s not reality.

There are two ways this plays out:

  1. Client starts off spending a decent amount and increases that spend because they are seeing a good return. But over time, that return becomes less so they get scared and dial back on the spend. You’re now making less money for the same amount of effort, simply because they got scared.
  2. Client starts off spending a small amount. You think you can convince them to spend more once they see a return. In reality, they’re happy with that return and you’re now stuck with a client who is never going to increase their spend. Oh, and they get frustrated that you’re trying to get them to increase their spend when they’re very happy with it.

Issues all over the place here.

To make sure I wasn’t crazy here, I spoke on the phone with Kirk Williams of Zato Marketing. I specifically asked him this question:

Why would a business not increase their spend if they are hitting profitability goals? Why turn it off for the rest of that month if they can make more?

He answered that there are two or three main reasons:

  1. They are part of a larger organization and it takes them time to get buy-in from higher in the company’s bureaucracy. The person interacting directly with the agency is often not the person controlling the budget and they do not have permission to increase spend.
  2. The company is happy reaching a certain level of profitability/revenue and does not need to exceed that as it may not make a material difference to their business (eg if they are publicly traded). They more care about consistent spend and returns than dramatically improving the bottom line.
  3. They are a small shop and increased spend means increased conversions that they might not be able to handle. This often occurs when there is limited stock of a product/service or the business owner is working too much and needs to hire someone to help out.

Incentives are misaligned with percentage of spend

Just like paying based on hours worked where the business is incentivized to get the most from the fewest hours and the agency/consultant is incentivized to work as many as possible.

Paying as a percentage of spend is the same way. As a business owner, you’re incentivized to maximize every dollar of your spend and to spend as little as possible. As a consultant/agency, you’re incentivized to get your clients to spend more even if it’s not what’s in their best interest.

No one wins when this power struggle exists.

There are some ways to structure your relationship that eliminates this dynamic, which we will explore below.

What should you pay for?

We’ve already covered how the incentives of paying a percentage of spend misalign everything. So what should you pay for?

A few things:

  1. Access to your consultant/agency’s expertise and keeping them from working with your competitors;
  2. The effort they expend to set up, manage, optimize, and maintain your accounts;
  3. The return they get for you.

Let’s look at each of these.

Access

First, part of what you pay for in a retainer is your consultant/agency’s expertise. You are paying for dedicated access to their brain and their help in solving your business’s problems. For some that’s going to be actually running campaigns/writing copy/building landing pages if you do not have the time. For others, a project will simply involve helping think through strategy and organizing their team to get things done.

At the base, you’re paying for access to them.

Effort

Second, for the work that they are doing for you. Spending your money is not doing work for you. Setting up campaigns, doing audits, and maintaining campaigns is real active work that should be compensated. Some agencies will do this as a flat fee, others include it in their retainer.

Time spent should be rewarded, but not on a worked/not worked basis.

Return

Finally, you should be paying for results. I’m not talking about a percentage of sales made, though some people will structure programs that way and it has worked for some of my friends.

The real payment for getting an agency getting a return for your business is continuing to retain their services. If you’re happy with their work, getting a good return, and they’re an integral part of your business then you keep paying them, they keep doing good work for you, and everyone is happy.

What is the way forward?

Pricing is one of the trickiest parts of running an agency or working with an agency. It is always some combination of:

Hours worked x hourly rate x expertise cost x some other factor

There is no one size fits all answer to how PPC agencies/consultants should price their work or how a business should compensate their PPC provider.

I always recommend a combination of:

  • Base retainer to cover basic time costs;
  • Add on setup fees for new campaigns, which really is compensating them for the hours worked to do the research and actually create the campaigns;
  • Ongoing maintenance fee with specific deliverables.

Is paying percentage of spend *always* wrong?

Contrary to the tone used sparingly above, I do not believe that it is always wrong to pay an agency/consultant a percentage of spend as their fee above a monthly retainer (which we’ve already covered sufficiently above).

However, before you get into this sort of relationship with an agency you need to have a few elements in place.

First, if you have any questions about if they will report to you enough and give you enough information to make a decision on if your investment is paying then you should not hire them in the first place. Any legitimate PPC agency or specialist will be transparent with you and let you have ownership of the accounts they are setting up and managing for you.

Second, you need to make sure all of the following are present:

  1. They will give you status reports at agreed upon times around spend vs profitability so you can make decisions with the data;
  2. They will never increase your spending in a month without your written approval;
  3. They may cover the downside by eating overspending if it happens, or they make it right the next month with a “discount”

Third, there are two types of PPC agencies:

  • Those who are consultative and high-touch, managing your accounts and being creative for you to increase your profitability (hopefully) wildly;
  • “Services” oriented agencies that simply try to get you in the door and are very low-touch. Most businesses should avoid these.

There are indeed times to pay hourly – for a specific task, for quick advice, etc – but these are few and far between. If you have the above three areas covered, I have no problem with you paying a percentage of spend. But if they are not in place, don’t take the risk in my opinion.


There are very few hard and fast answers in the consulting world and especially not with pricing. Pay close attention to what you are paying for, whether you and your agency/consultant are actually on the same page, and if your project has the right elements in place to make paying a percentage of spend a wise choice for you.

I welcome your thoughts and comments!