visibilitymagazine-winter10

Pros and Cons of Pay For Performance in Search Marketing

by Rob Laporte
Visibility Magazine – Winter 2010
(original article reprinted below)

Pay for performance (PFP) in search marketing maximizes profits for both clients and agencies or freelancers, but poses complexities in contracts, tracking, and risk management. These complexities add time to negotiations and contract writing, which adds to the need for PFP deals to span at least a year. This article reveals pros and cons of PFP, and provides three case histories.

This Great Recession is likely causing an increase in PFP contracts in search marketing. However, the advantages to both clients and agencies probably would have inspired an increase in PFP deals if there were no recession.

Wikipedia defines PFP as a “business model used in online advertising whereby an ad agency charges a marketer for the results achieved by the ad campaign.” There exist many forms of PFP, primarily pay for SEO positions, pay for traffic, and pay based on revenue or profit. Of course PFP can be used in all marketing; this article focuses on search marketing.

Regarding PFP’s maximizing of returns for both client and agency, my winter 2009 Visibility Magazine article, “The 80-20 Rule in SEO, CRO, and Social Media,” stated:

“deep analysis often shows that, while a modest 20% investment is certainly worthwhile, one would make much more profit, even if less marginal returns, by investing more like 60%. Yet many marketing managers are reluctant to spend even the 20%, especially in this economy. This situation creates enticing opportunities for agencies to do what smart capitalists have always done during depressions or “great” recessions: take more ownership of businesses, in this case by deals that claim a few years of results in exchange for non-paid work up-front. This helps the clients too, by reducing their risk and up-front cost and by aligning incentives, though at the cost of probably paying more in the end.” (see full article).

Below I list salient advantages and disadvantages of PFP for both client and agency. Each of the five lists generally descends from most to least obvious.

Advantages for the Client:

  • Little or no up-front payment.
  • Pay only for positions, clicks, or a viable percent of revenue or profit.
  • The agency has 100% incentive to do only what promises best results fastest.
  • Not locked into rigid deliverables or labor time agreements; agency is freed to rapidly change work according to the changing marketing situation or the problems and opportunities discovered during work.
  • The client consumes less resources managing search marketing vendors, employees, and proposals, allowing focus on the core business of product development and customer service.

Advantages for the Agency or Freelancer:

  • Probably higher income over the duration of the contract if reasonable success is achieved.
  • Monthly revenue stream, as later months’ payouts compensate for the initial large commitment of hours.
  • Agency employees experience higher motivation to excel, especially if the agency has performance-based bonuses or profit-sharing for its employees.
  • The agency has incentive to learn and implement tactics that are promising but hard to sell to clients, thus perfecting service offerings for all clients.

Disadvantages for Both Client and Agency

  • Establishing and using payout benchmarks and tracking methods usually takes much more time than in typical pay per service contracts.
  • Resolving click or conversion attribution can be difficult and lead to unforeseen conflicts. What if the client implements a TV or print ad campaign that increases SEO or PPC clicks and/or conversions? If the PFP deal is for new, additional SEO clicks, should one factor web-wide search trends? And what about seasonal trends? There are legion tracking and attribution issues like these, and while most have contractual solutions, no solutions are perfect, and all take time to articulate and agree on.
  • Therefore, contracts tend to be complicated and should span at least one year, preferably two to five years, thus requiring more legal work than in pay per service deals.

Disadvantages for the Client

  • If the agency is reasonably successful, the client pays more in the end than under pay per service contracts (assuming that the agency balanced risks and rewards competently in the contract).
  • If the agency performs poorly, disengaging from the contract to find better results elsewhere is usually more difficult than in pay per service contracts.
  • The relatively long duration of PFP contracts means that if the agency performs poorly, sure, the client doesn’t pay much, but potential successes are delayed. Under a pay per service contract, the client can start small, evaluate the agency, and replace it with a better agency relatively quickly if needed.
  • In revenue- or profit-sharing deals involving diverse web marketing activities, proprietary profit data and marketing plans are shared with the agency more than in pay per service deals, and the agency could later work for your competition if the contract is terminated or expires without renewal.

Disadvantages for the Agency or Freelancer

  • The agency depends on the financial health of the client. Often much of the work is done in the first months, especially in SEO, and what if the client goes under during later months?
  • If not managing the website, the agency can incur losses due to the client’s website changes damaging PPC conversions or SEO positions and conversions.
  • In revenue or profit sharing, the agency is subject to the client’s product/service quality, closing on leads, customer service, and product availability. What if poor product quality or weak customer service engenders bad reviews that depress clicks and conversions? What if the supply chain and order fulfillment are clogged by shipping problems from China or by natural disaster?
  • There exist possible legal liabilities if revenue of profit sharing entails or implies partial ownership of the client’s business.

THREE PFP CASE HISTORIES

Two Small, Simple PFP Deals

In 2001, I made two five-year PFP deals, using simple one-page (!) contracts. My firm had worked with each client since 1998, and we had great mutual trust. In one of the cases, we didn’t even sign the contract, but merely shook hands. I don’t recommend such informality, but in this case the client was a former cold-warrior CIA black-ops guy and libertarian, and I knew his handshake and word were good as gold. In both cases, my firm got 10% of revenue and managed the sites and marketing. Site maintenance beyond four hours in a month was billable. In one case, we got 10% on ecommerce orders but not phoned and faxed orders, and in the other case, we got 10% for all orders, including wholesale not transacted through the website. The clients paid PPC click costs, and trusted my firm not to raise click costs to produce many orders at a loss to the client, while we trusted one client to report non-website orders. Both of these contracts expired four years ago, but we continue the deals because they work well. Once or twice per year, my firm reports time spent vs. payouts, so that everyone knows the deal remains fair. When my firm has downtime between big jobs or when waiting for other clients’ feedback, we work on these two clients.

A Large, Complex Profit-Sharing Deal

On the opposite extreme from those simple PFP deals, my firm made a three-year profit-sharing deal where we do all web marketing, amounting to what in a typical pay per service contract would come to about 170G in year one, with most of that done in the first six months. My firm will have worked on virtually every aspect of web marketing, including site redesign and rebuild, SEO, PPC, conversion lift, social media, reputation management, affiliate marketing, selection of specialized vendors where needed (e.g. affiliate network and parts of link marketing), and much more. The negotiations required many hours, detailed spreadsheets, and precise contract language. Monthly payments at half our hourly rates counted towards future revenue share payouts.

To illustrate this PFP model, below I simplify two spreadsheets among the several used.

Monthly Non-PPC Revenue Share

 

Non-PPC Orders, Shown by Google Analytics for The Month

$20 per Order up to 169, Paid to DISC

Above 169 at $30, Paid to DISC

Total Owed DISC

April

296

$3,380

$3,810

$7,190

May

318

$3,380

$4,470

$7,850

All months and totals in spreadsheet

 

Monthly PPC Profit Share

 

PPC Orders Shown by Google Analytics for the Month

X 95% to Account for Bad Orders, Then X 85% to Account for Returns. (DISC’s work will reduce returns, so this figure may change in the future.)

Multiplied By Percentage that $90 (Gross Profit) is of Total average Order of $120.80 (74.5%), for Total Gross Profit

Total Month’s Click Charges

Total Gross Profit Minus Month’s Click Charges, Which is Monthly Net Profit

50% of Monthly Net Profit Owed to DISC

April

$61,314

$49,511

$36885

$17478

$19,407

$9,704

May

$63,000

$50,873

$37900

$20229

$17,671

$8,836

All months and totals in spreadsheet

The client experienced inadequate work and consequent losses under three previous SEM firms that sported apparently excellent credentials, so the client was reluctant to try another firm. The client agreed to PFP with my firm, and quickly began winning again. DISC has made less than our hourly rate so far, but our monthly labor will decline, we have two years to go, and we have plenty more ways to increase mutual profit.

As you can see, PFP is more complicated than typical pay per service deals, but when structured intelligently between healthy firms, everyone wins. Expect PFP models and supporting tools to continue to improve. A fertile entrepreneurial imagination can invent PFP that maximizes mutual profits for any kind of business.