Busting Ad Compensation And Liability Myths

It’s hard to identify any area of our business that hasn’t — or shouldn’t – have changed over the past few years. This is particularly true when it comes to the assumptions that guide our policies for extending credit to advertisers and their media buying agencies.

As Robin Szabo, president of Szabo Associates media collection professionals and a past member of MFM’s board of directors recently observed, the economic realities in recent years have compelled advertisers, agencies and media to rethink some of their traditional practices for compensation and payment liability.

One tangential benefit of this reevaluation, according to Szabo, has been to dispel old myths about how agencies operate. Eliminating these misperceptions can help media companies develop better compensation and credit liability practices that protect their own interests while fostering a win-win relationship with these valuable industry players.

Applying his knowledge of the credit and collections marketplace, Szabo identified seven commonly held beliefs about ad agencies that he says fly in the face of reality:

Myth No. 1: All advertising agencies that purchase media have adopted the “Sequential Liability” position.

Szabo reminds us it was in 1991, 20 years ago, that the American Association of Advertising Agencies (4A’s) recommended to its members that they adopt a Sequential Liability position. As defined by the 4A’s, the policy states that the agency shall be solely liable for payment of all media invoices if the agency has been paid for those invoices by the advertiser; prior to payment to the agency, the advertiser shall be solely liable.

While many 4A’s members, particularly larger agencies, have adopted the Sequential Liability position, Szabo reports that there actually are more than 15,000 U.S. advertising agencies routinely purchasing media that have not done so. In many instances, these agencies have accepted the media providers’ terms and conditions. Often these include a Joint and Several Liability position, which holds all parties — the advertiser, agency, and buying service (if applicable) — liable until media receives payment. This is the policy currently endorsed by MFM and its BCCA subsidiary.

Myth No. 2: Advertising agencies need more time than direct accounts to pay for media purchases.

As Szabo points out, agencies typically bill their clients on estimate — either on credit with 30-day terms or cash-in-advance — at the time the media order is placed. Most agency invoices should have been paid by the time the agency receives media invoices.

Myth No. 3: An advertising agency’s sole compensation is the standard 15% agency commission, received when the agency purchases media.

There was a time when media commissions were the predominant method of agency compensation. According to Szabo, this method was based on the idea that the agency, as a result of its efforts on behalf of the advertiser, would profit as the advertiser’s business grew. The reverse would also be true, with agency revenues stagnating or dropping if the advertiser’s business failed to grow and media budgets shrank.

However, as media costs began to soar in the late 1980s, particularly for television, advertisers that were paying huge commissions to their agencies began to revisit their agency compensation arrangements. In addition, many national agencies had become parts of publicly traded holding companies, making it more important to deliver on predictable revenues.

Given this, there has been a shift toward alternative compensation models. Szabo says these include a fee-based model, which takes into consideration such activities as hourly rates, project fees or monthly retainers; “value-based compensation,” which links the agency’s compensation entirely to the value it provides the advertiser; and a “performance incentives” model, which usually adds an incentive bonus to a fee-based or commission-based structure.

A 2010 survey of major marketers by the Association of National Advertisers illustrated how these newer approaches have eroded the agency’s reliance on media commissions. Traditional commissions now account for only 3% of compensation plans.

Myth No. 4: Since the advertising agency checks the creditworthiness of the advertiser, the media provider doesn’t need to.

“Determining the advertiser’s creditworthiness can save you a lot of grief if nonpayment occurs,” Sabo advises. Unlike in the situation of a Joint and Several liability position, where media companies can pursue any and all parties involved until the invoice is paid, the Sequential Liability position means the agency isn’t obligated to pay for the media buy if it hasn’t been paid by the advertiser. In this scenario, Szabo warns, the chances of getting payment directly from the advertiser are severely diminished if the advertiser has gone bankrupt or is facing deep financial distress.

Under a Joint and Several Liability position however, if the agency goes out of business, the station may still be able to seek payment from the advertiser, even when the agency had received payment from the advertiser, since the advertiser received a benefit from the media buy. In any case he recommends (and so do I), the additional protections afforded by evaluating the creditworthiness of both the agency and advertiser are well worth the extra effort.

Myth No. 5: Advertising agencies have a fiduciary responsibility to pay media providers when they are paid by the advertiser.

The legal definition of a fiduciary is “one often in a position of authority who obligates himself or herself to act on behalf of another and assumes a duty to act in good faith and with care, candor and loyalty in fulfilling the obligation.” An advertising agency is not a fiduciary. In simple terms, the advertiser generally does not entrust funds to the agency to pay media on its behalf, Szabo explains.

“Agencies treat media money received by the advertiser as ‘general’ commingled funds, not as segregated funds held in trust for the media provider,” Szabo notes. “Agencies can do whatever they wish with the funds they receive from advertisers. They can also pledge as collateral any accounts receivable that are due them,” he added.

Myth No. 6: Ad agencies provide advertisers with detailed billing, which includes the names of the media companies from which space/time was purchased and the individual amounts due each.

In reality, most billing to advertisers is not detailed and may only reference a particular campaign and month. Szabo says this practice makes it very difficult to look at an invoice received by the advertiser and determine which (if any) part of the agency invoice covers charges from a particular media provider.

The agency’s invoice may include amounts due to any number of unnamed media providers. Agency invoices may also make it difficult to determine the amount that an advertiser paid to the agency for a specific buy, which becomes critical information if an agency has gone out of business and the station is trying to collect from the advertiser.

Myth No. 7: Advertising agencies are “agents for a disclosed principal.”

To further protect its agency members, Szabo says, the 4A’s suggests that client agreements include a clause that states “for media and production purposes, the agency is functioning as an agent for a disclosed principal.” He points out that, “By law, a person or entity acting as an agent for a disclosed principal is not liable for the contract debt of the disclosed principal.” While this may sound very legal and correct, saying it doesn’t necessarily make it so. An agent for a disclosed principal must have proper, documented authority which means without it, any advertising agency cannot bind its client, the advertiser, to any agreement.

This last point also relates to an issue that has always concerned me about Sequential Liability agreements. I must say that I am not a lawyer, nor am I privy to the terms of agreements between advertisers and their agencies. Still, I have wondered how an advertiser can be bound to an agreement that he or she never signed.

This is a question I raised recently when we were talking to the Interactive Advertising Bureau (IAB). The IAB has been collaborating with the 4A’s to develop standard terms and conditions for Internet advertising that advocates a Sequential Liability position. At MFM we are also looking for a way to bridge the liability position gap, a way that addresses both the ad agencies’ and the media providers’ concerns.

In addition to this “myth-busting,” Szabo outlines a number of suggestions for ways that media businesses can use this information to improve their practices in dealing with agencies. These tips and the full text of Szabo’s “seven myths” appear in an article in the March-April issue of MFM’s The Financial Manager (TFM) magazine, which features a special report on Credit & Collections. The issue is currently available to non-members via MFM’s website as part of our broader mission of advancing financial management practices throughout in the industry.

Improving the industry’s credit and collections practices will also be a major area of discussion at Media Finance Focus 2011, the 51^st annual MFM/BCCA conference. Themed “Empowering Growth, Inspiring Progress,” Media Finance Focus 2011 will be held May 15-17 at The Westin Peachtree Plaza in Atlanta. It is the only event in the media industry that’s fully devoted to financial decision-makers from media and communications companies nationwide.

The annual MFM/BCCA conference is also when we recognize members of the association and other industry leaders who have helped to advance exemplary financial management practices in our industry. In fact, one this year’s honorees is Robin Szabo, who will receive our Rainmaker Award, which is presented to MFM members whose efforts and contributions have helped the association grow.

In addition to his submissions to TFM such as his “Seven Myths” article, Robin’s numerous contributions to the Association include serving on the TFM Editorial Advisory Committee and the association’s IT/Emerging Media and Membership Services Committees. Szabo Associates consistently ranks as one of the top supporters of the MFM/BCCA annual conference, our regional seminars and is a regular advertiser in TFM magazine. Thanks to members like Robin Szabo, I have no doubt that MFM will be empowering growth and inspiring progress in everything we do for years to come.

Mary M. Collins is president & CEO of the Media Financial Management Association and its BCCA subsidiary. Her column appears in TVNewsCheck every other week.You can read her earlier columns here.