The Ins and Outs of Contracts
Contracts between agencies and advertisers set the ground rules for a great relationship. Getting it right and respecting what’s been agreed allows everyone to focus on delivering great business results. Stephen Broderick explains.
In times gone by the contracts signed between agencies and advertisers were significantly shorter – sometimes they only took a couple of pages.
These contracts were also less relevant to the way people did business, $100m deals were happily done on a handshake and once signed the contract was filed away to gather dust.
That might have been acceptable when agency appointments were for life, but at a time when clients review their agency relationships more often than they replace their car, it’s no longer sensible.
Responsibility for abiding by the contract lies with both parties. It’s not just a case of the marketing director hauling his agency over the coals or regarding their agency with suspicion, it’s a case of both sides making sure they are constantly complying with the terms and conditions that have been mutually agreed.
So, what should be in the contract and what should be avoided?
The first thing that every contract should specify is an annual review. The media world changes so fast and the work that agencies are asked to do evolves on a daily basis. Digital, which now dominates media thinking, for example, is in a state of constant flux given the emergence of social media and mobile devices.
Similarly, trading practices change so factors that are now commonplace, such as volume rebates, were rare five years ago. A contract that doesn’t specify their return may entitle the agency to retain monies that would be returned to an advertiser with an updated contract.
The bottom line is that if a contract isn’t reviewed regularly then it will quickly become outdated.
Second, there should be the option to amend the contract to reflect any changes in the scope of work and fees.
In addition, where an agency is expanding the relationship to carry out work outside the remuneration agreement, the fees or commissions should also be documented and a basis for calculating additional fees detailed in the contract.
It’s not uncommon for an advertiser to have hired an agency for classical planning and buying but then slowly expand the relationship to include new communications channels, be it branded content or search. The cost of these additional services should be clear from day one.
Third, the agency’s remuneration and any bonus schemes should be clear and well documented. Many of the schemes designed to reward agency contributions to business success are inadequately drafted. The reward should be relatively simple to calculate and the contract should detail how it is measured and when it will be paid.
If using hourly rates, these rates should be included by person and the methodology behind their calculation documented (standard hours, overhead rate, margin). These schemes are far more effective when everyone knows what they stand to earn.
Keeping your eye on rebates
Fourth, the contract should set out how AVBs, rebates and discounts are to be treated. It should specify that these payments, even where they are made to group or associated companies of the agency, should be passed back to the advertiser. The contract should also explain the method of calculation (ideally pro-rata basis on client spend for each media owner).
The creation of group trading companies within agency groups has shifted the focus on rebates away from the media agency brands and visibility is essential.
Rebates have also increased significantly in recent years as the rise of digital has forced media owners to offer more benefits to the agencies either in terms of cash or free inventory. Failure to include clarity on this issue in the contract can be costly for clients.
Fifth, audit rights should be clearly stated within the contract. These should cover both the advertiser’s and the agency’s obligations, as well as the need for appropriate access to data.
Some agency contracts will try to specify a large and generalist accountancy firm carries out this process but such firms may not have the knowledge to track the money flows through the complex arrangements of today’s media landscape.
Advertisers need unlimited access to data for analysis of performance or competitor performance and for day to day planning and buying needs. Advisers, such as auditors, have the same rights and entitlements to this data as do their advertiser clients.
Sixth, the contract should specify how unbilled and unreconciled pass-through costs should be managed. This is something that needs to happen regularly, as otherwise the sums involved can build up significantly.
It is the obligation of the advertiser to insist that this review is carried out, but it’s also in the agency’s interest that it happens regularly as well. One client hadn’t requested a review for four years and when it was finally carried out, the agency had to return a sum in excess of seven-figures back to the client.
The penultimate point that all good contracts should include is a commitment to transparency. While this is a generic point, it’s important to ensure that both parties are signed up to this principle should any dispute over access to information arise later on.
Finally, there should be a clear management reporting timetable so that everyone knows when they are required to reveal and deliver fee reconciliations if required under the contract, production balances, unbilled media balances and AVBs.
We would suggest that this happens at least every six months, with AVBs repaid on an annual basis.
Make sure this isn’t included
If those are the good things to have in your contract, then there are also significant elements that you don’t want in there. Sometimes these can go unnoticed until it is too late and the contract has been signed. Our five key clauses to avoid are:
Any restrictions on the advertiser’s choice of auditor. As stated above, even an apparently innocuous limit such as a demand that you use only a large and generalist accountancy firm can leave you short on expertise in what is a complicated area.
Any restrictions that limit the information provided to just the agency buying/planning brand. In an era of group holding companies, it’s important to be able to follow the money wherever it leads within the agency group.
Data restrictions should not be permitted in any form. Agencies have been trying to limit the amount of information that advertisers and auditors can see around agency trading desks, in particular, but without such information it’s impossible to tell whether they are buying effectively, at a competitive price and how the advertiser’s data is being used.
More recently, we’ve heard reports that some agencies are asking media auditors to sign a separate NDA direct with the agency (and not just with the client). If not properly limited in scope, these documents risk severely limiting the auditor’s ability to carry out the audit effectively by restricting the information that can be shared with the client and the way in which the advertiser’s data can be used.
At negotiation stage an agency may seek to insert a clause into the advertiser contract which states that no audit can be carried out without such an NDA. Unfortunately, such moves can be overlooked by an advertiser that rightly wants to focus on the marketing challenges.
The final must-not-have clause is anything that allows agencies to generate revenue from media owners, whether via consulting or providing research data. As some agencies look for new ways to boost revenue, we have seen a number of examples recently in Europe that can be dubbed the “million dollar pencil”.